By One Classic Test, U.S. Telecom Markets Remain Unstable

Most big markets eventually take a rather stable shape where a few firms at the top are difficult to dislodge.

Some call that the rule of three or four. Others think telecom markets could be stable, long term, with just three leading providers. The reasons are very simple.

In most cases, an industry structure becomes stable when three firms dominate a market, and when the market share pattern reaches a ratio of approximately 4:2:1.

A stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest, according to the rule of three.

In other words, the market share of each contestant is half that of the next-largest provider, according to Bruce Henderson, founder of the Boston Consulting Group (BCG).

Those ratios also have been seen in a wide variety of industries tracked by the Marketing Science Institute and Profit Impact of Market Strategies (PIMS) database.

By those rules, most mobile markets, globally, are unstable. Using those ratios, the U.S. fixed network business also is unstable. So are some other related markets.

Many have noted the concentration of smartphone profits by just two suppliers--Apple and Samsung--for example.

A couple of important additional ratios seem to be important. Under certain conditions, competitors can reach a point where destabilizing the market is viewed as dangerous.

A ratio of 2:1 in market share between any two competitors seems to be the equilibrium point at which it is neither practical nor advantageous for either competitor to increase or decrease share, Henderson has argued.

That would seem to explain why marketing attacks in stable markets are not designed to upset market share, but only to hold existing share.

Any competitor with less than one quarter the share of the largest competitor cannot be an effective competitor. In a market where the largest provider has 30 percent share, that implies an attacker has to gain at least 7.5 percent share to remain viable.

There are some very-important strategic and tactical implications. Virtually any market that does not yet have the “rule of three” pattern and the 4:2:1 market share structure is going to be unstable, unless there are government-imposed restrictions on competition that allows the market structure to change.

But when markets are allowed to consolidate, growth is key. All competitors who survive must grow faster than the market average.

All except the two largest share competitors will be either losers and eventually eliminated or be marginal cash traps reporting profits periodically and reinvesting forever.

Anything less than 30 percent of the relevant market or at least half the share of the leader is a high risk position, long term.

Firm strategy also therefore is clear: cash out of any position quickly if the number-two market position cannot be gained, or aim to take the number-two spot.

Definition of the relevant market and its boundary barriers becomes a major strategy evaluation. In other words, knowing “who else is in our business?” is necessary before any firm can assess its market share position and challenges.  

Shifts in market share at equivalent prices for equivalent products depend upon the relative willingness of each competitor to invest at rates higher than the sum of market growth rates and the inflation rate. In other words, if markets are growing at two percent, and the inflation rate is two percent, than a leading contestant has to invest at rates greater than four percent annually.

Anyone who is not willing to do so loses share. If everyone is willing to do so, then prices and margins will be forced down by overcapacity until someone stops investing.

The faster the industry growth, the faster the shakeout occurs, Henderson has argued. There also is one rule that applies directly to the U.S. mobile market: near equality in share of the two market leaders tends to produce a shakeout of everyone else.

That is the case for Verizon Wireless and AT&T Mobility, and underpins the argument advanced by Sprint and T-Mobile US that they cannot prosper, long term, unless they merge.

The market leader controls the initiative. And though equity holders do not like the practice, cutting prices to maintain share is the “right” strategy. Any market-leading firm that chooses to maintain near-term operating profit while losing share, will not survive.

If the market leader, under attack, prices to hold share, there is no way to disrupt the market, unless the company with number-one share runs out of money to maintain market share, Henderson has argued.

One might argue about why such patterns are seen, but market share seems directly related, typically, both to cost and profitability. In other words, cost and profit margin are functions of market share.

Under most circumstances, enterprises that have achieved a high share of the markets they serve are considerably more profitable than their smaller-share rivals, according to the Marketing Science Institute and Profit Impact of Market Strategies (PIMS) database.

The ratio 4:2:1, representing market shares in telecom markets, is key. That pattern suggests the market is stable. At the moment, it is hard to identify too many telecom markets that fit the pattern well.

And tells you what you need to know about market disruption. It is possible, because markets are unstable.