The problem is that it is smaller at the expense of significant features.
The 3000, which will be sitting next to it on shelves, can do everything that the Go! can do, but ALSO gives you the option to play UMD games or movies. It still has the same exact downloadable game functionality that the Go! does, and all the same controls.
Sony is asking customers to pay more money in order to get a device that can do less. It's simply not a good idea.
It is also simply too early to lock out physical media; in 2008 33% of music sales were digital, which is a growing trend, but that also means that
two thirds of music purchasers STILL insist on buying physical media, despite the fact that digital media is generally cheaper, and allows for more flexibility in purchase choices (buy individual tracks instead of full albums.)
These are two benefits which DON'T exist for digital games, at least not for Sony's. Sony has historically offered their downloadable games which are also stil in print physically at the exact same price as their physical counterparts (Warhawk, GT5

, Burnout Paradise) Yes, they have discounted a few out of print PSP games which they've released over PSN, but they've also jacked the price UP on some of those games (Loco Roco costs $23 on PSN, despite the fact that not only was it a Greatest Hits title, but it also originally LAUNCHED at $19.99.)
And there simply is no analog to buying individual song tracks in video games. The closest would be buying individual game levels, but because of the way that games are structured, as opposed to music albums, that simply wouldn't make much sense. There ARE some games which are simply shorter, shallower, and cheaper than so called "full" releases, but these are more comparable to CD-Singles than to individual music tracks. The reason that so few of these exist in pysical media is because of the game industry's irrational fear of releasing cheap games.
The time simply isn't right for Digital-only, and even if it was, the way to go about it is to bring somehting new to the table, not to take a device that is already out there, and just strip it down.