Though if they want to do it, fine. I wouldn't mind MS shooting themselves in the foot.
You know, we've all gotten so used to the idea of Nintendo always doing something each and every generation which fucks things up for them, whether that be sticking with cartridges on the N64, or forsaking online with the GC, and so on. But now with the Wii U its really hard to pinpoint anything Nintendo is doing wrong. So could it be that Nintendo has shaped up and gotten their act together, and passed the blunder torch on to Microsoft? Is it now Microsoft's turn to fumble their way through a few generations of terrible design decisions with their consoles?
Making the console download only does have some appeal for developers/publishers, but a lot of consumers are against it, and retailers are definitely against it because they can't make any money if there are no tangible games for them to sell. Sure, they can sell the systems and the accessories, and some redeemable cards, but if they lose all the games of that system its a serious loss of revenue and I think retailers would revolt over that, and probably refuse to sell the Xbox420 hardware at all since they can't also sell the games with it.
Without retailer support, the system would end up like a Neo Geo or Atar Jaguar or something like that. It would be this weird console you read about in gaming magazines, but you never see it on store shelves, and none of your friends own it. The only way to get it would be to order it directly from Microsoft or the small number of retailers Microsoft manages to get on board.