The "Rule of Three" explains the smartphone market perfectly

The "Rule of Three" explains the smartphone market perfectly

Summary: The smartphone market may look like it's changing every day, but the Rule of Three tells us everything about the shape it has today, as well as the shape it'll have tomorrow...

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TOPICS: Smartphones
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If you're like most ZDNet readers, you're here because you're trying to understand and learn the industry you work in. For all of us, this is a time of considerable change -- not a lot of which looks particularly logical.

Luckily for us, there are tools that we can use to help us understand what's happening. One such tool is the "Rule of Three".

This tool was developed by Dr. Jagdish Sheth and Raj Sisodia and was popularised in their book The Rule of Three: Surviving and Thriiving in Competitive Markets.

Hey, "competitive market" -- the smartphone market is quite competitive, right?

The idea

The principle behind the Rule of Three is that competition within a market ends up creating distinct, recognisable, and repeating patterns in any given market. The authors examined two hundred different markets. If you're instantly thinking "this doesn't apply to the technology industry", statistically speaking, this idea almost certainly does.

In any one market, the authors discovered that typically three market leaders will emerge. They call these the "Big 3". Think of any market and you can likely name three winners. Walmart, Target are the two at the top, with perhaps Walgreens as the third. How about American Airlines, United, and Delta. Want some more close to home? Lenovo, Dell, and HP.

These Big 3 are generalists and take up between 70 percent and 90 percent of the market between them. To be sustainable as a generalist, the authors say you need 10 percent of the market. Typically the Big 3 end up with 40 percent, 20 percent and 10 percent of the market respectively.

The remaining space in the market is then divided up between specialists. Specialists can either be product specialists (what it does) or market specialists (who it does it for).

The "success curve" of each type of business varies. Successful generalists enjoy more profit as they gain market share thanks to economies of scale and increased protection from competition due to their mass. Successful specialists enjoy more profit providing that they do not gain market share, because their specialisation allows them to maintain high margins.

This is where things get weird. In the middle between specialists and generalists is something the authors call "the ditch". If a generalist gets too small that they cannot defend against competition they will end up in the ditch, and flounder because their margins are too low to sustain their size given that they are not selling as much as the other generalists. If a specialist gets too large, they too cannot defend against competition from the generalists and have to decrease margin to compete on sales -- they lose what makes them special, and also flounder.

The authors provide this helpful chart that explains the phenomenon.

Rule of Three
The general idea behind the Rule of Three. Generalists, specialists, and "the ditch".

Credit: Jagdish Sheth and Raj Sisodia from their book "The Rule of Three"

Smartphones

This is likely the part where you're thinking how it applies to the smartphone market, tablet market, PC market, etc. And you're probably thinking that it doesn't.

The first thing to consider is that the smartphone market is not "iOS, Android, Windows Phone, and BlackBerry". A generalist, non-technologist consumer doesn't think in term of platforms. They think in terms of brands. Our generalist consumer does not walk into Best Buy looking to buy an "Android phone". If they do that, they're not a generalist consumer and we can ignore them.

The brands that apply in the smartphone market are Apple, Samsung, Nokia, BlackBerry primarily, and then the dregs: HTC, LG, Sony, Sharp, HP, and others.

The Big 3 generalists in the smartphone market today are -- in the first two places -- Apple and Samsung. Then we have a fight for third place between Nokia and BlackBerry.

Windows Phone is -- to all intents and purposes -- solely Nokia's if we look at it from this high level. (In theory we can subdivide the market and look just a Windows Phone OEMs and find the Big 3 players, and specialists within that subdivision.)

The Rule of Three tells us what's happened to BlackBerry. They fell into the ditch. Their market share got so small that they were unable to compete with the other generalists in the market and so now they are floundering. But the authors' work tells us what they need to do -- re-frame themselves as a specialist. Specialists provide for higher margins to allow for lower sales.

Ironically, BlackBerry was a specialist. They messed up the transition to generalization chasing a far bigger (and fast expanding) consumer market without enough mass to back up the play. If they survive as a distinct entity, returning to being an specialist in the enterprise market on a "we're good at security" ticket is likely to be successful.

The perhaps more interesting story here is Motorola. Google already has a brand in the smartphone market -- Nexus -- but it's a specialist brand. If you're buying a Nexus, you're a technologist who's interested in Android.

Motorola was an existing cellphone/featurephone generalist brand. Google's intention -- if we look at it from the Rule of Three -- appears to be to bring Motorola into the market as a generalist brand that they control.

With BlackBerry out of the game, we're now talking about four brands looking for generalisation: Apple, Samsung, Nokia, and Motorola. The Rule of Three isn't the Rule of Four, so one of those needs to fail, fall into the ditch, and either exit the market or become a specialist.

