I don't quite agree with everything you've said. You're right that track times or cornering speeds are not everything and shouldn't be the main reason why people buy a certain car (although for some hardcore enthusiasts who track their cars, it could).
What delivers driving pleasure? Good steering feel, good brake feel, solid feeling when cornering, and fast acceleration come to my mind. Generally, I think driving in the city during rush hour traffic is NOT the situation which would deliver driving pleasure, whether you're driving a Toyota Corolla or Ferrari F430. For most people, driving pleasure comes when driving at a brisk pace with or without turns to take advantage of the capabilities of a car.
If you're not on an deserted twisty road, or on a track, you simply cannot enjoy the advantages of the 3 series over any of its competitors (like the C-class or A4 or IS or G35, etc). Sure, you can engage in illegal high speed runs on the highway, or you can take a curvy on-ramp at higher than average speeds, but unless you're really close to the edge of cornering limit, a 3 series will not feel that much better than a W203 C-class or B6/B7 A4. Yes, a Porsche Boxter or S2000 does obviously feel much better taking that same on ramp at speed, but that's a completely different class of car.
Do you notice where magazines test their cars to decide which car "performs" the best? They either do it on a track to measure objective performance numbers, or they take it to the open road with minimal or no traffic so they can see what happens when they tackle turns at speed. Only then can you gauge how the steering feels, whether the brakes have good modulation, and whether the shifter feels good or not. When they do it in urban traffic (where most people drive), the C-class historically always gets better compliments about smoothness, comfort and quietness.
Bottom line: I think you have to drive faster than usual to really notice the differences between the 3 series/C-class/A4, and that means typical urban driving won't do it.
A big reason the 3 series is so successful is because it is "hip" and "popular" with the younger crowd. BMW has done an excellent job of marketing itself towards this segment by selling a sporty image. Many people would consider Mercedes to be an "older" person's car. Sure, the 3 series cars are actually very capable, but I guarantee you that most 3 series buyers decide on the car because of style and image, rather than the fact that the it handles better or has better steering feel than the competition.
The fact that the 3 series has always won most comparison tests in car magazines only adds to the advertising of the car. And remember, most car magazines rate cars based on PERFORMANCE.
Unless MB is happy being with the C-class being 2nd rate in terms of sales compared to the 3 series, I think Mercedes SHOULD try to take on BMW in this compact segment. And that means putting an emphasis on performance or driving experience for these small cars. With the W204, they're marketing the Avant Garde (or Sport) models to be the sporty representative. Let's see whether it will truly give the 3 series a run for its money with the upcoming "advanced agility" package.
The facelifted W203 C-class was the closest MB has ever gotten to the 3 series (including the E90) in terms of driving dynamics, as many car magazines have attested to. I am hoping that the W204 will take the next step....although somehow I doubt MB is going to take that route.
