You're misunderstanding what MKV is. It is not a format, it is a container. As it stands at the moment it is the very best container around. It can hold any kind of video, audio or subtitle stream. This makes it very powerful and flexible.
If you rip a DVD straight to MKV all you're doing is taking the data that is in the VOB streams (contained on the disc) and re-packing them. This is handy for archiving and playing on home theatre systems, but not practical for portable players. The archive quality MKV file can be encoded down (typically to h264 video with aac audio) to produce a very high quality/small file which is suitable for portable players.
As for why we need MKV? AVI is old and barely supports any formats, the formats it does support are awful quality/compression wise (DivX and XviD I'm looking at you). MP4 containers while newer than AVI have a more limited feature set than MKV. We need MKV because it's the future.
You can do more reading here: http://www.matroska.org/technical/whatis/index.html
Some things that make MKV awesome:
* Fast seeking in the file
* Chapter entries
* Full metadata (tags) support
* Selectable subtitle/audio/video streams
* Modularly Expendable
* Error resilience (can recover playback even when the stream is damaged)
* Streamable over the internet and local networks (HTTP, CIFS, FTP, etc)
* Menus (like DVDs have)