We meditated on the question of difficulty in games last weekend, and Ernest Adams is now over at Gamasutra mulling the same problem (sort of). What's the best, most satisfying way to implement difficulty — or more precisely, difficulty settings? He looks at suggestions found in Interactive Storytelling by Andrew Glassner and has some of his own (and why dynamic difficulty adjustment may not be the answer):
... While some of these objections deserve attention — and their effects should be ameliorated when possible — I think that demanding that difficulty levels be "banned" from all games is throwing the baby out with the bathwater.
More importantly, Glassner's objections ignore the most important rule of game design of all: empathize with the player, i.e. provide what he wants. Players want settable difficulty levels, and removing them for purely theoretical reasons is not a good way to serve your audience.
He's got some interesting suggestions on how to implement dynamic difficulty settings, as well as potential fixes to some other issues or problems with difficulty levels.
The Designer's Notebook: Difficulty Modes and Dynamic Difficulty Adjustment [Gamasutra]