Framework Feature: BCG's Rule of Three and Four
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In 1976 the founder of Boston Consulting Group, Bruce Henderson published a strategy memo with a bold claim: “A stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest.” Despite this provocative statement, Henderson quickly clarified that it was a hypothesis: The Rule of Three and Four is a hypothesis. It is not subject to rigorous proof. It does seem to match well observable facts in fields as diverse as steam turbines, automobiles, baby food, soft drinks, and airplanes. If even approximately true, the implications are important. Henderson made two observations about the nature of industries:
Put more simply, it was the argument that most industries over time become captured by three companies, often in the ratio of 4:2:1. How does it stack up?Learning about this framework made me curious. Are there examples of this dynamic in today’s world? Beer in The US – Passes The Test ✅It’s easy to get information on the beer industry on the beer industry in the US so I thought I’d see how it fared. The three biggest companies control about 70% of the market as follows:
The ratio between the companies is 3.4 to 1.7 to 1 which means it passes both tests. There are only three significant competitors and the largest has less than four times the market share of the smallest. Digital Ads Companies: Fits With ExceptionsBased on the following graph, Google, Facebook, and Amazon combine to control about 64% of the digital ad market. Facebook and Google are close for the industry leaders, followed by a long tail of companies with a small market share.
While it passes the test of the largest competitor not being more than 4 times the smallest competitor, the ratio between the companies is more like 2.8 to 2.4 to 1. Henderson argued that the ratio of 2 to 1 is a likely equilibrium point where it is not worth it for either competitor to increase market share. While one might think Amazon is too small to seriously compete with Facebook and Google, we need to remember Henderson’s exception: “An otherwise prosperous company is willing for some reason to continually add more investment to a marginal minor product.” This is the case for Amazon. They are known for being willing to lose money for a long time in an industry or on a specific product to capture market share over the long term. The Rule of Three and Four might tell us that Amazon is already at an equilibrium point and that it is not worth it to compete or try to become a larger player but it is likely too soon to tell. The digital market industry is still relatively nascent and Amazon has only recently tried to compete in this space. What’s The Point?The value of frameworks like this is as a mental model to increase the range of ideas you have about how to think about a company’s situation. For this framework, if you are a massive company and need to capture more of a market, you might ask yourself if it is worth it. Or you might use it to pressure test overly optimistic goals. Has it ever been done in this or other similar industries? Want to learn about more frameworks? Here are five more including Porter's five forces and 7S. |
Paul Millerd
Freelancer, creator & writer
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