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I really don't know that smaller stores is the answer. Why do people buy from Amazon? Two reasons, one they almost always have the book you want in stock and two convenience. A small store isn't the answer to either issue.
B. Dalton's and Waldenbooks were the first book stores that I frequented since they were at the local mall and there were not any other book stores near by. This was in the early to mid 70's.
IMPO, B&N won out as much because they catered to readers as anything else. It was a great place to go, relax, browse, get some books and then sit and read with a cup of coffee. The staff was generally very knowledgeable and friendly. The draw was as much social as anything else.
I would argue that B&N lost that focus on their core customer group as they started branching out and chasing the financials. That started their downward spiral as much as Amazon did.
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