You are pefectly right, the quality has declined. The W203 was a good example of this.
There were many explanations, cost-cutting is only one of them. Because the environmental issue made it expensive and difficult to have environmental-friendly materials that feel so smooth and lasting than others...Recycled materials have been integrated, in Mercedes more than in others, and the materials have to be recyclable...So the feeling of quality fell a lot.
Also the competition was harder, and Mercedes decided to be even more innovative than before, but did not test enough all the electronic functions, so the result was the 2002 and 2003 E-Class disaster...However, very few mechanical problems, the E-Class is now the most reliable car of the category...
But Mercedes has changed everything recently.
The W204 is the car that had the most extensive testing programm ever, the car made 24 millions kms test from what I remember, before it was released. The new ML had been delayed, because they decided to test it 6 months longer before selling it.
The W221 is the most reliable S-Class since the W126, it is the most reliable car of the last JD Power survey, despite beeing in its first year (the most dangerous, where all the problems appear); the ML is the most reliable suv, the E-Class leads its category too, as does the SL...
Mercedes has known hard times, both from a quality and reliability point of view. Even the W220 S-Class had not the best finition you can imagine, with some hard plastics on the door panels or some light cup holder...
This has changed with the new generations.
Finition has improved a lot, and even if some plastic can sometimes be criticized, the quality of them, their durability, is class-leading.
And, like you, I like the W211, find it very well finished, but it does not feel "built to last"... The W204 feels built to last, it really felles like an old Mercedes, imo. Less gimmicks, more serious in the design, less appealing for some sides... But more German, more quality-oriented. Nothing feels light or fragile in this car. Everything smells quality imo, that what I love in this car.
I read somewhere that for a lot of plastics, Audi uses hard plastic with a big layer of smooth-paint on it, so that it is soft to touch. But with time, this paint can fell on certain places...It happens on my Golf IV at certain places, and I saw lots of B6 A4 with that...
Mercedes never uses it, if the plastic is hard it is hard, but if it is soft it is a soft material, not just a soft paint... It is more expensive, maybe less appealing, but it lasts... This is the way Mercedes is taking: the stress is put on the quality and reliability now, more than before.