It's Apple's answer to the 2004 problem: "All phones will soon include free MP3 players. As this will eliminate the iPod cash cow, how do we compete with these new telecom competitors?
"Answer: We'll add a phone to our MP3 player."
So I see it more as a "How can we make a cool pocket macbook which has a killer browser" rather than how to save the iPod. After all, no other mobile browser can compete at the moment.
But it still plays in the phone league. It replaces a purchase of another phone. If hadn't bought an iphone, you probably would have bought a nokia.
The beauty of Apple's approach is that rather than allowing phones to make playing music a secondary feature of phones, they have found a way to make voice calls a feature of portable tablet computers.
And while they were at it, they made playing music a secondary feature of portable tablet computers as well.
This is evident by the fact that it's primary purpose is to serve as a nice multimedia player and internet browser, but nothing really productive.
I say this from experience. I used to use my blackberry (sometimes heavily) for work. I have an iphone now and can't fathom doing anything approaching work with it.