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Sensor technology just wasn't advanced enough at the time to get good enough quality out of such a small sensor, and the physical limits on viewfinder brightness and size due to the smaller sensors meant the viewfinders were awful. The mirror box meant that the cameras and lenses also couldn't really be all that much smaller than APS-C DSLRs.
It was just too early, once the technolgy caught up a bit and it became possible to drop the mirror and replace it with an EVF m4/3 became what 4/3 had promised to be.
