Apple openly acknowledges that the iPhone is cannibalizing its iPods [CC] — and they don't seem to care;
It's better for you to cannibalize your own products, than for your competitors to do it for you. There was a recent quote from El Jobso (can't find off hand, sorry) saying that (in his absence) Apple just sat on the top end of the market with the Mac, got greedy, failed to innovate, and suffered. Their success with the ipod seems to support this. They cover nearly the whole market while still remaining the high end brand.