Those expenses would include mailing out your statements, manning the telephones, tax reporting and all the other functions that take place behind the scenes. So, small accounts, being loss leaders, are not highly prized by fund companies. At this cost it's still a loss to the fund, and larger accounts are forced to subsidize smaller accounts. If Vanguard were to raise their minimum account size, or impose even higher annual account fees, or both, they could have even lower average expense ratios. Of course, Vanguard's problem is not unique.
All financial institutions face similar choices.
Many other fund families have either much higher expenses, or higher minimums, or both. In the real world that the fund companies have to live in, too many small accounts means you go broke. From that perspective, Vanguard's policy is pretty reasonable. I always favor full disclosure. Vanguard's record on disclosure is one of the best in the fund industry.