I think there's a minimum size set so VLC would have to be recompiled to change that.
You could have a look at some of the VLC skins (some are small/minimal; although most of though will open the video in a separate window):
http://www.videolan.org/vlc/skins.php
It also might be possible to edit one of the skins to have a smaller minimum width (using the VLC Skin Editor).
Arite.