The mistake they made was investing heavily in a business product which the market was moving away from and downgrading the excellent Diamond Service as well as having their finger in too many pies and doing nothing particularly successfully.
Of course hindsight is a wonderful thing but I think they should have done the following in the late 1990s:
LHR Product
1) Rationalise LHR fleet into single type - A319 ideal
2) Stay one class
3) Transform into a Jetblue style product at LHR keeping Diamond service but with the frills paid for by budget ticket holders
4) Provide a "business" upgrade allowing an improved ground product (check in and lounge access and FFP) and free food on board (maybe £5 allowance)
5) Not join Star but allow interlining with all carriers
6) Operate to niche destinations that BA do not serve, as well as trunk routes
7) Negotiate take-over of some domestic routes from BA allowing them to focus more on L/Haul
8) Forget Long Haul aspirations
Regional Product
1) BMI Baby brand split into Business and Leisure Routes
2) Dash 8-400 for Business routes
3) A319 for leisure routes
4) 3-4 bases with 6-8 aircraft per base
5) Business product like LHR; Leisure more like current BMI Baby
6) If routes don't fit the profile of the two aircraft types don't operate them!
They could have stolen a 3-4 year march on Flybe in many markets and had a very neat business with 50-60 aircraft (of which 12 or so DH4) that could have been significantly rationalised with the simple business model.