I think another instructive analogy is the SACD versus DVD-Audio war. Sure, it's audio, not video, but in other respects it seems more apropo. A next generation format war to replace the CD. Cons: New players required; expensive players; expensive discs. Pros: Slightly better audio quality.
Ironically, the successor to the CD has turned out to be the mp3...slightly (or imperceptibly, depending on who you ask) WORSE quality, but greatly improved convenience.
I've got a pretty substantial DVD collection, a Blu-Ray player (which also can play games, when the occasional good one comes out), and a nice HT setup (Sony 1080p projector, 96" screen, 8 good quality speakers, etc.). Even on this setup, I'm quite happy with DVD quality video and audio.
So, is Blu-Ray perceptibly better? Video, yes, but not to nearly the same degree as DVD to VHS, and only if you've really got a sufficiently large display. Audio...not really, perhaps discernable in ABX testing, but not for real world use.
I typically buy Blu-Ray for big budget, audiovisual-feast-oriented new movies, but I wait and look for good deals, and really haven't found myself buying many. I still buy DVDs for everything else, because the difference in quality just isn't worth a significant premium. And I know far down the snob-spectrum from the typical user.
If Sony wants Blu-Ray to catch on, they're just going to have to view it as a "keeping pace to make piracy harder" play, not a "let's extract MORE money from the consumer" play, and get player prices to the sub-$100 range, and the disc premiums to only a couple dollars or less. Staying in the top 1% to 5% of the market just isn't a good survival plan for format.