[citation][nom]xbeater[/nom]Steve died, now they don't need to listen to him anymore. Now Apple can go on with milking their customer's wallets and pay less attention to stevie's ideologies.Wow... that was awfully negative what I pointed out there....[/citation]
I think a number of you are correct to say that a smaller form factor would go against what Apple (specifically Steve Jobs) has said in the past.
However, lets remember it's not even a rumoured device launch - just rumoured testing.
It may be that the new CEO doesn't agree with Jobs' philosophy which has proved to be very successful. Diversifying your product line can sometimes be counter productive, for a few reasons:
1 - Fewer economies of scale (smaller device will need some different parts.
2 - The smaller model will be cheaper so there may be a net loss in revenue if someone who would have previously bought the larger one decides on the smaller one.
3 - If you broaden your range too much it can confuse mainstream customers, the fact that there's always been only '1' new iPhone or iPad at any time makes it very easy for them to be comfortable in their choice.
4 - Device support - everything has to work on both devices which may have different resolutions / hardware - may not be a problem if the smaller version uses the same resolution as the iPad 2. Samsung had this problem with the original Tab, they failed to keep the resolutions consistent which made developing much harder than it should have been.
5 - Accessories - the reason iPhone and iPad accessories are so easy to create and popular is that they have a single model to target, meaning a better choice of accessories for these devices.
Of course, I'm pointing out why diversifying could potentially be bad for Apples profits (although of course it could be beneficial too if done right). For the customers, surely having more choice is nearly always a good thing.
If this does happen it could be the first sign that Tim Cook is tweaking Apple's trajectory.