"Even if I stipulate that Android will never be more than "good enough", a statement I would not necessarily agree with but let's go with it, you will still find a lot of not-Apple-partisans getting peeled off proportionally to the price delta between the iPhone and the Android. In which case Apple will either have to drop prices and profits or firmly entrench itself as the high-margin, low-sales player... and drop profits."

With iPod, Apple played this almost perfectly, driving down their component prices by always being the single biggest customer of their suppliers, then deciding how long they could charge a premium versus lowering prices to keep the delta with competitors prices from getting too large. They kept the prices close enough that most consumers were willing to pay the premium for the Apple brand.

I actually think they will do the same thing with iPhone. They are getting close to having the previous iPhone version a "free" throw in with new contract, and there are rumors of Apple developing an even lower version for pay-as-you-go contracts.

I think angering content providers is a much bigger risk for Apple right now.