The paying market for larger phones also contains the potential market for smaller phones.
There is no ADDITIONAL market in selling smaller phones, and not enough free market to make users switch brand for a smaller phone. So there is nothing to gain.
Crucially, even if 10% of the iPhone users want a smaller phone, they won't buy a smaller phone unless it's compatible to the iOS ecosystem. So roughly half of the market can only be effectively converted by Apple and for Apple it turned out to be not profitable enough to convert them.
