But it WAS too expensive. The fact that the iPhone price dropped within two months of it being introduced is proof of that. And you have to remember, that most touch phones sucked at the time, and they ALL sucked if they didn't have a stylus, and it was a really, really, big deal to have an all touch interface that truly worked.
And, it wasn't as if Microsoft didn't have a mobile OS. Windows Mobile always worked decently, but never was just truly great. And it never focused on being just for phones. It was adaptable to any type of mobile environments, like Android is trying to do right now.
It is also more difficult to implement new technologies on top of old ones, which was Microsoft's first choice when they tried to make the phone part of Windows Mobile more modern, until they realized that that house of cards wouldn't stand. Then they did a rewrite of, which lead to Windows 7.
So, from Microsoft's point of view, it was a limited phone, that had no way of adding apps, no business functionality, no keyboard for typing, no true enterprise security, and for a whole lot of money, only available on AT&T. I too thought that the original iPhone wasn't that great, only marginally better than the ROKR E1, functionality-wise. Though, I did think that that original iPhone screen was truly awesome.
So, let's not come down to, to hard on Balmer for not recognizing the iPhone at first for the threat it came to be.
If you watch jobs unveil the iPhone, there is a moment, when speaking of three new revolutionary devices being released that day (http://youtu.be/0KfrSzyXmiw?t=1m5s), he says "the first one is wide screen iPod with touch controls. The second is a revolutionary mobile phone. And the third is a breakthrough Internet communications device.", repeats the line, and then chuckles as everyone realizes that they're all one device... I remember streaming that live and thinking: "Holy crap, phones don't suck anymore". If Balmer watched that and laughed at it, I'm going to be hard on him. He had the chance to react and he let Jobs walk away with it. So many people, including me, we're just waiting for a cell phone that didn't suck.
But as a leader of technology, Ballmer should have realized that in the early stage, new technology is expensive, and people (particularly fans of apple) will buy. The iPod only a few years earlier was also too expensive, and had a bunch off early tech 'flaws' ( Mac only, FireWire only, etc), yet came to dominate the market, and Microsoft couldn't catch up. Ballmer, or the other senior leaders at MS should have recognized the iPhone as the evolution of the iPod.
Everything is too expensive when it first comes out. The first cars were so expensive that building a car that the men on the assembly line could afford was an innovation (so was using an assembly line). Ballmer himself probably remembers when microcomputers were fairly expensive. Maybe he laughed at his college buddies for dropping out to write microcomputer software and start a company on that premise. But if he didn't learn his lesson in his decades in the tech industry, I don't know what he thought he was doing at Microsoft.