I agree with your general point, though MAN-SOU didn't have a "relatively small" number of passengers pre-covid. It supported upto six return Q400 flights per day. It is a much-needed route. I'm acutely aware that FlyBe failed, but I'm confident that the MAN-SOU route wasn't the reason for that. The issues faced by this company have been extensively discussed elsewhere - too thinly spread, expensive leases, uneconomic bases, and more.
Where I do think there is a problem is the very high payouts for short domestic sectors specified by delay compensation rules. I suspect that these payouts were a major factor in killing off Stobart's MAN-SEN route. The demanding schedule implemented on those ATR72's meant that delays often built up through the day, leaving many passengers eligible to claim very generous compensation. I would favour a system under which delay compensation for domestic flights is capped at the price paid for the ticket (similar to rail).