"but they picked a battle against the entire industry" - That's an excellent point which is often ignored. When you set yourself up to do everything on your own (OS, CPU, Other hardware design etc. in case of Apple) that poses serious scalability challenges and it of course exposes you to more and more competition from all directions.
They are basically pissing off everyone - so they still don't have a free navigation app with turn-by-turn to compete with Google and they will struggle for some time to get that done. Now they got to do their own ads too. Own CPU too - so it's going to be longer than competitors to get a great dual core ARM CPU out. I understand there are different teams and Apple can hire as many people as they want but in reality it just doesn't scale in the long term. (They still need to shuffle teams between OS X and iOS as far as I can tell.)
But Apple knows they cannot play the numbers game - so they will stay a #2 or #3 and get away with it by increasing their profitability - that's a no brainer. But how it affects their competence in delivering new features and hardware advances against competitors - that remains to be seen.
I wouldn't be so quick to discount the idea of doing everything on your own. (Besides, they aren't exactly making all of the components on their own...just ones they believe they can improve upon)
Judging by Apple's rapid increase in portable computer sales in the last decade, I think many would say "picking a battle against the entire industry" hasn't worked out too terribly for them. Apple's one-model approach for mobile devices (with a small set of possible hardware configurations) has and will continue to pay off big for development purposes and will allow for more advanced features to be integrated thoroughly and simply across the platform more quickly (examples - GPS & gyro now & touch sensitive back & NFC technologies in the future).
The bottom line is that I would expect Android to continue to push the industry forward on many specification style features like high quality cameras, speedy hardware, and storage space while the iPhone will have more "leapfrogging" features like the examples listed above. Android software implementations will probably continue to be piecemeal while the iPhone implementations will be more thoughtful yet limited. (example - push notifications & UI)
Just to be sure, I wasn't discounting them - as I said it remains to be seen how they scale to the DIY challenges that I mentioned. Also the impact of any limitations resulting from these scale issues (if they prove to be a problem) may not be that much in terms of lost sales - as more than anything Apple's success lies in building brand loyalty and the Apple customers may choose to live with those limits. But it will pose problems for them if they target rapid sales growth outside the US.
Apple's ability to smoothly (re)use OS X components for iOS and vice-versa seems like a big plus. They can easily move staff around if need be, and the best features move back and forth quickly.
They are basically pissing off everyone - so they still don't have a free navigation app with turn-by-turn to compete with Google and they will struggle for some time to get that done. Now they got to do their own ads too. Own CPU too - so it's going to be longer than competitors to get a great dual core ARM CPU out. I understand there are different teams and Apple can hire as many people as they want but in reality it just doesn't scale in the long term. (They still need to shuffle teams between OS X and iOS as far as I can tell.)
But Apple knows they cannot play the numbers game - so they will stay a #2 or #3 and get away with it by increasing their profitability - that's a no brainer. But how it affects their competence in delivering new features and hardware advances against competitors - that remains to be seen.