The ever-improving slate of top-notch games available as “games on demand” for the Xbox 360, as well as rumors that Sony may offer downloadable PlayStation 2 and Sega Dreamcast titles on the PS3, make it a great time to look at the state of downloadable offerings on this generation’s game consoles.

When the Xbox 360 launched with Xbox Live Arcade featured prominently on the dashboard, it was pretty clear where downloadable console games were headed. Unlike the clumsy offering on the Xbox, Microsoft’s revamp was integrated directly into the 360’s operating system and required no disc to run. What’s more, the console’s always-online nature made it much easier to make impulse sales.

It wasn’t much of a surprise when the PS3 launched with a similar service, or when Nintendo saw the potential for exploiting the nostalgia for its enviable library of classic titles with the Virtual Console. When Nintendo expanded into the realm of selling brand new games via WiiWare, it seemed like an official declaration that the future of console gaming is going to look a lot like the future of PC gaming: dominated by downloads.

But we’re not there yet, with a number of factors preventing downloadable console games from gaining traction.
On the Wii, the problem is one of hardware and integration. Unlike the PS3 and 360, the Wii has no hard drive, relying on a small amount of internal flash memory and cards similar to those you might use in a digital camera. It’s not feasible for most folks to download more than a handful of games.

What’s more, the Virtual Console and WiiWare require you to download “channels” that enable the services. They’re not directly integrated into the Wii’s operating system. In other words, some Wii gamers may not even be aware these online stores exist.

The Xbox 360 runs into trouble on the issues of hard drive size and price. The biggest hard drive you can buy is 120 gigabytes. That sounds like a lot of space, but all the downloadable games, add-ons and video content for sale on Xbox Live, plus whatever disc-based games you rip to your hard drive, fill it up fast. And with Microsoft charging a ridiculous $160 for its biggest drive, that problem’s not likely to go away soon. Seriously, guys, charging an arm and a leg for a rinky-dink hard drive is killing your sales of downloads. How about bundling something much bigger with some points that allow the hard-drive buyer to sample what you’re selling?

Even when folks do sample Microsoft’s wares, they may come away cold. For the most part, the $5 to $15 Xbox Live Arcade games are reasonably priced, and Microsoft has shown plenty of willingness to put these titles on sale. But the Games on Demand service, which offers downloadable versions of retail games at retail prices, is a real head-scratcher, despite a library of games that includes hits like “Grand Theft Auto IV” and “Mass Effect.” Anyone willing to hunt for deals can get physical copies of the games, which come with a manual, shiny disc and the ability to resell them or give them to friends, for less money.

Of all three consoles, Sony is probably in the best position to offer retail games as downloads. For one, the PS3’s 160 GB hard drive can be swapped out for any old commercial hard drive you can buy for cheap. Secondly, provided they can get their software emulation working at a high level, Sony has the entire PS2 game library to tap into. (Original PlayStation games already run on the console just fine.)

But Sony will still have to deal with the pricing issue, perhaps the biggest obstacle to reasonably priced, downloadable versions of full-fledged retail titles. The problem is best summed up thusly: If Microsoft or Sony starts selling downloads for cheaper than retail, they undercut the big box and online retailers responsible for the bulk of their consoles and accessories. While you might not see the PS3 disappear from stores if “Uncharted 2: Among Thieves” goes on sale this week as a $40 download, $20 cheaper than retail, you might see it displayed in a less prominent position in the store.

Until a solution to this dilemma can be hammered out, the best downloadable gaming deals will continue to be exclusive downloadable titles like those sold via Xbox Live Arcade, WiiWare and the PlayStation Store.