Suppose that Bitcoin has 1 MB blocks and transaction fees of 50 cents. Suppose that Bitcoin could move to 10 MB blocks without significantly harming decentralization, but the community chooses to stay at 1 MB blocks to be safe.
Suppose a competing cryptocurrency identical to Bitcoin is released, but with 10 MB blocks. Call this TenCoin. If all Bitcoin users were using TenCoin they'd be better off, but initially TenCoin would have very low security because it begins with just a handful of users. Money has network effects so its unclear whether TenCoin could ever pose a threat to Bitcoin.
To see how TenCoin could take over, imagine you're one of the Bitcoin users who cares the least about security and the most about low transaction fees. Suppose your use case involves making small bets of about 5 cents each with your friends around the world. Bitcoin is unusable for you because its fees are 10x the amount of your average bets. Even though TenCoin has very little security and is likely much more volatile than Bitcoin, it beats paying 1000% in fees. So you and people like you migrate over to TenCoin. However now that more people are using it, TenCoin becomes slightly more valuable because of the equation of exchange. This means mining rewards increase, so TenCoin is a little more secure and a little less volatile, making it more attractive for the next group of marginal Bitcoin users who previously just barely favored Bitcoin over TenCoin. In this way, TenCoin can gradually peel off more and more users from Bitcoin based on its superior parameters which allow it the same level of inherent centralization pressure as Bitcoin, but lower fees.
For a longer version of this argument, see the comment thread between pztorc and Elliot on this post.
Why is it bad that another cryptocurrency takes over? It undermines the concept of digital scarcity if new coins emerge and replace old coins. If it happens even once it sets a bad precedent. The faith that people have in the future value of a currency is what makes a currency stable and functional.
The Bitcoin community would have time to react to any competing cryptocurrency if it started to take its users in this way. Bitcoin has no credible threat right now, so we can afford to play it safe with decentralization.
Because money has network effects, new cryptocurrencies will only gain traction if they are providing something new and filling a niche ill suited to existing cryptocurrencies. They must have features that can't easily be added to existing currencies. New cryptocurrencies will only gain traction until all existing niches are filled adequately. Because genuine innovations are scarce, digital scarcity will continue even if Bitcoin is overtaken by another cryptocurrency.