Business Issues  



The Rule of Three: Specialist or Generalist Player

By Professor K C Chan and Elyn Leevana

Today's competitive corporations change in a far less predictable fashion as compared to the past. However, once they have reached maturity they display many similarities across industries and across national borders. Further, each industry tends to be occupied by three major market share leaders. Such phenomenon is evident in industries such as the soft drinks, personal computer and smart phone industry. See Figures 1 to 3. Apparently, three of the top corporations in each industry together dominate over 40% of the global market share. Obviously, the niche players will serve the balance. This is the theory of the “Rule of Three” as expounded by Professors Jagdish Sheth and Rajendra Sisodia. It gives an insight into the industry dynamics.

Figure 1: The US Carbonated Drinks Market Share 2013 (Source: Statista).

Figure 2: The Personal Computer Industry Market Share 2013 (Source: IDC Worldwide Quarterly PC Tracker)

Figure 2: The Personal Computer Industry Market Share 2013 (Source: IDC Worldwide Quarterly PC Tracker)

The Rule of Three Theories
The general observations are:
• When markets get organized by competitive processes, it results in three full line generalists and lots of product / market specialists.
• The three full line generalists serve between 70 and 90 percent of the total market.
• The product / market specialists serve the balance of the market each with a very small market share of between one and five percent.
• The Number One Company usually holds 40 percent; Number Two holds 20 percent and Number Three holds 10 percent market share.
• If the three full line generalists do not focus on 70 percent of the market, there is room for a fourth full line generalist to penetrate, so long as each has at least 10 percent market share.

Full line generalists are volume-driven players while product/market specialists tend to be margin-driven. Figure 4 shows that the financial performance of full line generalists gradually improves with greater market share, while the performance of product/market specialists erode rapidly as their market share increases. For marginal full line players, with market share of between 5 to 10 percent, they are in danger of being pushed into the ditch by the larger and more established players. Product/market specialists that grow without a robust strategy are also in danger of entering the ditch by fighting for a bigger market share at the expense of meagre profit margin. Therefore, in the knowledge-based economy firms should transform strategies into innovative projects / products, services and solutions to sustain their survival by avoiding falling into the ditch. Indeed, winning firms should be able to jump over the ditch and thrive as a global disruptive innovative player. Just like what Samsung has done to Apple in the i-phone and i-pad business.



Figure 4: Market Share and Financial Performance

Strategies for Generalists and Specialists
Table 1 gives the comparison of generalists versus specialists under different operating context.

Table 1: Generalists versus Specialists

The generic strategies adopted by full-line generalists can be summarised as follows:
• The No.1 full line generalist will become a fast follower (e.g. IBM, Microsoft) and/or grow the total market size (e.g. Coca Cola, Wal-Mart)
• The No.2 full line generalist will coexist with the leader (e.g. Samsung, Lenovo) and/or challenge the leader (e.g. Pepsi, VW)
• The No.3 full line generalist will be insulated from the competition (e.g. Pirelli, Sprint) and/ or innovate its products/services (e.g. RC Cola, Hyundai)

The generic strategies deployed by Product/ Market Specialists are as follows:
• Niche players will consider selling to the full line generalist (e.g. Gatorade, eBay) and/or climb up to become super niche players (e.g. Bentley, Rolls Royce)
• Ditch dwellers will have to refocus as specialist (e.g. Black Berry, Service Merchandise) and/or become a consolidator (e.g. General Motors, Dell)

Figure 5: Strategies of Generalists and Specialists

Figure 5 captures the different strategies engaged by full line generalists and product/market specialists.

The Rule of Three and Globalisation
No matter how large the market, the “Rule of Three” remains relevant. Hence, when markets grow from local to regional or from regional to national, or from national to global, there is a further consolidation of the industry.

With globalisation, the No.1 market leader is best positioned to survive as a global full line generalist. Other players either go through mergers as a consequence of global consolidation, or they selectively exit certain businesses to become product or market specialist, often by geographic region.

For example, in the consumer electronics market, the Japanese firms (Panasonic and Sony) are experiencing tough competition from the Asian counterparts (Samsung and LG, Lenovo and TCL). The worldwide battlefield will determine which players will finally survive as global full line generalists.

Whilst in the airline market, globalisation together with the numerous national restrictions on foreign ownership of airlines and in the absence of true “open skies” competition, the global industry has witnessed the merging of three big alliances. These alliances are Star Alliance (SIA, Lufthansa, Thai Airlines, etc), Oneworld (American Airlines, British Airways, Cathay Pacific, etc) and Skyteam (Air France, Delta, Korean Airlines, etc). After the 911 tragedy, the shakeup in the airline industry makes the “Rule of Three” even more of a reality as we witness the Chapter 11 downfall of United Airlines (one of the largest in the world). In 2013, Emirates, Qatar, and Etihad emerged as the top three best airlines.

When the Rule of Three does not apply
The Rule of Three applies wherever competitive market forces are allowed to determine market structure with only minor regulatory and technological impediments. However, the Rule of Three is irrelevant for the following industries:
• Patent based (e.g. pharmaceuticals)
• Owner managed business (e.g. professional services)
• Regulated monopolies (e.g. utilities)
• Regulated markets (e.g. Communist Bloc, China, India, Brazil)

Once the above-mentioned barriers are gone, markets start to fit into the Rule of Three.

