If a studio downsizes, they might be able to survive making lower budget games. And while it's true that if every studio does this, the industry would get better, there's incentive for _one_ studio to pump up their funding and make a super-high-fidelity game, and grab all marketshare.

This makes it a 'race to the bottom' style (or a race to the top?) competition, where higher funding gets you more marketshare, but only against lower funded studios. It's akin to advertising budgets. Mostly a zero sum game in the end.