Well as you lose territory you'll lose ships and pilots. Which could reduce the size of your battle groups as discussed above. Would that be sufficient or do you believe that having a small territory specifically would mean a race fielding less ships per engagement? If so I'm interested in hearing more about that.
Smaller territory limits the number of several aspects:
1. military stations/bases
2. number of planets which have specialised orbital shipyards
( they can't build many ships at one time to increase their numbers or replenish losses)
3. if a race has only several vital planets which house all of the key infrastructure then that means "you lose if you lose them"
4. less resources to build spaceships like Quantium 40
So I think that races with smaller territory simply have smaller fleets because they can't afford to supply larger ones (or they would have to do that at the cost of their citizens - a similar concept appeared in an old game called Master of Orion 2: Battle at Antares:
you needed space stations and communications to provide command points which limited the maximum size of your fleet, also government type was important - democracy had less command points than an empire, you could always built more ships but that drained your cash )
ou're suggesting this for gameplay reasons I suspect? Do you think this is a good idea? Penalising a race for being technologically advanced I mean? I am of the opinion that if you (as a player) choose to fight a war as the League of Non Aligned Worlds against the Vorlons you pretty much know you've set yourself a difficult challenge
Well, generally speaking yes...
Such races have a really huge advantage so they are able to decimate the younger races without any difficulties
Of course as you said the First Ones
aren't in such numbers as they were in the preevious eras, because mainly the Shadows and Vorlons stayed in the known galaxy...
So I would suggest to limitate their numbers for simple game balance like 1/2 or 1/3