I think there is no negotiating with some fundamentalists, so I don't see that as a failure. We obviously can't negotiate with UBL/OBL.
The only reason they are in charge of that city is that we are still attempting to fight a relatively sterile war (yes I know no war is sterile). We don't want to inflict more civilian casualties than we have to and we don't want to invade the holy site. That is a good thing, but I don't think you should give the militants too much credit. Militarily, they did the stupidest thing they could by clumping in one spot. They should have stayed in guerilla(sp?) bands.