Which one? I suspect in the US market it'll be Nokia that fails, and in the EU market it'll be Motorola that fails. Google is likely to be able to better market itself and Motorola to the US market. Outside of the US market, Nokia is stronger.

What about other markets? It'll be the the one that serves less-affluent markets better. That will depend a lot on market positioning and either could make it. Nokia already has a play for lower-cost handsets. Google are actively making Android work better on at lower-cost handsets for emerging markets with Android v5, aka Key Lime Pie.

Conclusion

To me, the Rule of Three explains an awful lot of what's happening in the highly competitive smartphone market.

So, the next question is "what can the Rule of Three tell us about the tablet market"?

What do you think? Post a comment, or talk to me on Twitter: @mbrit.

Topic: Smartphones

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44 comments
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  • The point is?

    I am scratching my head... :-)
    anonymous
    • The point is there if you read the article

      The point is that the smartphone wars are primarily played out by the handset makers, and not creators of operating systems.

      He further suggests that third place will be a battle between Motorola and Nokia, as blackberry has ceded the field.

      There - you now know the point.
      Mac_PC_FenceSitter
      • Point

        No, the point is Owllllllllllllllllllllllllllllnet didn't see Microsoft's name as #1 so he pretends to 'See No Evil'
        THavoc
      • Good point, but

        I'm not sure why Motorola and Nokia would be competing in this scenario.

        If a generalist consumer walks into a store to buy a phone I'm not sure their choice would be a decision between a Motorola and a Nokia. At what point does a Motorola get recommended over a Samsung? or an HTC for that matter.

        I guess I just don't see the scenario where the motorola phone enters into the decision making process for someone buying a phone. iPhone, Galaxy and then ? I can at least see where the salesperson can explain the different features between an iPhone-Galaxy-Lumia. I'm not sure where the Droid line enters in there as a compelling choice.
        Emacho
        • Brand choices

          Indeed, customers always chose on brands, not on specific features, such as what software the thing runs. Brands however, grow or shrink based on what specific values they bring, but that is an relatively slow process so consumers still get to chose by brand.

          Motorola enters the equation, if Google decides and is able to revive their smartphone business. In my opinion, this is not very likely.

          Which leaves only three major smartphone brands: Apple, Samsung and Nokia.

          Now, I understand what you want to ask: what about Windows Phone? Thing is, the fate of Windows Phone is entirely in Nokia's hands. Ironically, it does not even depend on Microsoft at this moment. If Nokia bankrupts or decides to abandon Windows Phone, just like they already abandoned Symbian etc, then there will be no Windows Phone on the mass market -- it will only be offered by specialist vendors. I am not even sure Microsoft will be willing to financially save Nokia, if need be, because that might be huge resource drain ... and Microsoft just recently got bitten by their hardware experiment with the Surface.
          danbi
          • i wasnt going to ask about nokia

            I just don't see any reason why Motorola is somehow going to jump to the third place position. Saying that Google is backing it as the reason for the surge makes as much sense as saying the same thing about Nokia and Microsoft. Neither is guaranteed to succeed.

            In order for Motorola to grow it needs to become a compelling choice over Samsung or htc, not Nokia.
            Emacho
        • Overseas Nokia is considered the best smart phone maker.

          Motorola once was, many years ago; but since has lost its market dominance. People here look for Nokia, iPhone, and Samsung smart phones. Motorola is not sold in the kiosks or by the cellular carriers; except as a 'cheap', usually dumb phone.
          dveed
          • Motorola

            In my country, Motorola left the shelves 4 or 5 years ago. I still have my Razr in a drawer somewhere but young people don't even know what a Motorola is anymore. On the other hand, they all know what a Nokia is. It will need a lot of work, stamina and expense to pull Motorola back up to where it was.
            petin_y
      • Which is gravely wrong.

        Based on another article I just read on zdnet -> (http://www.zdnet.com/should-blackberry-have-gone-android-the-answer-is-no-and-these-numbers-show-why-7000019409/?s_cid=e539&ttag=e539)..

        It clearly states that Lenovo and LG are competing for the #3 spot behind Samsung and Apple... By the looks of the graph, Nokia is showing promise with Motorola bringing up the rear. Even HTC is doing better than Motorola, so what gives? Obviously we're talking about the US market only but let's face it.. the US is but a fraction of growing markets worldwide and handset makers like Lenovo, ZTE, LG and others get it which will fuel their sales in the US..
        tahoe_guide
    • Not surprising

      @OwlllllllNet : You rarely get the point of anything.

