Yeah, posting 2 threads at a time gives a bad impression on me, but looking at blogs of game designers is so much fun.
Steve Perlman, founder of OnLive, made a somawhat shocking post of how customers actually wasted their money:
http://www.stevestreeting.com/2010/02/26/50-of-what-you-pay-for-a-game-is-wasted/
I uploaded the graphic here.

...so spend your money with us, OnLive, instead! That way we'll get that fifty percent.

Building an infrastructure for (and maintaining) something like OnLive is a waste of money if you ask me.

Platform royalities? 60$? Why are you bothiring with console games?

I'm not, I stopped bothering.

That graphic and article are very shallow analysis of things. The price of games depends on an economy of scale, where the number of copies sold has to support the development cost of the game. If physical distribution increases sales of a game, it contributes to that economy of scale. Also, having something sitting on the shelf at a retail store is a form of advertising. The only way physical distribution is bad from a price perspective is if it doesn't pay for itself in profits, or if all of the same customers would buy online. Neither of those points is likely to be true.

I can't quite understand why OnLive are using a console game breakdown to promote a PC game service. For one thing there are no royalties and in most countries no returns on PC games.

I understand this notion, but it's like saying that we'd all be better off sucking milk directly from a cow's teet.
We don't all have access to cows. There are still plenty of homes out there running older computers, lower speed internet, or simply don't understand online mediums yet. It's still relatively new stuff (remember Oblivion was really the first DLC anyone ever saw on a console of any note). Yeah, those of us here may be more savvy about it, but there are way more gamers than the hard core.
Hell, more families probably own a Wii right now than a computer that will be capable of running the upcoming Civ V. Those things are a chore to use online--and don't have a lot of space for it in the first place. Even the suddenly download friendly XBox 360 started out with such a small hard drive that people wouldn't have been able to install FFXIII on the original hard drive.
This new world is not one that's ready to abandon the physical all together even if some of us would transition into that world easily. For that matter, keep in mind that some of us are multi-platform users and I, for one, am not in the mood to download an entire loaded Blu Ray worth of content onto my PS3 hard drive, nor do I want to download two discs worth of Mass Effect 2 to m 360 just to play it.
It's sometimes distracting enough to rip stuff from the disc before I play. I don't want to also have to consider which 20gig title I should delete just to try a new demo or install another game--especially if each install requires that I download it again.
Besides, some of us enjoy physical copies of our games (even TellTale Games understands this by offering fans DVD copies of their digitally distributed titles).
For that matter, I like knowing that if a company suddenly goes belly up (such as Steam, GoG, TellTale) that I'll have a physical copy of the game I want to play even if the distribution hub is gone.
It also doesn't take into consideration people like me, who have the Blockbuster Gamepass, and enjoy being able to rent games. I save tons of money renting 8 hour titles like Star Wars: Force Unleashed rather than paying for a shallow experience. If we didn't have physical copies then I imagine we'd see a market that completely excludes certain titles.
Why? Because I'm not likely to buy a risky new game (such as Batman: Arkham Asylum) over an entrenched series like GTA or Final Fantasy. By renting Batman I was able to figure out pretty quickly that this wasn't the traditional mess of a Batman title and I snatched up a copy.
Plus, like books, sometimes it's nice to be able to lend a cool title to a friend. Right now I've been able to lend out my copies of God of War Collection and my copy of Fallout 3 because they are physically and not digitally distributed. So, in that case you wind up doubling the value of each game--which doesn't show up on that chart.
Let me also say that this entire thing is completely dismissive of the people who actually do and have shown developers support over the last 30 years.
There was a time that there was no retail market for games, but certain retailers gave them a shot anyway. Retailers also take pre-orders and help promote and expand the demand and propagation of titles.
GoG is an excellent example of this. This is a team that really cares about games and works hard to bring awesome older games to the masses--this also creates exposure for the companies that made those games.
The same is true of a lot of retailers--yes, some of them have lost sight of the value of the artist/retailer relationship at times, but the financial power enjoyed by the gaming industry is as much a product of retailers, publishers and first parties that took risks as it is a product of developers.
In fact, when you look at developers like the now defunct 3DO, or 3D Realms, it's pretty ballsy for someone to point the finger at publishers or retailers as a wasted revenue stream. Sometimes the waste starts at the top--and the retailers go ahead and promote crappy products anyway. There's no way you can tell me that Dante's Inferno or Alien vs. Predator (both awful titles) would have made as much without the push and promotion seen on the retail end.
In fact, they probably made more than they deserved at all simply because the retail community incentivized and encouraged purchases of those titles.

