Sunday, March 19, 2006

Micromarkets Part 2

A few weeks back, I wrote about the dichotomy of micromarkets and mass markets. On a recommendation from Tom Austin, I just read The Rule of Three -- a book which nicely ties together my musings on how small, focused companies can thrive in the shadow of industry giants.

The Rule of Three, by Jagdish Sheth and Rajendra Sisodia, posits that over time, every industry comes to be dominated by three large generalists, with any number of small niche players also thriving. Examples abound: in athletic shoes, it's Nike, Adidas, and Reebok coexisting with specialists such as Saucony. In airlines, it's United, American, and Delta, with focused niche players like Southwest.

Niche specialists thrive by earning high margins serving a small percentage of the overall market. Generalists focus on efficiently addressing the needs of a large share of the market. Niche companies that try to grow too fast, and generalists who fail to achieve critical mass, are in danger of falling into the dreaded "ditch," as illustrated below. Their market share is too small to enable them to compete effectively against the giants, while their product and market focus is too broad to enable them to compete against the niche players. Northwest Airlines, which is currently flirting with bankruptcy, and K-Mart are examples of ditch companies.

Markets are dynamic, of course, and the makeup of the big three can change over time -- and sometimes in a very short span of time. For example, IBM, the undisputed leader in PC manufacturing in the 1980s, is no longer even much of a niche player in the space. Niche players can become market leaders (though the path is fraught with peril), smaller generalists can leapfrog leaders with new technology, or smaller generalists can combine through mergers and acquisitions to emerge as big-three companies.

The Rule of Three also provides a wealth of strategic advice for companies in each market position. Market-focused niche players will be most successful by developing new products for their tightly-defined market. Product-focused niche companies succeed by finding new markets for existing products (the ever-expanding number of uses for baking soda is a classic example).

Market leaders are advised to be fast followers rather than innovators. For example, Microsoft is the leading provider of word processing, presentation, and spreadsheet applications -- although it didn't invent any of them. The third-largest company in any industry normally is -- and needs to be -- the most innovative. For example, Chrysler brought back the convertible and developed the minivan.

The structure applies to b2b companies as well as b2c firms. In the business software market, Gelco Expense Management is a classic product niche; it has one narrow product (online expense reporting) that suits multiple industries. SoftBrands is a market niche company -- it sells a broad suite of software and services to a narrow slice of the manufacturing market: midsized companies that produce assembled products. The company's strategy may appear confused because it also sells software to the hospitality industry. However, as The Rule of Three points out, niche companies can successfully compete in more than one niche -- as long as operations remain separate and focused. The danger for niche companies is the temptation to grow by becoming generalists. If SoftBrands tried to compete head-to-head in business software applications with SAP, Oracle, or Microsoft, it would find itself pulled into the ditch.

The Rule of Three does an excellent job both of explaining industry structures -- how micromarkets and mass-markets co-exist -- and of providing strategy advice to companies large or small who want to thrive and avoid being pushed or pulled into the ditch.


Terms: The Rule of Three, micromarkets, niche marketing, business strategy, strategic focus

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