The Rule of Three: why profitable brands are usually very big or very small

Why profitable brands are usually very big or very small

This article from some time back by Jagdish Sheth and Rajendra Sisodia sheds fascinating light on the business case not just for expanding brands but also shrinking them as well. According to the authors’ “Rule of Three”, the quest for scale is quite literally a race first for dominance and then for survival. But if you can’t win, don’t try.

Sheth and Sisodia’s research reveals that in most mature markets, there is only room for three volume-based competitors competing across a range of products and markets. Together, these three players control 70 – 90% of their market. To be viable as a volume driven player, the authors say, companies must have at least 10% market share. Financial performance continues to improve as market share increases, up to about 40%. However, once they expand beyond that 40% threshhold, brands can find themselves subject to a loss of advantage in economies of scale and heightened anti-monopoly scrutiny.

(Bruce Henderson of the Boston Consulting Group has a view that not only must there be no more than three significant competitors but that those competitors must exist in an arrangement ratioed 4:2:1)

Stay away from the middle market

The extent to which each of the big three can consolidate market share depends on their respective abilities to alleviate the pressure of fixed costs on their pricing.

There is only room for three volume-based competitors competing across a range of products and markets

While downturns, price wars and market changes can see three top players reduced to two for a time, in the longer run a third player will return or rise to claim the vacant spot. Of these three players, the market leader is generally a responder rather than an innovator while the third placed competitor is most likely to be the market leader in terms of instigating change.

Not surprisingly, the most profitable participants of the remainder of the market are those with small and specialist roles. For those contemplating a serious play for size, this observation will surprise some of you I’m sure: “The performance of specialist companies deteriorates as they grow market share within the overall market, but improves as they grow their share of a specialty niche.” (That’s because when specialist companies become even more niche, they become bigger fish in smaller ponds.)

The most vulnerable are the mid-sized companies looking to get above the 10% threshold. They are generally the least competitive players and the poorest financial performers. Sheth and Sisodia label this middle market space the “ditch”. They continue, “the most desirable competitive positions are those furthest away from the middle. Firms on either side of the ditch especially those close to it need 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.”

How to succeed at scale

Because The Rule of Three applies and renews itself at every stage of a market’s and presumably a brand’s geographic evolution from local to regional, regional to national, and national to global, Sheth and Sisodia’s findings suggest some fascinating strategies for brands of all sizes, from big players and to those struggling to gain foothold in scale-focused markets:

1. Grow and then shed. Once a brand reaches that critical 40% threshhold, it should review (but not necessarily change) its growth strategy. At that point, decision makers could debate a range of options:

  • Continue to increase in size whilst ensuring that the market itself remains transparently competitive
  • Restructure the business so that it combines scale brands with specialist niche brands
  • Shift markets or expand footprint into other markets in order to stay under that 40% mark overall

2. Better to merge than to die. Middle-market brands, particularly those stalled in a position for some time, should look for ways to make themselves more sale-able rather than hoping for the stars to suddenly align and their position to change. They can do this through the development of, or gaining access to, advantages such as exclusive rights that will make them attractive to one of the big three. Or, if a market only has two major players at present, they could merge with another middle market player to form an entity capable of competing for the third position.

3. If you can’t grow big, grow smaller. If your brand cannot break the top three, you should look seriously and proactively at developing a portfolio of niche or super-niche brands, either on your own or through being bought out and becoming part of a top three player’s own portfolio.

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