iPhone needs a 4.7 inch phone to stay competitive.
I own an iPhones 4. My so called "daily driver", but recently purchased the Galaxy Nexus to play around with.
Without getting into another iPhone vs. Android debate, I can tell you one area where Android has a big advantage over the iPhone are the massive screen sizes. Nope, you can't use a 4.7 inch phone with one hand, but as it turns out people really don't care. It is not stopping people from purchasing the Galaxy S3 and other large screen phones. I even saw a lady recently talking on the Galaxy Note. It can't help but think how stupidly big that phones looked when she was holding it up to her ear, but that is not the point. The point is that the large size did not stop her from buying it.
Ask yourself this, if you could choose between a 3.5 inch or a 4.3 or bigger inch iPhone, which would you choose? I'd take the bigger screen iPhone in a heart beat.
I am sure Apple put an incredible amount of thought and design in the iPhone size, but despite Apple best design intentions the market is saying it wants big phones.
Better yet, why don't Apple put it to the test. Release a 3.5 in. and a 4.7 in. and see which one sells better. Apple realized that one size does not fit all when creating their iPod lineup. I wonder why they don't create different phone sizes. But I already know the answer to that. It is to maximize profits. By settling on a single phone design, they minimize costs.