Just to answer a few points, I did not intend to suggest that the developers write the story for each of these units. That's dull in the extreme, and generally ignored by most folks. X-Com's style of generating units is a little closer to what I mean than, say, the prewritten histories of heroes in Romance of the Three Kingdoms (by Konami).
I also want to emphasize the importance of traits as seen in the Total War games, where an idle unit might pick up the drunkard trait, and a unit that executes prisoners might gain the bloody trait. In essence, procedurally generated story, sans the crappy writing of the computer. This adds personality to units, as well as benefits and penalties, without materially affecting the utility of the base unit itself.
An important element of this sort of story is the where, who, and how. A log of where the unit was created and the major battles it fought in would be key to keeping track of how it performed over time. An easily identified commander would add to that, especially if that commander had other units attached to him, or, even better, developed friendships and enmities, a family, and grew old and died. Nothing too significant, just basic family tracking along the lines of Crusader Kings or EU:Rome. Awardable titles would also be kind of neat. In essence, make it so that each wee unit is a mini-character with mild rpg elements.
I will say that I conceive of this game as played with between four and six cities -- any more than that would remove a great deal of the flavor and reduce it to the unit spam so prevalent in Civclones, where a big stack of the strongest units is sufficient to overrun any old place.
I really do want to reiterate that fantasy style games and stories are at their best when they focus on the interaction of interesting characters, and at their worst when they attempt to create a complex political drama. It's the difference between something like Firefly and Serenity, or A New Hope and The Phantom Menace. Fantasy, whether with laser guns or fireballs, is character driven. Lose that, and you may as well be playing a Tom Clancy game in terms of emotional appeal.