In what sorts of markets does rapid market share growth really matter for the long term? In what markets is it possible to shift share positions once markets are mature? When should firms focus on specialties and niches? When is an aggressive growth strategy called for, and when is it ill advised?
When and why should leaders shift to profitability rather than growth, in growth markets? When will business leaders reach the limits of their growth strategies and have to consider becoming asset sellers?
The "Rule of Three" is a concept in business strategy originally introduced by the Boston Consulting Group that might inform business leader decisions of these types.
The rule suggests that in mature, competitive markets where there are barriers to entry; economies of scale or are capital intensive, three companies tend to dominate, with the largest player holding 40-50 percent of the market, the second-largest holding 20-30 percent, and the third-largest holding 10-20 percent market share.
The concept is useful for strategists and market researchers as it suggests reasonable strategy possibilities, such as whether it makes sense to undertake disruptive actions to gain share, and if so, what rational possibilities for gains could occur.
The other corollary is that profitability also tends, in such markets, to correspond to market share.
So the rule suggests the importance, in capital intensive industries, of taking advantage of barriers to entry; economies of scale and industry segment leadership, especially when young industries are emerging.
Hence the importance of rapid growth and share gains in software, some types of hardware, connectivity services, commercial aircraft manufacturing, search or cloud computing, for example.
Such Rule of Three markets generally are not susceptible to disruptive attacks, once the pattern is set. If one assumes market share is roughly correlated with profitability, then the market leader will have twice the profitability of provider number two, which in turn will have twice the profitability of provider number three.
A 40-20-10 pattern could hold, with the balance held by numerous other specialty firms. That advantage in profitability contributes to all other efforts to maintain market leadership on the part of the leader, and also limits the possible range of actions by providers two and three to compete.
Pricing attacks might generally fail for the simple reason that the market leader can simply match any price reductions attempted by the smaller providers. A firm with 10-percent margins could easily see zero margin, which is not sustainable. And a firm with a 20-percent margin that is sliced in half could not easily sustain such outcomes for too long, much less a permanent halving of profit margin.
That also tends to be true of attempting value attacks (bundling, for example), which often can be matched by the market leader.
The Rule of Three does not apply to fragmented industries, though. Consider the U.S. fast food market, where brand matters; product segments are diverse; barriers to entry are quite low and economies of scale might not be decisive.
And though lots of markets--consumer and business--are concentrated, many are not. Concentrated industries are more likely to resemble the Rule of Three pattern, while fragmented industries tend not to show the pattern. The exceptions are that some segments of fragmented industries might well show a quasi-Rule of Three pattern.
Athletic footwear might provide one example of a Rule of Three pattern, even within a larger industry category (fashion and apparel) that might be fragmented.
The U.S. home broadband market provides another example. Looking at all providers, the Rule of Three does not seem to hold. But within the category, looking only at legacy telcos, the pattern does seem to hold. AT&T has 15- to 18-percent share; Verizon seven to 10; Lumen two to four.
The caveat is that AT&T, Verizon and Lumen do not actually compete head to head in most markets. In fact, market share corresponds to homes within the respective provider service territories. In contrast, where AT&T, Verizon and T-Mobile compete head to head across virtually all markets, shares are roughly equal.
So even if mobile service is highly capital intensive, mature, with high barriers to entry, there seem to be offsetting factors, even when brand preference might be relatively stable. At some level, the regulatory context might prevent any of the providers from amassing too much more share. And most observers would likely agree that offers are highly competitive.
Likewise, the Rule of Three seems to apply in the U.S. cloud computing “as a service” industry. Some will point to Microsoft’s share as deviating from the expected pattern. But real world markets often do not perfectly match what theory tells us to expect.
Also, Microsoft’s revenue in the “intelligent cloud” segment historically has included productivity software, for example. But Microsoft has gradually been realigning revenue reporting to better reflect performance of the “cloud computing as a service” activities that compete head to head with Amazon Web Services and Google Cloud.
The point is that Microsoft cloud computing revenue has for some time not been an easy “like to like” comparison with AWS or Google Cloud “computing as a service” revenues, as Microsoft once included other revenues, such as game platforms, within intelligent cloud.
On the other hand, Microsoft, in removing productivity software subscription revenue from intelligent cloud, has added advertising revenues to the intelligent cloud category.
The upshot is that there should be a temporary resetting of Azure market share, in a downward direction.
The Rule of Three might be relevant early in a concentrated industry’s emergence as well as once the market share pattern is established, as it suggests disruption will be highly unlikely.
The rule will be less useful--or break down--under some circumstances, such as when a major technology disruption threatens the legacy business model; when governments decide to regulate or deregulate an established industry; when some innovation enables non-traditional suppliers to enter a market or when consumer preferences change significantly.
Economic downturns, new business models, supply or distribution chain disruptions or cultural or societal shifts could, in principle, be disruptive to established industries. Auto manufacturing might provide an example, as consumer shifts in preference for higher-mileage vehicles; sport utility vehicles rather than sedans; trucks rather than passenger vehicles; or hybrid and electric vehicle demand occur.
As the artificial intelligence market grows, business leader strategies might well turn on expectations about whether the Rule of Three actually applies, as if so, where in the business.