      Fascinating article, although I'm not sure how ironclad the "rule of 3" is. For example, we traditionally have a "big 3" among U.S. automakers (GM, Ford, Chrysler), except that Toyota has the same market share as Ford, and Honda has the same market share as Chrysler, so in the U.S., we have a big 5 — a situation that seems likely to persist for a long time.

      Worldwide, the big 5 seems to be Toyota, GM, VW, Hyundai, and Ford, again a stable proposition.
      S_Deemer
      • Large numbers of big things

        It may be that the "Rule of Three" expands a bit when the item in question is not only sold in large numbers, but each of the numbers is big, i.e. virtually every car sale is a 5-figure number. That means you can have a smaller market share than the Rule of Three would suggest, and still be able to afford the sort of machinery etc., that makes your manufacturing competitive. You won't have as =many= robot welders, but you'll have robot welders.
        Robert Hahn
    • Scrathing your head?!?

      @OwlllllllNet
      You just need to read the article with more than a passing attention, if you're able to do that, then it'll come naturally, you won't need to scratch your dumb head anymore. The proverbial light bulb might even light up over your dumb head (though very doubtful in your case).
      Eleutherios
  • Good Read

    I usually don't like your articles. They seem too much like click bait. However I really liked this article. Parallels come to mind from other sectors like the auto industry..........Thanks
    calfee20
    • Agreed. It was refreshing to have a tech pundit

      finally realize we are talking about products not platforms and quit making the silly comparison between iPhone (a product) and Android (a platform). I think he also nailed the two big players and then those who were fighting it out for third place.
      baggins_z
  • Motorola is in the ditch

    The flaw in this article is Motorola is nowhere near a 3rd place position in the market. That might be what Google/Moto hopes to happen but its a big stretch to assume it will. Motorola is on life support just as BlackBerry, a former player with nothing to show in terms of results. Google isn't even betting on Moto by awarding a Nexus unit to its own manufacturer, maybe they will take the gamble but currently Nexus is at best a specialty brand bit player.

    Yet even more trouble ... slice and dice the markets any way you like Moto's not a player even in a niche market and we already know its illogical and dangerous to waste money on niche market also-rans.
    greywolf7
    • Not necessarily. By any measure, the Macintosh is a niche market product.

      Premium price = high margins. Rock-solid. Well-designed. Still, few would consider buying a Macintosh computer to be a high risk.

      On the Windows side, there are lots of opportunities to purchase high-end or specialty Windows PCs. These are often high-margin devices for specialist applications (such as gaming). No matter how small the market-share, these are not "also-ran" products.
      M Wagner
      • Not necessarily...

        Yes, Motorola is not necessarily in a ditch but neither is it vying for 3rd place because it is actually in 10nth place after Apple, Samsung, LG, Lenovo, ZTE, Sony, Blackberry, Nokia, and HTC. But I think you are correct in saying it can be a niche player and still be profitable.
        petin_y
  • It's called an Oligopoly.

    It depends on the type and geographical size of the market. Between 3 and 5 "players" OWN the market. By the time the fifth "player" has gotten established (if there is a fifth player) the bar to entry is too high for anyone else to enter. Customers have already settled on a vendor, suppliers don't want to risk dealing with a startup with potential financial problems. Necessary technologies have been patented. All the knowledgeable people already work for one of the players. The players can offer better products and services at a lower price because of economies of scale and "how to" knowledge acquired over decades. Newbies just can't compete with that.

    It's basically the same as a MONopoly except that instead of just one major "player" there are several (never more than 5, and if more than 3, the last two are small by comparison).

    For instance, a number of years ago Corel--which makes WordPerfect Office Suite--was in a pretty bad situation financially. MICROSOFT invested $150 million in them. Why? Because MANY *lawyers* use WordPerfect. (It is a LOT more user-friendly if you do a LOT of text drafting.) If WP disappeared, Microsoft could EXPECT antitrust complaints.
    Rick_R
    • I am sure there are very few instances of more than three being needed ...

      ... to dominate 70% of the market. The 40-20-10 split makes perfect sense. Look at PCs. It's Microsoft's operating system (90% market-share) but it is Lenovo, Dell, & HP fighting over 70% of the market. No need to add #4 or #5 to make the author's premise work.
      M Wagner
      • Re: It's Microsoft's operating system

        Key thing here, is that you are not talking about the "PC market", but about the market of "PCs running Microsoft's operating system". Once you get that straight, everything else starts making sense. And, as a bonus you don't get to argue with Linux fans :)

        The culprits for this confusion are the various "market studies" and journalists, who make no difference between brand and platform and this produce absurd results.
        danbi