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Published: Jan 16, 2002 in Knowledge@Emory

When regional air carrier US Airways wanted to really spread its wings to become a national airline, it took on industry leaders American, United and Delta. The result? It lost money and fell into the ditch between the far-flying generalists and regional specialists. Unable to mount a real challenge to the Big 3, US Airways recently accepted an acquisition offer from United — and will soon become just another name in aviation history books.

US Airways’ downfall was no surprise to Jagdish Sheth and Rajendra Sisodia, coauthors of a new book entitled The Rule of Three: Surviving and Thriving in Competitive Markets. The airline’s failure fulfilled their Rule of Three thesis: Virtually every industry (free of excessive government intervention) will eventually consist of three dominant competitors. Think General Motors, Ford, Daimler-Chrysler; Anheuser-Busch, Miller, Coors; Citigroup, Bank of America, J.P. Morgan Chase; McDonald’s, Burger King, Wendy’s. Sheth and Sisodia cite hundreds of examples in industry after industry.

The Rule of Three, is a unique, fascinating study about the life cycles of entire industries, from A (Accounting/ Consulting Companies) to W (Wireless Carriers). Sheth is professor of marketing strategy at Emory University’s Goizueta Business School, and Sisodia is professor of marketing at Bentley College in Waltham, Mass.

They assert that the Big 3 players in a given industry are surrounded by a host of niche specialists, and while both ends of the spectrum can prosper, there is great danger in a firm being caught in the unstable, unprofitable middle, or the “ditch.” For example, Sheth advises retailers to pay attention to Nordstrom’s plight: ” … this West Coast Department store acquired a sterling reputation for customer service, setting the industry standard for personal service. Then in the late 1980s the company decided to expand rapidly. By 1999, Nordstrom had grown to 99 stores in 22 states.

“In effect, Nordstrom lost its regional specialty status and became another mid-sized retailer in the industry. The company’s growth undermined its reputation for service as well as its fashion leadership. Its information systems were woefully antiquated … the company was highly decentralized and fragmented: its 900 buyers caused serious efficiency problems. There was no national marketing effort; advertisements were created regionally. Nordstrom runs counter to our prescription for successful generalists. In contrast, the much larger R.H. Macy & Co. has only 100 buyers, sophisticated IT, centralized operations, and national marketing,” the authors note.

How did Sheth come up with his colorful “going in the ditch” analogy? “I was driving down a divided four-lane highway, and it struck me that the grassy ditch separating one side of the road from the other — a place where no one wants to end up — is exactly the predicament companies can find themselves in if they don’t understand how industry life cycles work.”

Sheth continues with another analogy: “Look at the whole Rule of Three concept as if it were a shopping mall: There are a trio of anchor stores, and clustered all around them are dozens of specialty shops.” Everyone can be successful in this environment, Sheth asserts, but the competitive nature of markets demonstrate there can be only three “anchors” — a trio of full-line, volume-driven competitors that typically control 70 – 90 percent of an industry.

The Rule of Three draws on over 20 years of the authors’ research to corroborate its thesis and, even more importantly, to give “counterintuitive insights, which inform suggested strategies for the ’Big 3’ players, as well as for mid-sized companies that may want to mount a challenge along with advice to specialists who want to flourish.”

Sheth and Sisodia argue that “naturally occurring competitive forces … will create a consistent structure across nearly all mature markets.” First and foremost, that structure rewards the most efficient companies. But with too much competition, customers can become so confused that they don’t buy, and the competitors slug it out by slashing prices and/or quality — which jeopardizes everyone’s profitability.

That’s where the Rule of Three comes in: “When the drive for efficiency runs headlong into the wastefulness of hypercompetition, most markets respond with a logical solution” — a seismic shakeout period that yields three dominant players, with a host of specialist/niche players off to the side. Such a structure “provides the best blend of competitive intensity, overall efficiency, industry profitability, and customer satisfaction.”

Sheth found, however, that the Big 3 do best when none of their individual market shares exceeds approximately 40 percent. Any higher, and they can lose profitability, face regulatory problems (think AT&T and its forced breakup in 1984), and run out of growing room. So incremental markets and customers can become more expensive to acquire and often generate less revenue.

For corporate managers, some of the most valuable and practical insights provided by The Rule of Three are the concise sets of differing management strategies given for each of an industry’s Big 3 players, as well as for specialty companies. For instance, the strategies for #1 companies are:

Be a “fast follower” in innovations.

Push for the adoption of industry-wide standards.

Develop world-class marketing and advertising through single or dual global brand positioning

Use multiple distribution channels.

Emphasize both low costs and product differentiation, and focus on volume over margin Grow the market.

Avoid dogmatic thinking

An example of following the above strategies for #1 firms is Anheuser-Busch. In terms of being a “fast follower,” it waited as Miller Brewing Company took on all the costs of developing and marketing its Lite beer, then launched its own product. Anheuser-Busch’s ’second but better’ strategy paid off. In January 2001, the company announced that Bud Light — the second largest beer brand in the world behind Budweiser — registered its ninth consecutive year of double-digit growth.”

When asked what his biggest surprises were in researching the book, Sheth replied, “One was that the #3 company is more innovative than either of its larger rivals, although they have larger R&D budgets … and this means #1 and #2 have to pay close attention to new ideas developed by #3. I also found that the larger a specialist company gets, the more likely it is to fall into the ditch rather than to join the Big Three by unseating a larger, generalist rival.”

The authors also point out that the Rule of Three “allows for the presence of any number of niche players, [so] there is continual market entry, change, and growth even while a relative degree of stability is maintained.” In fact, every industry contains both oligopolistic (full-line generalists) and monopolistic (product and market specialists) competitors — that’s a large part of what makes up the fluid, dynamic life cycles of markets.

Sheth urges executives not to see the Rule of Three as merely “an interesting theoretical construct”; rather it is a “powerful empirical reality that must be factored into corporate strategizing. Understanding the likely end points of market evolution is critical to the ability of executives to develop strategies that result in success,” he said.

Because such market evolutions are usually lengthy, “strategizing must therefore be done with time horizons spanning decades or more, far exceeding normal planning [time frames]. In particular, managers must be on the lookout for the major drivers of market restructuring: new technologies, regulatory shifts, and market shifts. Failure to understand and appreciate these events can cause [corporate leaders] to engage in ’unnatural’ [i.e., anti-Rule of Three] marketplace behavior, perhaps ultimately dooming their companies.”

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