Yep, at work I saw the new medium. Back of the blister pack said "REQUIRES: On-line broadband activation." It was for a pre-school math game. I showed my manager and he said, "Yup, say bye bye to DVD's." So I guess that's the end of an era. Feels kinda weird but I guess we'll see what happens to the future of games. It really doesn't make sense to switch to USB because the main problem they were having in the cartridge wars was the manufacturing took to long. With CDs they could just flood the market.
I don't know I guess I'm just sentimental.

It's a bit like the old Nintendo... just with an on-line activation *facepalm*

Don't expect this to take hold in the general videogame market. The "educational software" market, targeted at schools and parents, is a rather... unique... market environment, where things like competition and consumer choice don't factor into the picture very much. For the rest of the videogame market something like this would be an absolute non-starter for any company that has a modicum of sense. This is because this system increases production costs, makes it worth less to customers (as it's an added annoyance), and is probably about as effect as every other DRM system ever made. Not a good combination for any competitive market (and the videogame market seems to be becoming more competitive every month).

Yea, it was The Learning Company.
I guess it's a good testing platform, always opposites that start this BS.
Beta vs VHS
Tape vs CD
CD vs MP3
Floppy vs CD
DVD-R vs DVD+R
Which will the consumer choose? Let's see. It's just nuts.

When you say DRM USB do you mean like a USB dongle that has to be in while you use the software? we have that at work and school so the software won't start unless it's plugged in.

Not only everything you just pointed out, but for a game publisher to go ahead with any sort of physical DRM product they would have to abandon online retail...that coupled with a more expensive production cycle is not exactly going to be a popular choice.

The manufacturing cost of optical discs has reached the point of being negligible (except perhaps for Blu-ray). This is not quite the case for thumb drives unless it is only used for DRM verification purposes, which defeats the point anyway. Digital distribution is always going to be a loophole in any dongle DRM scheme because Steam and the like won't include one (offering an easy avenue for cracking without having to disable or emulate dongle functionality) and yet if the title isn't available digitally many people will simply refuse to buy it.

I believe he means the game itself comes on a thumb drive instead of a CD/DVD and has to be 'unlocked' by being connected to the internet.

I don't think it's a dongle. It advertises 1GB right next to the drive. I'm half tempted to buy it to try it. I assume the game is on the drive. You have to activate it on-line but it probably drops the write protection guard on the drive while you're playing the game. Which means there's a window of being able to copy data. Sorry that's my over curiosity kicking in.
Or maybe the 1GB just means it's reusable.

There is a few things it could be, based on the edutainment software I've encountered over the years at work.
1) The game may be on the USB drive, instead of a CD/DVD.
2) The USB drive is used to copy across settings throughout the school network.
3) It's a free bonus, for buying the product.
I've seen all of these, though they usually don't relate to edu-games, rather school management software.
Online activation is bad enough, even more so when you have to find a way to tell it to get past the filters in place run at the department level (to which I have no control). School software is also notoriously clunky to use/install since they tend to support way back to win3.11/w95 upto Vista.
Because of that, I've started to only deal with places that do not use activation, else I'd be taking the server home to work on the weekend..

Don't expect USB dongles to take off. Like others have pointed out they're costly to make for the result they yield, and most consumers with any sort of knowledge won't put up with this sort of treatment.
Steam and D2D have verified that they're on the map for at least the next several years. They've paved the way for digital distribution and, if anything, I expect DD to increase its sales over the next few years ;)