Bad example. AvP sold well because the game is actually good. Once people stop listening to biased games journalists and get away from the "WAAAAH this isn't AvP2 made pretty!!!!" they find it's an enjoyable game in it's own right.

On-Live is not the only streaming system out there, and TBH the way there going about it is stupid. There trying to get people to think On-Live is going to be the only thing we will have in 5-10-20 years. This, to me, is stupid.
There is, however, another Streaming group. Gaikai. They are looking at it more as another way to publish a game, rather than the one way you should play games.
However there system is VERY different from On-Live as well. On-Live needs specialty hardware. This dose not. With Gaikai you could play Crysis on your MOBILE PHONE.

er, what?
[Large edit: I just read the LA times article and figured out that "returns" meant something different]
Platform royalties are not "waste", they're something the developer signs on to in order to access the support and market share of that platform. I'm not sure what this has to do with "shifting little bits of plastic around", as Steve Streeting claims. If publishers don't like that, they should develop for a platform without royalties. Like, I don't know, a PC?
According to that graph, only 18% ($11) is actually tied up in the physical distribution of the product. TheMadSpin has identified some of the key reasons that physical media is still popular, and $11 isn't a huge price to pay for those privileges. Vendors like Steam provide valuable service (support, forums, download management, licensing) that will command a significant royalty, so there's no convincing reasons to believe that we'll see the "retailer margin" go away any time soon.
As we've already seen with services like Steam, the publishers already know that we'll pay $60 for a game, so they'll just increase their margins when they reduce their costs, and keep the game at $60. This is great for the publishers, but doesn't give any of us a compelling reason to switch across to digital downloads.
That blog post also seems to assert that the publisher's piece of the pie is the only part that's not "waste". Developers, who see only a fraction of that fraction, might have a different perspective on how much money is wasted.

Digital-only savings sound all well and good until you actually start thinking about this and realise that it won't happen; various factors will lead to the distributor gobbling up the sales previously taken by retail, big-budget titles will continue to be backed by publishers paying the bills, and retailers will bemoan their losses if the prices are too low. The end result will be games that are maybe $10 cheaper than the average retail price.
OnLive's list prices will be lower, but based on what they have revealed so far you will need an OnLive subscription in order to access the games themselves (somewhat similar to Xbox Live's Games on Demand). This makes it even worse than Steam; you lose your Steam games if Valve ever shuts down, which wouldn't happen for several years at the very least, but with OnLive you will seemingly lose your games the moment you stop subscribing, essentially making every game work just like an MMO (buy a boxed/digital copy to start playing, subscribe to keep playing).
On top of that there is the very big issue of whether OnLive's purportedly revolutionary technology will actually do what they claim it does.

Consider that the source is someone involved with onlive, have you seen their descriptive diagram of how their service works?

That article makes a massive, glaring error that completely overshadows any other problems with it: things are not priced based on what they cost to produce, they are priced based on what people are willing to pay. Any decrease in production or distribution costs will not be passed on to consumers, it will be used to increase the margins of everyone involved with the selling of the product. If you want to see direct proof of this simply look at the costs of any new release- are the digitally distributed versions less expensive than the retail versions to reflect the lower distribution costs? QED.