I achieve the best quality/size ratio with the almighty mencoder and fine-tuning of the parameters. If anyone is interested in my kickass parameter list to encode a .vob file with mencoder to a great quality mpeg4 avi, here it is (3 pass encoding):

for the audio:
mencoder -ovc frameno -oac mp3lame -lameopts mode=1:q=0:aq=0:vbr=3:br=96 -o frameno.avi movie.vob

video pass 1:
mencoder -oac copy -ovc lavc -lavcopts vcodec=mpeg4:vbitrate=700:vhq:vqmin=2:vlelim=-4:vcelim=9:lumi_mask=0.05:dark_mask=0.01:vpass=1:vmax_b_frames=1:v4mv:trell:cbp:idct=8:vfdct=5:vstrict=-1 -sws 2 -vf crop=714:428:5:74,scale=608:256 -o movie1.avi movie.vob

the same for video pass 2, just change vpass=1 to 2 and movie1.avi to movie2.avi

if the resulting smile is too small for you (meaning you want to fill a cd with it), just use a higher vbitrate.

XviD has superceded libavcodec mpeg4 for a while now since api-4.

Also, since you're using frameno, you should always specify the bitrate (-ofps 24000/1001 for example) otherwise for NTSC vfr mpeg2 it may interpret vobs as 29.97 and waste space padding a 23.97 fps source to 29.97.

I also use mencoder 3 pass, but encode lame mp3 audio manually because I can use a52dec to normalize the ac3 file. XviD 1.0rc2 defaults + qpel is incredible.