The Rule of Three in the Machine Tool Industry
The machine tool industry can be considered as a barometer of the economy. When the economy is thriving, demand for machine tools will increase because of the need for additional production capacities. On the contrary, when the economy is sliding, demand for machine tools will be one of the first to be effected because there will be extra production capacities. In short, machine tool is a derived market because they are utilised for the production of parts for the automobile, personal computer, mobile phone, consumer appliance, etc. The conventional machine tool industry is about 150 years old. While the NC to CNC machine tool market is about 40 years old. The evolution of the conventional to the CNC technology machine tool market traces back to the oil crisis in the 1970s, which change the manufacturing landscape from high volume mass production to flexibility production for medium to small batch size. The efficiency versus growth machine tool industry cycle is depicted in Figure 6.

Figure 6: Efficiency versus Growth Machine Tool Industry Cycle

UK the birthplace of the Industrial Revolution is where machinebased civilisation has its roots and also where the machine tool industry first originated. Whilst US is where NC technology for machine tools was first invented in the early 1950s. However, it is Japanese firms that mass-produced and make the technology economically viable and turned it into a cornerstone of the multi-billion dollar CNC machine tool industry. According to the American Machinist and Japan Machine Tool Builder Association, it was reported that Japan’s production accounted for almost 40 percent of global production, maintaining the number one position the nation had held for 30 years since overtaking the US in 1982. CNC machine tools hold about 80 percent of all the orders received in Japan which also make Japan as the biggest producer and consumer of CNC machines. The different expansion strategies deployed by the full line generalist versus the specialist is captured in Figure 7.

Figure 7: Market Expansion Strategies for Full Line versus Specialist

In recent decades, the machine tool industry has had to adjust on several occasions caused by severe, economic environmental turbulence. These include:
1972 : • Nixon Shock
1973 : • First Oil Crisis
1979 : • Second Oil Crisis
1980 : • International Debt Crisis
1990s till : • Demise of Communism and
2010s Triumph of Capitalism
• Opening of Eastern Europe
• Curb in weaponry, ordnance on a worldwide scale
• Cost driven competition in manufacturing worldwide leading to offshore assembly, foreign sourcing of production, i.e. lean manufacturing
• Emphasis on world-class quality for manufacturing and services (ISO 9000 & 14000 certification; Malcolm Balridge National Quality Award)
• World economy dominated by service sector activities
• Outrage of the Japanese Bubble Economy
• Return of the Economy Depression: Asian Crisis

Clearly, there is no consensus for the reasons underlying Japan’s success. There is no single causal factor but rather there are various key success factors and interrelated socio-politicocultural features of Japan, which explain its competitiveness in the machine tool industry. See Table 2.

The Japanese already dominating the US and European markets for high value-added machines, have sequentially targeted the Asian market, forcing rivals to retreat. This strategy is based on the insight that the rate of adoption of technological innovation for such high-tech/high investment products in Asian countries is slow as compared to the industrialized countries of the West. Having produced in volumes, thereby reaping the economies of scale, the Japanese are then able to penetrate the Asian market by low pricing strategy (cost leadership). Furthermore, they are also able to cross-subsidize their market penetration. They are focusing increasingly on the lucrative high end of the market and are confidently erecting barriers to their competitors by being a single source total solution provider with complete turnkey project capabilities.

11 Japanese firms were in the list of the Top 20 for 2013, ranked by volume of worldwide sales of machine tools. The Japanese have perpetually established themselves as world class leader in the CNC machine tool industry, earning a reputation for reliability, quality, state-of-the-art technology and speed of delivery. In this industry, Japan is undoubtedly globally successful. They are both world class and global players.

Conclusion
The Rule of Three is not a theoretical construct. In the machine tool industry, the Japanese have firmly established themselves as world-class firms as full line generalist global players. Their generic strategy is to provide full line of products, high volumedriven producers for market share leadership. It is evident that Japanese machine tools hold 40 percent of the global market share. In particular, 80 percent of the 30 percent global market share belongs to CNC related products. This phenomenon agrees with the principles of the Rule of Three.

The CNC machine tool is entering the mature industry phase (see Figure 4). With the advent of communication, internet and large scale microprocessor technologies it is making direct numerically controlled (DNC) of more than one CNC machine using a personal computer economically and technologically plausible. On the whole, it will keep the costs of CNC applications down resulting in lower unit cost of production for end-user products (e.g. consumer electronics parts, automobile parts, precise engineering components, etc.). Based on the Rule of Three, the competitive market evolution of the CNC, Post-CNC and “Factory of the Future” is summarised in Table 3.

In the final analysis, an implicit understanding of the Rule of Three lies behind GE’s business strategy - be “No.1 or No.2” approach to restructuring in the 1980s. GE would have to be No.1 or No.2 in any business that it remained in, otherwise, as No.3 or lower there is a constant pressure and pulls on businesses toward the ditch. The relevance of the Rule of Three in the machine tool industry, i.e. the CNC machine is real. You should act on the Rule of Three to reassess your corporate positioning and strategic goals or watch the competition passes by at your peril. The furniture industry is not spared.

PROFESSOR DR K C CHAN
is a practice professor and stragetic project management and International Business Consultant.