Apple has a 2GB iPod Shuffle, an 8 and 16 GB iPod Nano, an 8, 32 and 64 GB iPod Touch and a 160GB iPod Classic. They have a product for every niche within the mp3 market and several price points. Anyone willing to buy one of these products has it with no other prices attached or limitations due to another company.
There is the 8GB iPhone 3GS, and the 16 and 32GB iPhone 4. All come with a limitation (in the US) to one carrier. They also only have one form factor.
In comparison, Android has phones on every major carrier and many of the smaller ones that now come in the three major form factors for smartphone, all touch screen, slide out QWERTY and candybar. There are a variety of price points and specials run with them too. To my knowledge there has never been a sale on iPhones. In comparison you can get major discounts and deals on Android phones from day one. I believe the Samsung Vibrant could be purchased for a dollar when it came out from Amazon. That is much more attractive than the $200 the equivalent iPhone would run you.
It would be very hard for them to maintain the lead in the market versus a foe like this. Some limitations are likely to always remain, there will probably never be a hardware keyboard iPhone for instance. And they won’t be offering nearly the number of models of phones as Android has on the market. Although I would guess sales of the iPhone far exceed the combined sales of any 3 models of Android phone by one manufacturer or probably even the best selling 3 Android phones.
I’ve always had 2 basic problems with iPods, you have to use their software to load the thing, and they all run a good 10 to 20% more expensive than the competition. I got a 32GB Samsung P3 that works just like a USB drive when it comes to loading software, has a speaker (pretty good one even), can play games (though I don’t care), has 5 “on the fly” playlists plus how ever many “permanent” playlists as you want to load, and it was $50 less than any 32GB iPod. This is why I don’t understand the iPod’s market dominance, at any level you can find better products for cheaper. The biggest thing I see pushing their market share is they’ve managed to become synonymous with “MP3 player”, kind of like Kleenix, Q-Tip and Xerox used to be, I think a lot of people don’t even look at anything other than iPods.
Which isn’t to say your analysis of why the iPhone slipped is wrong, just to say it should be true of the iPod too. I think the big thing is smartphone competition came on early enough and hard enough to prevent iPhone from becoming synonymous with smartphone so people looking into the market aren’t self limiting their language.