I may be being simplistic, but isn't most of the hardware required in phones and MP3 player these days? If you could have a bluetooth earpiece connected to a pocketsized device that does the processing for you most of the miniaturization issues are solved. It may be a step back from an all-in-one device, but most people have pockets full of gadgets these days anyway. So imagine a lapel mike, an iPod nano sized processor and a wireless earpiece - now it's a software problem. (Any programmers on Slashdot these days?)
Even if the software needed a professional set-up to calibrate for the individual surely this would drive the price down.
And think of the PR - all those people claiming MP3 players make you deaf - what if you made one that helped the deaf to hear?
Please, no jokes about the iEar or Google Cyborg.