It is the price. If it was free it would be really popular.
You know, I think Apple's actually been very clever with iPhone pricing and features in the UK.
The current model is, let's be polite here, not cheap. However there will always be a core market for this sort of device, the people who have to have the latest and greatest first. For those people Apple have delivered a phone which, and I say this as a user of smartphones since the original Orange SPV, is lightyears ahead of the competition in terms of interface and applications (quality not quantity obviously).
Not only does Apple get a ton of cash from these early adopters, it can use them to gauge reaction to what it's done (remember this is their first attempt at a phone after all) and see what works (interface), what doesn't (sms) and what needs a hardware upgrade (camera). They also get to see how a single hardware spec is received in various markets across the world. At the same time these relatively small numbers of users (compared to the overall market) are showing off their devices in public and it's very rare indeed that someone isn't at least impressed by the looks of the thing.
Next up Apple introduces a 3G version at some point in 2008 with revised hardware specs and other tweaks. At the same time the SDK will have been available for a while and some decent third party applications will be available. At that point Apple reduce the price on the original unit and it takes the place of the mass market phone (£100 plus a 12 month, £25 contract for example) while the 3G phone comes in at the same price point as the current model.
So no, iPhone is definitely not a failure in the UK market. Heck, if you want proof of that have a look at all the other phone manufacturers scrambling to produce their own versions (and all missing the point about what makes the iPhone special, the interface, but never mind). It's selling well enough to build the brand image and that will play into Apple's hands when they launch the next version. Besides, if it was free then they could never keep up with demand.
This is a long game Apple are playing and, as we've seen with the iPod (and for that matter the Macbook, Macbook Pro and iMac) they are very, very good at this. Most importantly, this one phone that's sold somewhere around 200,000 units has shifted the goalposts so far that they're currently out of sight and I have to say that for that alone Apple deserve to succeed. Mobile manufacturers had become far too complacent and now they've been given a damn good kick in the unmentionables to get their attention we as consumers should see the benefits pretty damn soon.
Think of it as the Nokia 7110, the phone Nokia introduced with the spring loaded sliding bit at the bottom after the Matrix made the discontinued 8110 such a hit. It never sold in huge numbers but its influence on handsets was felt for years afterwards (first WAP phone, interface experimentation with the interface elements) and is still around in some of the really high end stuff today.