pigeonpigeon probably best highlights why I feel retreat to be so important to strategy games: As a general rule, I strongly dislike "all-or-nothing" battles where the fate of two entire empires are riding on the outcome. Yes, I know it's happened often enough in real life, but it's usually not very fun from a gameplay standpoint. Being able to withdraw your forces (or at least most of them) would go a long way towards insuring said make-or-break battles don't happen very often.
I agree that great lengths should be made to avoid the all-or-nothing battles ala HoMM. Those battles are always epic and fun, and are usually the only ones that pose any sort of challenge at all in the late game, but I personally usually get bored afterwards and just start a new game instead of finishing.
I completely agree. Retreating/withdrawing your army from combat should definitely carry some kind of cost or penalty for doing so; I would never suggest otherwise.
A couple examples: In games like the Total War series, the losing general often loses a command star (which affects how well their troops fight in battle), and/or any soldiers under his command suffer a permanent morale penalty. In Birth of the Federation, a lost battle (whether from your forces being destroyed or simply retreating) causes a morale drop on all of your planets (which is important in BOTF since morale affects how quickly you produce and research stuff).
Now I'm not sure how practical it would be to apply either of these systems to Elemental. I highly doubt heroes will have anything equivalent to "command stars" like in Total War, and we don't really have any idea yet as to whether what effect cities will suffer if their morale/happiness drops (assuming cities in EWOM even have morale/loyalty/happiness ratings).
What I'm thinking is that armies that retreat would suffer an XP reduction, compared to what it would've been had they won the battle. For example, an army that decides to withdraw from combat only gets 75% of the XP it would earn had it won instead.
Obviously, any such XP penalty would have to be carefully balanced: Too steep a penalty, and there won't be enough reason for armies to justify a withdrawl. Too small a penalty, and armies could simply use it as a "get out of jail free" card as ABruner outlined. I do think it could work, though.
This and Pancernik's post have got me thinking... I have to admit, being able to implement guerilla tactics with fast/stealth units would be a lot of fun. But if the penalty for retreat is too high, then guerilla tactics won't be very effective. But if the penalty is too low, then I think retreat will be used to the point of frustration.
I think to even make any good suggestions we'd need to know more about how the combat system is going to work. If it's turn-based in any way, then maybe retreat could take a certain number of turns based on their speed (faster units can retreat faster). In addition, no units can retreat from battle if they are adjacent to enemy units (this also prevents slower units from running away unless the opponent lets them, or the defender guards them). The penalties could scale with how long it takes your units to retreat. That way if you're harassing an opponent with an army of light cavalry, you could send them in for a quick strike, and then run away again while suffering only a small penalty. But if you're engaged in a huge battle and decide half-way through that you are losing, you probably won't be able to retreat all your units (sometimes maybe not very many at all, even), especially not your slow ones. And the ones that do get away will suffer a large morale and/or experience penalty. (By experience penalty I mean they get less XP than they would've if they'd won - they would never lose XP they already have).