Large hard drives weren't a necessity to play games on a PC in the early days either, you could run a complete game off a floppy disc. But things have changed a bit since then. You either adapt or you stop playing, it's as simple as that.
Except that Skyrim won't require you to install it on your 360 HDD in order to play. Most likely.
So they're still not a necessity, and probably won't be for a long while.