Even when they work with external suppliers (and a few of them for some reason) for items such as the Nexus devices, they still have failings such as very flat shapes that are hard to hold comfortably without dropping and smashing (like the older Nexus phones).
If they had attempted to do their own hardware, it would have been a horrendously uphill battle against the phones in the market at the time (Apple had tiny share, Nokia colossal).
Putting out the OS meant that hardware manufacturers could compete with different features whilst still (theoretically) having a common OS that users could mostly navigate around and app developers could write for. Contrast this with Nokia at the time, where S40 etc. worked wildly differently on different phones, with different JSRs supported by the J2ME runtimes on each phone, and where they essentially competed with their own other Nokia phones for specs; Nokia did a massive range of phones that were mostly the same but looked different or had very mild changes - it was too much choice!
This way Google could carry on doing software and leave the hardware to external companies that were used to doing hardware. I still have my TMobile G1 though, for history's sake. Don't use it though - it practically has no RAM left over after boot.