Imagine if Apple in 2001 had released the iPod, but it didn't play mp3 files (that everyone had at the time). Instead, it played only protected AAC files. The iPod most likely would have been a failure.
Different time, and probably a different market.
The mp3 scene of the late 90s was driven by geeks. The iPod gave them, if not exactly a new way to enjoy those songs on the go, at the least a slicker and more stylish way to do so.
As people seem to go to great pains to point out, the ATV doesn't do anything that an XBox, or PS3 can't do, and certainly nothing that a small form factor PC/Mac can't do. Geeks aren't going to be the target market here. Consequently Apple need to build a market with with the kinds of people who would never even consider a PS3 or an XBox.
Personally I have no need of an XBox, or a PS3, and even with the price drops, the units look ugly, and don't have a user interface that my wife could be bothered with. The AppleTV is a valid choice then for me. For my parents, if they even considered a streaming device at all, which is really Apple's major problem, the ATV is the best choice on the market (by a very narrow margin) for them.
I think there are a few too many 18-24 year olds here who need to try looking beyond their own needs.
Apple can make a success of the ATV, and if they get rolled, it isn't going to be because of the PS3, it'll be because Netflix or Amazon put something far more compelling out there, or TiVo regains some serious share. These are the brands that most consumers recognize, and understand. This is where Apple needs to be playing.