The 737 was supposed to be replaced in the mid-late 90s. Boeing got hung up on appeasing Southwest and backed themselves into a corner. The 757 would have been a much better aircraft to modernise and put all the effort into, especially with the cross crewing ideas they had in the 80s, which Boeing dropped and now Airbus has run away with. Basically Boeing decided that the competitive angle was going to be 737 old school no frills, thing you know vs all the bells and whistles, computer with wings and plastic bits A320.
The 757 was a great idea, but the US airlines wanted widebodies, and if it wasn't wide the 737 did everything else. Now they want a 200+ seat narrow body, but hang on, you guys had it in the 80s....