I could actually see them offering 3.5" and 4" side by side... I know several people who got the 4S in the past few months just because they thought the 4" screen on the 5 sounded too big.
"Sounded" too big? Did they actually hold one in their hands before deciding? I still have a 4S (I won't be eligible to upgrade until June) and have held friends iPhone 5's and the screen doesn't really seem that much bigger because the size only increased vertically, plus it is thinner and lighter.
I wouldn't mind if Apple offered something close to the 4.8 HD Super AMOLED display like on the Galaxy S3 has, but of course that would cause headaches for developers I am sure and cause more fragmentation.