The issue is that people apparently see iPhone games for $1 and think "oh, games are cheap, why would I spend $40 on a Nintendo game then?"
I don't think that really happens though, just that marketroids and executives, who are scared of the quality of their own product, think it does. I see plenty of iPhone games for $1 that I like, and plenty of games for free that I like too. But I'll happily shell out $40 for a game that gives me 40 more entertainment than an iPhone game, which thankfully most console or PC games do. Purely anecdotal of course, but most other games I know feel the same way.
Compare the occasional 15 minutes of diversion you get from Angry Birds, for $1, with the (just to pull a random example) 60 hours minimum you get from a run through of Fallout: New Vegas (with enough left over for a few more run-throughs) at $50, and I don't think the competition is in anyway unfair or that the price difference is out of whack.
The only legitimate I could see for a big game studio feeling threatened by $1 games was if they knew all along they weren't delivering $40 of value with their $40 games. And if that's the case it's hard to have much sympathy for them.