It wasn't a 'failure' of Dynamix really.
Dynamix was designing their own engine for their own game (Red Baron II/Starsiege). Sierra wanted that new version early, and Dynamix wasn't ready to release it on the market. Remember new engines take plenty of time to actually develop, before they are used for games themselves...
Think of how long it is taking for ID Software to design new engines, and how long it takes for that engine to be released to other companies to start using them... ID Tech 5 engine for example, the one being used in Doom 4, has been in development since before 2007... The earliest usable version was shown in 2007, and its still in development now in 2011!
Doom 4 will probably not be released until sometime 2012 or so (i'd be surprised it it makes it out by Christmas 2011)... It will be quite a bit of time before any other companies have access to the engine to start using it for their games.
Keep in mind that engines and games are always two separate development cycles... It took years for Valve to design the Half-life engine (even though it was built on a highly modified Quake engine). Although since it was built on Quake, the game itself's development probably started alot sooner? It also took years for Halflife 2 Source engine (even it was based off a highly modified version of the Quake engine) to be completed!
Sierra wanted to push the engine beyond what Dynamix was designing it to do (simulator games)... Dynamix was still designing that game engine for their own games, and it wasn't ready for those, let alone the more complicated game Sierra wanted to use it...
Thus Sierra was forced to use an earlier previously released version, and modify it.
I think its improper to be continually comparing Tales of Monkey Island to King's Quest. Because of the island-hopping nature of ALL Monkey Island games, Telltale's model fit rather nicely. It was not much of a stretch at all to get a game that fits both the traditional format of a Monkey Island game and the traditional format of a Telltale game--because honestly, the formats aren't that different.
More importantly every single Monkey Island is chapter based, with 4-5 chapters telling the story.
The closest Telltale has ever come to that "Man, this game is big!" feeling old adventure games could pull off was exploring Flotsam Island in Episodes 1 and 4 of ToMI. Sure, most of it was because of that stupid maze, but I felt like I was walking through a huge island, and I liked that.
If you look at MI1 for example, Melee Island wasn't really all that large, nor had much exploration... The largest part of the island was taken up by a 'stupid maze'!... The later island, Monkey Island itself only had 3-4 places to explore, and another 'stupid maze' (hell).
In later MI games, its quite similar in that usually you only have a overhead map, and only 2-4 places to explore on the islands. Although 'stupid mazes' were less common, as the series progressed... (until TOMI that is)