I would completely turn the whole game upside down, add in a good combo system (minus the run) and drop the dumb *ALATIES and include somethings called "SUDDEN DEATH" and "OVERKILL".

With a Sudden Death (only on Round 3), it could be enabled by either player and this will darken the screen like in fatality mode. With this, you can pull off a Fatality anytime whilst moving around the screen - both players can, if you fail with the Fatality, this could either leave you open for the other player to perform his fatality on you or if you are quick enough to escape you'll return back to your normal stance and go at it again. This would enable combos -> fatalities for maxium effect.

Overkill, is just that... After you hit a fatality you'll have a limited amount of time to beat down on their dead corpse or perform another fatality. With this it wouldn't be possible to have a fatality where someone's corpse just disappears (like explodes) but you'll able to do explosions and the like with an Overkill so it all equals out.

Story-wise I'd probably lose all of the new characters. Sub Zero would be in again but not with Lin Kue and with that he'll with a yellow ninja costume - this would also signify the relation he had with Scorpion with the teacher / student / respect thing. Scorpion is in the pits of hell as usual. Raiden is out. so there are some choices I have kept it from the real MK3, you'll be able to fight Scorpion though by knocking your opponent into a portal (Stage Fatality), your opponents head will fly out of the portal moments later and by hitting another command of buttons the famous spear will fly out moments after that which grabs you and pulls you into hell and have like a "WELCOME TO HELL" thing he'll say.

I'd also keep that MKII atmosphere. That's all I have, what about you?