The Rule of Three and Four

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Image Credit: The Boston Consulting Group

The rule of three and four was first put forth by Bruce Henderson, founder of The Boston Consulting Group (BCG). This rule was first proposed in 1976, and is still valid today. The essence of the rule is as follows:

In a mature and competitive industry, there will not be more than three significant competitors. Furthermore, the market share of the three companies will be approximately 4:2:1.

BCG validated this rule through some fairly rigorous analysis.  They found that from 1976 to 2009, industries with one, two, or three dominant players ranged from 72% to 85% – the average was 78%. The three dominant competitor configuration (also called “three-generalist”) was the most common in 13 of those 34 years, and was the second-most common in 20 out of 34 years.

The BCG study also confirmed the “four” part of the rule (the 4:2:1 marketshare ratio). From 1976 to 2009, the top players in roughly 60% of industries with the three-generalist structure had relative market shares of 1.5:2.5, very close to the prediction of 1:2. One current example is the car rental industry which is led by Enterprise, Hertz, and Avis. They have respective market shares of 48%, 22%, and 14%.

All of this data is very nice, but what does it mean for management? The leaders of organizations which are in these “mature and competitive industries” should do the following:

  • Aggressively defend marketshare if your company is in the top three.
  • Attempt to improve the company’s position through consolidation or shift the basis of competition if your company is outside the top three. The company should also consider exiting the industry if it is not in the top three as most of the profit will be obtained by the top players.

If you are investing in a company, you should also consider whether the organization is a top-three player; or whether the organization is poised to become a top three player.

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