So the digital file, lets assume you're using apple lossless, is converted to Analogue by the ipod using whatever cheap D/A converter Apple were sourcing at the time. This is then passed over the dock connector into the dock where it is converted back to digital to be sent over a cable to your D/A converter to be converted back to analogue again.
I'm sure that helps improve the quality.
What exactly is in this dock apart from this pointless conversion that makes it worth £150? An ipod dock should simply be a passthru for the AV connections and a method of remote control.