To answer that last point, Nintendo won't do that because they can't really do it. The majority of people who play those games do so because they're available on a device they already own for other, unrelated reasons. Nintendo has made it very clear that they don't want to make games for other companies' hardware, and Nintendo's not going to design and release a multi-purpose smartphone/tablet type of device. Nintendo makes dedicated game systems, and that type of hardware sells primarily to gamers.
True, but that was why I tried to emphasize that Nintendo would try to emulate the model if they thought it'd work. By model, I mean releasing hundreds of small, super-cheap games made by miniscule teams in brief amounts of development time. Right now Nintendo is essentially hostile to that very idea; even their DSiWare service, which I believe was developed specifically to counter the app store, generally features higher prices and, worst yet, it only sees three to five new releases on a once-per-week basis. Considering how their current process requires more time and energy on their part, I have to believe that Iwata honestly thinks that the app-store model of gaming is unsustainable.
And yes, Nintendo is primarily targeting gamers. But as the last seven years and countless powerpoint snoozefests have shown, Nintendo's staked its future on creating gamers out of new people. They centered an entire E3 on a bathroom scale! And they've invested literally millions of dollars into market research to figure out what is creating new gamers and what is not. If it were true that the app store is making new, profitable gamers, I have zero doubt that Nintendo would be going all out to get on the gravy train.
The iPhone and similar devices may steal away some of the "casual" gamers Nintendo brought in with the DS, and that may be why Nintendo seems to be trying to appeal more to "hardcore" gamers with the 3DS.
This requires us to think that Nintendo is willing to surrender without a fight the very audience it spent half a decade trying to acquire, and that it's new strategy is to focus on the same group who by and large abandoned it a decade ago and who it antagonized in its attempt to reach the expanded audience to begin with. Nintendo's repeatedly made a point of saying that it does not think gaming is sustainable without a steady influx of new customers, i.e. without going far beyond the hardcore. I can't believe Iwata would be willing to pursue that business strategy. This is the same man who was willing to go super-casual in E3 2008 to combat the rumors that Microsoft and Sony were about to introduce motion controls to their systems. If he thought that the "casuals" who made the DS the best-selling system of all time were being leeched away by an alternative profitable business model, he wouldn't just throw the white flag up and surrender.
I would also submit that there are millions of people who would never and will never be interested in a video game that is meant to be played for hours at a time. Those people are part of the "blue ocean" being reached by these cheap/free smart phone games.
This is certainly true, but Nintendo has been making a concerted effort to reach those people as well. "Pick up and play" has seen somewhat more emphasis recently, and I submit that's due in large part to Nintendo pushing it. Nintendo's charts are certainly fond of fellating themselves over how awesome Nintendo's been at creating new gamers; can anything but the short-burst games really be responsible for that?
You may be right that the loss of developers is a bigger concern than the loss of consumers. But if the flow of games dries up, so will the gamers. And with ever-increasing amounts of talent and resources flowing to mobile gaming, there's obviously fewer and fewer of each going into other types of gaming. That wouldn't necessarily be bad for gaming, since it would just mean shifting resources from one area to another, but if mobile gaming isn't generally profitable for the developers, it follows that this shift is actually a loss for gaming, and that non-mobile gaming will suffer fewere games, and thus fewer consumers, for as long as this loss lasts. It's not an irreversible process, of course, but momentum is important in businesses, and if things take a while to correct themselves, it will take some time for gaming to claw back to its original position.