1. Selling Dock Connector stuff in 2013 and 2014 is just bad for fragmentation, so they have to get rid of the old connector for their entry level iPhone (and also iPad, there's no way that the iPad 2 will be sold by Apple after the iPad 5 is released).
How can they sell a device that has Lightning, but costs less than the 549$ they will charge for the iPhone 5 now?
They have to create one, they would either have to redesign the iPhone 4S to use Lightning, but then they still would have the "outdated" screen - or they can go the full lenght and do a new device based on the 4S but with all the newer stuff they need to decrease fragmentation of device features.
They chose the latter.
2. The iPhone 5 is even more costly to produce than the iPhone 4S (more difficult -> Scuffgate), but when they establish a plastic case at the entry price point, they will be able to sell a plastic phone that is based on the iPhone 5 when the iPhone 6 is released next year.
The plastic shell is big enough so that they probably could insert iPhone 5 mainboards into the case without having to change anything on the circuit board, like a case you're using for an iPhone 5 now - but without the aluminium shell of the phone inside the case.
3. Cannibalisation of their own products has happened always in the past and they prefer to cannibalize their more expensive products with their cheaper products to some other company's products doing that.
People have been joking how the iPhone 3GS was just the same as the iPhone 3G (even though the hardware was much better) and the 4S just the iPhone 4 with some unimportant feature (Siri) added that they also could have ported to the iPhone 4 and 3GS.
Some even ridiculed the speed improvements between iPhone 4S and iPhone 5.
This has happened in the past and it will always happen.
The iPhone 5S?
"Blabla unimportant fingerprint reader" and a bit faster...
The next generation of the iPhone doesn't have to be much better, because most people upgrade only every two years - and there's a big improvement from one iPhone to the one that's released two years later.