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There are several core frameworks that have made their way into the lexicon of business strategy. The SWOT analysis. Porter’s five forces. The 5 Cs and the 4 Ps.

I would propose a new addition.

Through empirical analysis of hundreds of industries, Jagdish Sheth and Rajendra Sisodia found a core commonality that links all industries together. They call it “The Rule of Three,” an innovative perspective on the business world described in their 2002 book, The Rule of Three.

The idea: explained

The Rule of Three states that, over time, all free mature markets will be dominated by three main players, with smaller players filling in the niches.

The three main players, or full-line generalists, cover the market’s major product categories and geographies while the specialists cover a specific niche product, geography, or both.

If a company doesn’t follow one of these paths, however, it is likely to fall into “The Ditch,” which often means destruction for the company via bankruptcy or acquisition. Both generalists, who lose market share and efficiency, and specialists, who gain share the wrong way, are susceptible of falling into the ditch.

This concept is shown below in a picture from the book, with the x-axis representing the size of the company and the y-axis representing a proxy for its efficiency.

There are three main reasons behind the Rule of Three:

The prospect of lower per unit costs drives consolidation in mature markets. Costs, and other benefits of scale, push industries to gravitate towards a small number of large players.
Industries with two or four main players are often unstable. Through their empirical analysis, Sheth and Sisodia show how companies in 2-player industries often cause the mutual destruction of one another while companies in 4-player industries tend to present too many choices for the average consumer. According to the authors, three companies present a perfect equilibrium for an industry.
It does not make economic sense for large companies to enter every market niche. As an example, think about the global automobile market. Toyota, the global leader, primarily plays in two segments with their Toyota brand and their premium Lexus brand. They largely stick to these two since these brands span the vast majority of customer needs. The economics of rolling out an ultra-luxury sports car to compete with Ferrari / Lamborghini make much less sense, so Toyota is content with capturing most of the market and leaving the niches to smaller players.

Examples

Here are a couple of examples of the Rule of Three playing out in high-profile industries:

Burger chains: McDonalds, Burger King, and Wendy’s

The Big 3 US burger chains own ~70-75% of the fast food burger market. Sonic, the #4 player, has a market share less than half that of Wendy’s (the #3 player). Niche companies exist both on the product side (e.g., Steak ‘n’ Shake with its diner setup) and on the geographic side (e.g., Whataburger with its stronghold in the southern part of the United States).
Market share information here

Wireless telecommunications: AT&T, Verizon, T-Mobile

The Big 3 wireless telecommunications companies own ~85% of the US market. Notably, this market used to be dominated by four major players (AT&T, Verizon, T-Mobile, and Sprint), before Sprint and T-Mobile officially merged back in 2020. Sprint, plagued by poor management and other issues, had fallen into the ditch, contributing to the merger. Additionally, many niche companies exist, such as US Cellular and Dish Wireless (through its Boost Mobile brand).
Market share information here

Airline industry: Historically American, United, and Delta

In 2000, around when The Rule of Three was written, the top 3 players in the US airline industry were American, United, and Delta, followed by several generalist players nearing the ditch: Northwest, Continental, and US Airways. As Sheth and Sisodia predicted, the Rule of Three took effect: Northwest was acquired by Delta in 2008, Continental by United in 2011, and US Airways by American in 2015.
Before the pandemic, the airline industry was still in a state of flux. As of 2019, there were four main players (American, Southwest, Delta, and United) that owned ~65% of the market, followed by several regional niche companies (e.g. Alaska, Hawaiian) and low-cost product niche companies (e.g., Spirit, Frontier). Southwest, which could be an entire case study on its own, successfully made the jump from a low-cost regional airline to more of a full-line generalist since 2000. The Rule of Three, however, would dictate that one of these four companies (likely United) will be in danger of falling into the ditch.
Market share information here

There’s always an exception

If you are as I was, you might be a little skeptical of the Rule of Three. I immediately thought of a ton of counterexamples, such as the banking or consulting industries.

However, as with many things, there are always exceptions. Sheth and Sisodia list many reasons why a certain market may not abide by the Rule of Three. Here are a couple of the most prescient reasons:

The market is in a transitionary period
- This is perhaps the biggest point. Sheth and Sisodia argue that, over time, markets tend to organize around a structure with three large generalists. However, at any one point in time, an industry (such as the US airline industry mentioned above) may exhibit tendencies of another market structure. For instance, a fourth generalist may occasionally rise up. According to the framework, however, these are simply momentary imbalances that will normalize over the long run.
The market is not mature
- The Rule of Three only applies to mature markets, meaning that markets early in their life cycle will eventually see consolidation into three generalist players. When the market is young and has a high growth rate, many players can benefit from its growth and coexist.
There are significant regulatory constraints
- The Rule of Three only applies to “free” markets. Whenever governments get involved, things get messy. There are many examples of heavily regulated industries such as plane manufacturing (Boeing and Airbus), banking (tons of players), or electric (monopoly tendencies) that do not naturally fit the Rule of Three market structure.
The market has exclusive rights
- Markets in which licenses, patents, or trademarks have a significant role may not abide by the Rule of Three. Sheth and Sisodia highlight the pharmaceuticals industry as an example, as patents and licenses has created restricted ownership, which allows many companies to coexist.
The market has combined ownership & management
- According to Sheth and Sisodia, industries that have joint owner-managers often do not exhibit this structure, as ownership creates emotional attachment. A common example of this phenomenon is professional services (e.g., accounting firms, consulting firms, law firms), in which many companies are able to coexist due to the partnership model.

Parting thoughts

There are a ton of other interesting concepts in the book, such as specific strategies for each type of player, the impact of globalization and price wars on the Rule of Three, and how specialists can cross the ditch to become a generalist.

Are there any industries that you can think of that do not quite fit under the Rule of Three? Are there specific structural dynamics causing this?

Do you agree with this idea?