I own the 1st and 2nd gen shuffle, and briefly the 3rd gen shuffle. As far as SQ, 1st >/= 3rd > 2nd. However, usability: 1st > 2nd >>> 3rd. To me, for a small grab-n-go player like a shuffle, usability is critically important. The 1st gen is very good in this: big tactile buttons, big slider, built-in USB port. The 3rd gen goes for the wrong direction: tiny and tough slider, no buttons, reliance on the earbud remote for playback controls.
The only big plus thing going for the 3rd gen is the support for Apple lossless, which is the first for the shuffle lineup. Other than that, it's not even gapless capable. I returned mine.