1. It dominated its niche because it was a legitimately good product, not just because it was free. There have been many free alternatives for a long time, even before Reader. For example if every Mac user actually used the built in RSS readers that ship with OS X they would have eclipsed the Reader userbase.
2. The fact that it is a small niche (and more importantly isn't really growing) probably better explains the "lack" of alternatives.
The fact of the matter is that when Apple finally kills off the Mac Pro there actually won't be (lega) alternatives, unlike the current situation with RSS where there are plenty of alternatives (its just that Google's was way better). This is my whole point: Google won on quality, decided it wasn't worth it for them, and then exited. Had they priced it from the beginning (either through ads or freemium or whatever), they would have still won in my opinion, and then still killed it. Reader winning and going away has nothing to do with free in my mind: there is just no universe where Google would continue supporting an RSS product because RSS is not a big enough market.
I guess my point is that Google would have "killed the space" no matter what, not because they made it free.