A lot of good ideas regarding the Mandarin here.
Truth is, yes, they could have gone a few different ways and made them work. For me, though, I thought this all worked just fine. The twist didn't feel all that shocking to me for some reason. And although I never liked the extremis storyline (granted I never actually read the story, just heard about it), I went along with it and felt like it fit with the movie and the universe that has been established.
Someone mentioned that Mandarin was never much of a villain in the comics, even though he's considered IM's ultimate nemesis. I generally agree with that. But I guess I can understand the viewpoint that people feel the movie squandered the opportunity to finally do something good with the character to make him worthy or IM's greatest villain, especially because everything leading up to the twist suggested this.
However, I still feel that the movie worked. Yes, they threw away the chance of a good villain, but they really didn't throw away an actual good villain. I thought the movie was fun, exciting, engaging, surprising, and I was emotionally invested in all the characters (even the henchmen) and Tony's personal journey. That's about all I ask for in a great comic book movie, and I got that in spades.