Scanning the newspapers recently I noticed that the revenues of our three largest telecoms players – Telstra; Optus and Virgin – were respectively $16.4B; $9.4B and $5.3B. Why did that capture my interest? It looked like it might satisfy BCG’s rule of ‘three and four’
In the mid 70’s Bruce Henderson (BCG founder) hypothesised that a stable competitive industry will have no more than three substantive competitors, and will find equilibrium when their respective market shares are 4:2:1. The hypothesis was never tested until recently when the BCG Strategy Institute tested it as part of BCG’s 50th anniversary program. What did they find?
Having defined a ‘generalist’ as a company with greater than a 10% market share the BCG Institute found:
- The most common industry structure was a ‘three generalist’ configuration … it prevailed in 13 of the 34 years studied, and was 2nd most common in 20 of the 34 years;
- Industries with a ‘three generalist’ configuration produced a return on assets a full 2.5% higher than those with more than three generalists;
- In ‘three generalist’ configurations, the largest player typically had 1.5-2.5x the market share of their nearest rival – relatively close to Henderson’s original 4:2:1 hypothesis.
Henderson put some caveats on his hypothesis: it applies only to stable, competitive industries with limited government intervention.
Our three major telecoms players reflect an industry structure that is pretty consistent with the ‘three and four’ heuristic. Essentially a three player sector, with market shares not too dissimilar from the 4:2:1 ‘rule’: Telstra’s revenue is about 1.75x Optus; Optus is about 1.75x Virgin.
An interesting observation by Henderson 40 years ago. But let’s explore it a little further. starting with markets where Woolworths and Coles play:
- In Australian supermarkets Woolworths and Coles have about 39% and 33.5% respectively; Aldi is sitting at about 10% and IGA below this at 9.3%.
- In petrol , Woolworths and Coles have about equal market shares at around 24% with BP around 15% and then independents.
- In liquor retail, Woolworths holds around 40% and Coles 20%. I couldn’t find market share numbers for Metcash (the owner of IGA) but its share will be much less than Coles.
What about markets where Coles and Woolworths are not players? In the mortgage banking market we have four majors: Commonwealth Bank (26.7%); Westpac (24.7%); NAB (16.3%); and ANZ (14.8%). The share of the top two is about 1.5x the revenue of the next two. Collectively the majors represent 80-85% of the market, with the balance being fought over by some 18 banks and non-banks.
In accounting services in Australia, PwC was the market leader in 2014 with revenue around $1.5B, with the other three – EY; KPMG; Deloittes – each posting around $1.1B in revenue. The ‘Big 4’ each have revenues around 3x the next nearest player – Crowe Howarth (formerly WHK). You might reasonably argue that we should look at the market segments (eg. audit; advisory/consulting; tax). While I don’t have Australian data, on a global scale there is more difference between segments, but not of the scale envisaged in the rule of '3 and 4'.
What can we take away from all these numbers. While the rule of ‘3 and 4’ may not fit directly, there are some patterns that are useful insights into your strategic thinking:
1. As markets mature there is an inevitability of market players consolidating into 2-4 major players. This is not surprising. McKinsey data on growth has shown that ‘market momentum’ and M&A typically account for around 80% of revenue growth: when market growth slows, M&A is the growth strategy of choice. Market share growth contributes an average of just 22% of overall revenue growth.
2. There is usually a large gap between the major players and the rest. If we exclude the professional services firms, there is a major gap between the market share of the top 2 and the rest. This is presumably part of what sat behind GE’s famous ‘#1 or #2 or exit’.
3. And given market share growth is generally limited, major changes in market share or industry leader tables are unlikely in mature markets, except under conditions of disruption (eg. Uber) or deregulation (eg. Telstra/Optus battle)
Here's three actions you could take given these patterns:
- Examine your industry structure. How many major players are there and where do you sit? If there are 5 or more substantial competitors consolidation is almost inevitable. The question is ‘where are you?’ What is your play in a consolidation phase?
- If you are not in the top 3-4 players, your first question is a portfolio question: do you stay or do you go? If you stay, remember you are by definition a ‘niche’ player. Be very clear about your strategy and ensure each choice reinforces your position – and the other choices you make – to protect your niche and still earn good returns.
- If you are one of the dominant players the potential loss of market share is a challenge: disruption can be life threatening. Your strategy needs to protect you against competitive market share threat, but you must also ensure you have robust processes in place to seek out ‘weak signals’ in the market place that might be telling you about an even more fundamental shift.