Um, mostly right but with one glaring error. They didn't 'send' books to bookstores, bookstores bought books. With that correction, that's exactly how things still work today.
Bookstores buy books on a sale-or-return basis. If they don't manage to sell them, they tear off the covers and ship them back to the publisher for a full refund and destroy the rest. And the books that they buy are often the ones that the publisher has spent some money promoting.
No, it's not "now feasible and affordable to do much smaller print runs" - because that means editing and marketing and other overhead must now be spread across a much smaller number of books.
Yes it is. I've talked with some publishers that specialise in exactly this. Some of the big publishers now outsource all of their copyediting to freelancers (some are bringing it back in-house, it oscillates a bit), but for small publishers it's very easy to hire a freelancer to copyedit a book and so they're not splitting copyediting staff, they're just spreading investment, and the copyediting on a book can cost under $1000 (it's a pretty crappy market for freelancers at the moment), so it's relatively easy to scatter money across a hundred titles and hope one does really well and the rest come close to breaking even.
Marketing, you might have, but marketing costs for small print runs are pretty small. Publishers scatter a few free copies to amateur reviewers and get some blog posts, put them on their web sites, and push them in the direction of book clubs. If they sell a couple of thousand copies, they've made a profit.
Bookstores have very little incentive to stock J. Random Nobody without a reasonable expectation that he will sell
Except for differentiation: no one wants to go into a book shop that just stocks the A-list books that they can get anywhere (and much cheaper on Amazon) and which the more active readers (i.e. their best customers) will have read already. People want to go to a book shop to find a book that they've not read before, and that means having a broad selection of things.