Finance:Rule of three (economics)

The rule of three in business and economics is a rule of thumb suggesting that there are always three major competitors in any free market within any one industry. This was put forward by Bruce Henderson of the Boston Consulting Group in 1976, and has been tested by Jagdish Sheth and Rajendra Sisodia in 2002, analyzing performance data and comparing it to market share. This is an attempt to explain how, in mature markets, there are usually three 'major players' in a competitive market.

The rule of three as put forward by Sheth and Sisodia in 2002 states that in a mature market, there will normally be three major competitors and several others, who only succeed if they are able to operate in a niche market. They based their studies on a review of a number of markets in North America. They compared market share to financial performance, and found that small, niche-market specialists and large, full-line generalists were those who performed best when holding a large market share. They also noticed a section in between the two in which companies performed poorly, which they referred to as “the ditch” (see reference); this is based on the form of the graph of market share versus financial performance as the graph slopes downwards for niche players (1% - 5% market share) and upwards for full-line generalists (over 10% market share). Sheth and Sisodia use the analogy of a shopping mall, in which they propose that there will be three major full-line generalist stores, along with various smaller, product and market specialist shops.

Sheth and Sisodia also make a number of observations with regard to how companies behave in such cases. For instance, the first-ranked player will often be the least innovative in spite of spending the most on R&D. However, the first-ranked player may 'steal' ideas from the third-ranked player.

It may be the case that, if a price war emerges between the first-ranked and second-ranked players, the third-ranked player may end up in “the ditch”, although a new third-rank player would be expected to emerge in due course.

Using a diverse sample of more than 160 US industries, two base-time periods, and numerous performance measures, Uslay, Altintig, and Winsor (2010) empirically tested the rule of three and reported that industries with exactly three generalists outperformed every other industry structure. They also found that micro-specialists, generalists with excessive market share, and firms "in the ditch" without clear strategic strengths tended to underperform others. Their findings provided empirical support for the “Rule of Three”.

See also

• Pareto principle

External links

Uslay, Can, Z. Ayca Altintig, and Robert D. Winsor (2010), “An Empirical Examination of the “Rule of Three”: Strategy Implications for Top Management, Marketers, and Investors,” Journal of Marketing, 74 (March), 20-39.