Other retailers would've been able to sell digital games. That was kind of the whole point of the DRM in the first place. Someone would go to Amazon/Target/Wal-Mart/Toys R Us/etc. and buy the same digital game that is available on Xbox Live. The only difference is that they get a case and a disc with it. But functionally, the digital game was the same as the downloaded from Xbox Live version.
PC has GoG, GMG, Steam, Origin, Amazon. Xbox One would have had Amazon/Target/Wal-Mart/Toys R Us/etc. (of course, download only games would be the exception to this, similar to
Steam-only games)
But now (similar to the past console generation), Microsoft is the only one that can sell you digital games on their console (just like every other console manufacturer). So MS/Sony/Nintendo is the only one that can set digital prices. The only way you can kind of get around this is through buying points/gift cards at retailers and then redeeming them on a console.
The "console digital game monopoly" everyone is supposedly afraid of has been happening for the past 8 years, and is continuing into next-gen.
Even if other stores could sell the game, it'd still have to be available on the Xbox network. They'd basically just be selling activation keys for the game, which means that Microsoft would be in full control, and could easily monopolize the entire market for Xbox games.
Of course, they'd allow the larger chains to sell their games to begin with to ensure sales, but once people realize that you can get the same thing on Xbox Live (And, probably, at a discount to begin with, then no discount when they are the only ones selling games.), and Microsoft controls the source, it seems very likely that Microsoft would want to be the only ones selling the games.
The problem was the forced every-24 hour internet activation. I'm pretty sure that the plan was to phase out the discs alltogether, and eventually make Xbox Live the only store offering games. No more reduced prices due to larger stores buying in bulk, or competing with other stores.
Consoles used to just be a tool to play the games - the console manufacturer wasn't necessarily involved with the games themselves. This line is blurring more and more. If the console manufacturer is the one that also controls the availability of the games, the price, and so forth, then the prices will most certainly increase, a lot.
If they were also responsible for actually selling the games to the people, they'd probably take a large chunk of money from that. Then publishers would complain, and increase prices, which Microsoft would be happy to do, etc.
Selling games on discs is good for the consumer - buying the discs, printing the discs, transporting the discs, storing the discs, and then, of course, selling the discs to stores as fast as possible (And, occasionally, they might sell them extra cheap to clear out stock.) -- the more discs a store buys, the cheaper the individual discs are. Stores might also compete with each other on the prices.
If all a publisher needed to do was to upload an .ISO file to Microsofts servers, games would most certainly increase in price due to the reasons listed -- and sales would probably be very rare.