As some commentators above noted: fragmentation is just another word for competition, and competition gives us choices, so it's good.
I do, however, think that there are huge flaws in the open source desktop market. The problem is that distributions trust upstream to provide quality software, and upstream is not to be trusted.
I am not sure why the treatment is different for server and development software. E.g. if was not unheard of that distributions would maintain two packages of Apache (e.g. current 1 and current 2), Python or PHP. Many distributions package several kernels even, so you can choose which one you want.
For desktop software, on the other hand, distributions always seem to make the wrong choice. E.g. they introduced KDE 4 before it was ready for prime time. Most new distributions are just following the development cycle of GNOME without thinking about implications to their users. It's not just about GNOME 3, but I remember when GDM (graphical login) was rewritten - many distributions just packaged despite the fact that it was still missing major features and in most cases we had to rely on third party repositories for the old one. Same goes for PulseAudio, etc.
I don't think this is very sustainable. It's OK for cutting edge distros, like Arch Linux or Fedora, but Ubuntu, Mint, Debian, Slackware and others who want to provide anything resembling LTS versions will have to take much more control and responsibility for what they package.
Ubuntu and Mint see this. Ubuntu provides Unity and as much as I dislike it, I am happy that they are doing actual development. From what I understand, Mint is behind MATE, and that's excellent.
To sum it up: distributions need to take responsibility for the software. They need to be able to patch software when needed, but they also need to be able to take over development when upstream goes bananas. This may not be realistic for a single distribution team and huge projects such as KDE and GNOME, but that's why packagers ought to be well connected with the development community and be able to stir things up when they see things are going badly for their distribution.