The giant face (not to be confused with Antonio's on again/off again unseen girlfriend on Wings, the big faced girl) vs small heel dynamic was a tough way to start the reign, especially at a time business was flat all around. I like a lot of your idea to run Diesel as a heel. Also like that you're aware that a heel run would have some of the same problems (not Diesel's fault, usually) as irl.
I still think some small tweaks could've helped. Have HBK (heel) come close enough at WM 11 to push a rematch at the first IYH. That leads to Shawn's turn. Hold the singles Diesel-Sid match for Summerslam. KOR and IYH 2 can be used to put Diesel over more, make Sid look like an absolute monster, build Mabel as a heel better, etc. They had a decent roster at the time, they just needed to use it better & it would've helped.
The biggest thing is probably expectations. Nobody was going to do 1987 numbers in 1995. Recognize that, build guys like Mabel up over months instead of expecting an overnight miracle, don't screw up booking Sid for the SECOND time in a row, etc.
Totally agree about an Allied Powers-Owen/Yoko feud. The idea that the roster was just too weak in 95 requires pretending they didn't have these 4 main eventers, Luger especially under/mid-used, around. Can headline house shows. Along with the tag matches on ppv, they can work various singles matches with runins; instead of running Luger off, book Luger vs Yokozuna 3 for the first night of Nitro, for example. This would also help Diesel too. Something like KOR or an IYH can have Diesel get a big, dominant win over somebody that has name value but not the biggest star (Backlund 2 as a face, 123 Kid as a heel) and still sell tickets & ppv buys with that tag title match & good stuff with Bret, HBK, Razor, Jarrett, etc.
One more possibility for a heel Diesel run in 95. Could they get Piper to do a ppv job for him? That'd make for a big headliner for Summerslam or something.
Edit:
If they pay Piper enough for that, make a new 3-hour ppv for September, then back to the irl schedule in Oct.
Some kind of "school" or Fall theme, WWF Homecoming '95 or something.
Diesel vs Rowdy Roddy Piper
Allied Powers vs Yoko/Owen
HBK/Bret/Ramon/Kid vs Sid/Tatanka/Jarrett/Pierre - elimination match, last man standing gets Survivor Series title shot (if more than one from the same team they'll face off at Oct IYH...Bret wins this and does what Piper, HBK, Sid, etc couldnt and beats Diesel)
Undertaker vs King Kong Bundy - big blue cage
and since we're not in self sabotage mode...Alundra has Wendi Richter in her corner to counteract Wippleman vs Bertha Faye or Bull Nakano