The "Rule of Three" explains the smartphone market perfectly

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.

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.