C.C.
My daughters are 5 and 8, and I totally understand your dilemma. My older daughter was awful at that age - she would act like such a little snot! Normally she is a very sweet girl, but at that age she became very exclusive when choosing her friends. She would "only" play with a few girls, and it became common to hear "You're not my friend!" or "I'm not going to play with you." Ugh. She seemed to love making other kids cry! Whenever I heard it, I'd immediately remove her from the situation - if we were at the park, I'd pack her up and take her away right that minute. If I was picking her up from school and heard it, I'd tell her she was going to bed an hour early (because only very cranky and tired children are mean to their friends! - at least that is what I'd tell her). She learned. She's now in 3rd grade and has LOTS of friends - and even the ones she doesn't really like, she is still kind to.
Basically I treat all undesirable behavior the same way - I make the consequences memorable, and therefore, persuasive.