Not wishing to get embroiled in the personal whys and wherefores (ps I don't work for First either) but it raises a number of points....
Firstly, we really must get away from this idea that before deregulation, everything was fine and dandy. I am old enough to remember vinyl seated Nationals and VRs in faded poppy red! Passenger figures were collapsing especially in the shires and this was despite the amount of money that was being spent. Councils were propping up services anyway, the National Bus Co was accruing debt at an astonishing rate, and there were other financial supports. Now, it's fair to say that between 1986 and 2014, ridership fell (outside London) from 4.5bn to 2.8bn (38%) journeys - that seems terrible in 28 years. Then look the previous 14 years fell from 6.5bn - a larger drop in actual terms in half the time and in percentage terms, not far off (31%). In the shires, subsidy was covering 20% of the costs and it was much higher in the PTE areas and yet patronage was falling faster. I know that people think that Nick Ridley and his transport act was all about bus wars and introducing competition - it was about cutting the cost to the taxpayer.
As for the current day, I appreciate that you are stating that there MUST be a market if only be virtue of the raft of cars on the roads locally. I think that's a moot point. Both Transdev and Connexions have attempted to run services speculatively in the past - therefore, one should really ask the question that if there is this seemingly lucrative market not being catered for, why haven't they done so? Quite simply, it's a mirage - there will be people who will NEVER deign to use public transport, or their life is built around or facilitated by the car (got to drop the kids off at the childminder on their way to work), or that common sections of road/route are populated by drivers with a range of disparate origin or destination points.
In fact, in a deregulated world, the fact that a service is not operated commercially is often an indicators of its true demand? Still, that would be an answer for never innovating and yet, as you say, Transdev in particular have been able to innovate and generate growth. Also, during the Labour administration, we had Kickstart schemes where local authorities and operators could put together cases for exactly the type of pump priming of new or enhanced services. Naturally, when the coalition came in, it was classed as obviously wrong, replaced by Better Bus Areas etc. Some were really well thought out schemes (especially the initial tranche) and are still with us - they involved not only investment from the operators (e.g. new vehicles and enhanced frequencies) allied to capital investment in bus priority and other infrastructure. However, the later examples have a number that didn't succeed - simply putting a bus on (built it and they will come) is not enough and so it proved. Nonetheless, it did show the potential of such a scheme if targeted in the right area. That is perhaps the point - in some areas, there is the potential and the ability to develop the market relatively easily - yes, there is a modicum of risk and that has been borne out with Transdev and CityZap. It is a risk - as we saw with Stagecoach, the success of one service into Bristol (SW Falcon) was not replicated with another (Belles Express) despite the raft of cars that apparently head down the M5 and towards the city every day! The question is whether an operator believes that there is a market for an Otley to Bradford/Guiseley type service that is frequent enough to be attractive and can somehow the extended journey times caused by glue pot traffic conditions.....?? First couldn't sustain it (a reflection on their management ethos?) but neither Transdev nor Connexions.... perhaps that is more telling.
You are correct that both parties arguing over the 965 is pathetic - like two bald men arguing over a comb! Unlike some (!), most of us can see the culpability on both sides and that it has little to do with the attractiveness or potential riches of the service. That sort of "personality based" skirmish is actually very rare thankfully. However, I think it's a leap to say that if they weren't arguing over X service, then they could operate Y service - Y service may never be viable irrespective of anything else.
Sorry for the extended missive - not wishing to be too contentious to any individual or business