Apple iPhones are being smuggled into China through word-of-mouth networks, dealing a blow to Apple's efforts to create official distribution channels for its popular devices, according to a report.

Tourists, small entrepreneurs and electronics goods smugglers are buying some of the Chinese-made iPhones in the United States for delivery back into China, the New York Times reported on Monday.

There are many unaccounted for iPhones in the hands of the public. Apple says it sold 3.7 million units last year. However the carriers offering wireless services for the device have reported that only 2.3 million units are registered for use on their networks.

Once in China, the phones are digitally unlocked so they can work on local networks. Those unauthorized activations can mean trouble to users because Apple software upgrades may not be compatible with the unlocked phones. The result could be iPhones which simply don't work. Apple has warned against unlocking phones, saying it breaks the purchase agreement.

There's no question many of them are ending up abroad, Charles R. Wolf, an analyst who follows Apple for Needham & Company told the Times.

Some analysts believe the related losses could end up costing Apple up to $1 billion during the next three years, the Times said.

Citing users in China, the Times says the $400 phones are selling for between $450 to $600 there. The typical price in Shanghai or Beijing is $555. To unlock the phone and add Chinese language software to it costs $25, the Times says.

Sellers in China usually get the phones from suppliers who buy the phones in the U.S. and ship them through airline passengers for a typical commission of $30, they say according to the report.

Apple's negotiations with China's largest carrier, China Mobile, were shelved last month. Among the sticking points may have been that Apple wants a cut of the revenue generated from wireless services offered.

If the phones were being used in the U.S. on the exclusive AT&T wireless carrier, Apple would receive $120 a year for each, the report states.