{"id":3607,"date":"2001-11-21T17:43:12","date_gmt":"2001-11-21T22:43:12","guid":{"rendered":"https:\/\/www.jagsheth.com\/?p=3607"},"modified":"2019-04-08T12:30:45","modified_gmt":"2019-04-08T16:30:45","slug":"the-rule-of-three-abstract-paper","status":"publish","type":"post","link":"https:\/\/www.jagsheth.com\/geopolitics-globalization\/the-rule-of-three-abstract-paper\/","title":{"rendered":"The Rule of Three – Abstract Paper"},"content":{"rendered":"
As competitive markets evolve, companies must avoid ending up in the “ditch.” Based on the forthcoming book, The Rule of Three: Surviving & Thriving in Competitive Markets (New York: Free Press, 2002)<\/h5>\n

<\/span>Abstract<\/span><\/h2>\n

Competitive markets evolve in a predictable manner and, once mature, exhibit many similarities across industries and geographies. Most notably, each market tends to be dominated by three major, volume-driven firms, which we term \u201cfull-line generalists,\u201d surrounded by a constellation of smaller margin-driven firms that are either product or market specialists. The three large firms together control approximately 70% to 90% of the market; niche players serve the balance. Further, a company needs a market share of at least 10% to be viable as a full-line generalist. In between the generalists and specialists is a gap, representing a market share of between 5% and 10%. It is in this \u201cditch\u201d that efficiency suffers and financial performance tends to be weakest relative to other levels of market share. The strategic implications of the \u201cRule of Three\u201d are myriad. Marginal full-line players (those with market shares close to 10%) are in danger of being pushed into the ditch by the larger players. Specialists that grow unwisely are in danger of being pulled into the ditch by the lure of greater market share. Particular competitive strategies spell success at various levels within a market; we present distinct strategies that companies need to pursue, depending on whether they are No. 1, No. 2, No. 3, ditch-dwelling or specialist players.<\/p>\n

<\/span>Introduction<\/span><\/h2>\n

Over the past several years, the world economy, principally in the developed free market economies of North America and Europe, has witnessed a unique combination of economic phenomena: mergers as well as demergers (i.e., spin-offs of non-core businesses) at record levels. Every year between 1997 and 2000 saw new records established for mergers as well as demergers. As a result, the landscape of just about every major industry has changed in a significant way. Industries as varied as wireless communications (Vodaphone merging with Mannesman), aluminum, banking, pharmaceuticals (the merger between Glaxo Wellcome and SmithKline Beecham to form the world\u2019s No. 1 drug company), petroleum (the merger of Exxon and Mobil) and airlines are in the midst of rationalization and consolidation, moving inexorably toward what we call the Rule of Three<\/em>. The recent economic downturn has slowed but not halted this fundamental evolution, nor has it altered its basic direction.<\/p>\n

<\/span>What is the Rule of Three?<\/span><\/h2>\n

Just as living organisms have a reasonably standard pattern of growth and development, so do competitive markets, and our research into approximately 200 industries has revealed that markets evolve in a highly predictable fashion, governed by the \u201cRule of Three.\u201d<\/p>\n

Through competitive market forces, markets that are largely free of regulatory constraints and major entry barriers (such as very restrictive patent rights or government-controlled capacity licenses) eventually get organized into two kinds of competitors: full-line generalists and product\/market specialists. Full line generalists compete across a range of products and markets, and are volume-driven players<\/span> for whom financial performance improves with gains in market share. Specialists tend to be margin-driven players<\/span>, which actually suffer deterioration in financial performance by increasing their share of the broad market. Contrary to traditional economic theory, then, evolved markets tend to be simultaneously oligopolistic as well as monopolistic.<\/p>\n

\"Figure<\/a>

Figure 1: The Rule Of Three<\/p><\/div>\n

The accompanying figure\u00a0plots financial performance and market share, illustrating the central paradigm of the Rule of Three: in competitive, mature\u00a0markets, there is only room for three<\/em> full-line generalists, along with several (in some markets, numerous) product or market specialists. Together, the three \u201cinner circle\u201d competitors typically control, in varying proportions, between 70% and 90% of the market. To be viable as volume-driven players, companies must have a critical-mass market share of at least 10%. As the illustration shows, the financial performance of full- line generalists gradually improves with greater market share, while the performance of specialists drops off rapidly as their market share increases.<\/p>\n

