The iTunes store is designed to make it so that apple can sell more iPods. The prices are artificially low. Apple makes a lower profit then they really should on song sales because they are trying to sell more iPods and similar devices
No arguments there, except for your point about Apple not doing well on iTunes sales. They're taking a 30% cut on each sale in iTunes, so all in all, I think they're doing pretty well.
They spend a lot on advertising as well. Plus as stated above they cover the credit card fees which are generally a small fixed amount plus a percentage of the price so they likely spend a lot on credit cards fees on a $0.99 purchase.
They also have to pay for customer service related issues on iTunes, like double charges, buying a song 2x, buying the "explicit" version of a song when they wanted the "safe" version. All of these tasks take manpower and money.