I think it actually looks great. And would be a really good alternative to a mini. As there isn't one at the moment.
I don't really see it "dilluting" the brand at the moment, when you consider you can buy a full specc'd mini for £30K, they're not that cheap, and i'm sure the A1 wouldn't be either.
You can make a "quality", premium, small car that maybe VW couldn't get away with. A posh, much nicer version of a polo.