Is smaller really better?
There are at least two companies that disagree with the Four Thirds "smaller is better" philosophy and are making cameras with larger than standard-size image sensors. One is Sigma, which is introducing a new point-and-shoot DP1 camera. Although most point-and-shoot cameras use image sensors that are absolutely tiny when compared to SLRs (think "balance on the end of your finger" sized). The DP1 uses a sensor roughly eight times larger than the norm.
The second, interestingly, is Leica, whose soon-to-be-released S2 SLR camera will sport a sensor more than three and a half times larger than a standard SLR APS-C sensor -- or six times larger than Leica's own Four Thirds sensor.
Why, when smaller sounds so attractive, would some companies and photographers be opting for bigger? Two reasons: noise and depth of field.
Much like a smaller negative will result in grainier pictures, smaller image sensors can result in noisier pictures. Smaller sensors mean each pixel has less area to gather light and that results in more image noise (unwanted variations in brightness and/or color) in the picture.
Depth of field describes how much of the image in front of and behind the subject is in focus. Imagine you are photographing someone standing in your living room. In one photo, the person is sharply in focus, as is the entire room. You can see everything in the foreground and the background clearly. In the second image, the person is in sharp focus, but the background and foreground are completely blurred. The first image exhibits a large depth of field while the second portrait demonstrates a short depth of field.
Depth of field is closely related to the length of the lens. The size of a camera's sensor will determine how long a lens you need to get the angle of view you want. All other variables being equal, a shorter lens will have more depth of field than a longer focal length lens -- and many photographers actually want less depth of field in order to draw attention to specific areas in a photo. As manufacturers move to smaller sensors, that professional short depth-of-field look becomes harder to achieve.