There is a discontinuity \u201cin the middle;\u201d mid-sized companies almost always exhibit the worst financial performance of all. We label this middle position the \u201cditch,\u201d the competitive pothole in the market (generally between 5% and 10% market share) where competitive position (and, thus, financial performance) is the weakest. The rule of competitive market physics is very simple\u2013those closest to the ditch are the ones most likely to fall into it. Therefore, the most desirable competitive positions are those furthest away from the middle. Firms on either side of the ditch\u2013especially those close to it\u2013need to develop strategies to distance themselves. If a firm in a mature industry finds itself in the ditch, it must carefully consider its options and formulate an explicit strategy to move either to the right or the left.<\/p>\n

The Rule of Three applies (and renews itself) at every stage of a market\u2019s geographic evolution\u2013from local to regional, regional to national, and national to global.<\/p>\n

\"Figure<\/a>

Figure 2: The Shopping Mall Analogy<\/p><\/div>\n

A useful analogy\u00a0to mature\u00a0competitive\u00a0markets is a\u00a0shopping mall\u00a0(Figure 2).<\/p>\n

Mature markets\u00a0are \u201canchored\u201d\u00a0by a few full-line\u00a0generalists, which\u00a0are akin to the\u00a0full-service\u00a0anchor department\u00a0stores (such as\u00a0Sears and JC\u00a0Penney) in a mall.<\/p>\n

In addition, a number of other players are positioned as either product specialists or market specialists. In a mall, a store such as Footlocker is clearly a product specialist, while The Limited is more of a market specialist. While Footlocker sells only athletic shoes, The Limited has a precisely-defined target market\u2013young, affluent, educated, professional women\u2013and caters to a wide range of their fashion needs. Store image, customer image and employee image all blend into one homogenous mix. The same company likewise operates stores such as Victoria\u2019s Secret, Lane Bryant and Limited Express, each a market specialist targeting a different customer group. This structure illustrates a maxim that we will discuss later\u2013that the best way for a specialist to grow profitably is through the spawning of new specialists.<\/p>\n

<\/span>How Competitive Markets Evolve<\/span><\/h2>\n

By observing how numerous markets have evolved, we have identified the primary drivers of change and a pattern of evolution. In the auto industry\u2019s late 19th century infancy, for example, some 500 manufacturers were building cars in the U.S. alone, none on a truly national scale. It took the 1909 launch of the Model T and Henry Ford\u2019s innovations in mass production to establish a standard and initiate the process of industry consolidation. By 1917, the number of manufacturers dwindled to just 23; by the 1940s, the market had consolidated further into three full-line players (GM, Ford and Chrysler) and several niche players such as American Motors
\n(which failed in its attempts at becoming a generalist and was acquired by Renault and then by Chrysler), Checker and Studebaker.<\/p>\n

\"Figure<\/a>

Figure 3: How Markets Evolve<\/p><\/div>\n

Eventually, the Rule of Three prevailed, with GM, Ford and Chrysler dominating the U.S. market.<\/p>\n

Two driving forces\u00a0shape markets:\u00a0efficiency and growth\u00a0(Figure 3). Growth\u00a0comes primarily from creating customer\u00a0demand while efficiency is a function of optimized operations. In cyclical pursuit of these objectives, markets get organized and reorganized over time.<\/p>\n

The starting point for a new market is almost always a new technology. Although early entrants can specialize in different ways, almost all tend to be product specialists. Young markets tend to have few technical standards, low barriers to entry and exit, and a decidedly local geographic focus. Newly created markets are typified by rapid growth and the presence of numerous competitors jockeying for position. This quickly leads to excess capacity as the market attracts more entrants than it can support.<\/p>\n

Even though viable start-up markets grow rapidly in pursuit of scale economies, they tend to be highly inefficient; firms within the industry lack economies of scale, operational experience and tools to automate production and distribution tasks. They tend to be vertically integrated, producing many of their own inputs, since a well-defined supply function has yet to emerge in the fledgling industry. Consequently, during the growth phase, the drivers of market evolution are geared to creating efficiency by enhancing scale economies and lowering costs. There are four key processes by which this happens:<\/p>\n