Marketing and rules of thumb
I’m sure most of us are familiar with the phrase “a rule of thumb”; some of us might even use one or more rules of thumb in our daily lives. Sayings just like these:
One hour flying equals one day driving.
$1 in capital allows you to increase your assets by $10.
A user should be able to navigate to any page on your site within 3 or 4 clicks from the home page.
The efforts of any employee must generate 3-5 times what the company pays that person.
They typically seem to have a simple logic that’s hard to deny. However, sometimes simple things are simply that, and they have little real value in an increasingly complex world.
How many marketers believe the cost of customer acquisition is five times higher than the cost of retaining an existing customer; that a satisfied customer is likely to tell five other people, while an unsatisfied one tells 11; or that it’s important to keep existing customers happy, because satisfied customers will tell their friends all about their experience and this will increase sales? Many of us do, but where’s our proof? It often simply doesn’t exist in a form that would stand up to proper academic review.
Such was the case with management consultant Frederick Reichheld’s Net Promoter Score (NPS) which he grandly and, as it turned out, somewhat foolishly trumpeted as “The One Number You Need to Grow”. It was derived from asking people the simple question, “How likely are you to recommend us to a friend?” Once published in the Harvard Business Review it became a metric for the burgeoning word of mouth industry as a way to quantify positive word of mouth – on the misplaced belief that sound science underpinned Reichheld’s claim that NPS was a superior metric.
Independent research by Keiningham et al subsequently published in the prestigious Journal of Marketing however concluded Reichheld’s work was seriously flawed and there was very strong evidence it suffered from research bias. Another simple rule of thumb, on reading Keiningham’s paper, immediately sprung to mind: If it sounds too good to be true, it is!
And so in 2002, when authors Sheth and Sisodia published The Rule of Three: Surviving and Thriving in Competitive Markets, I was interested to read (but not convinced about the general applicability of) their claims. Sheth and Sisodia had established their own rule of thumb which they called The Rule of Three, stating an industry consisting of three large generalists and numerous smaller specialists generates a competitive environment that is “optimal” for firm stability and profitability. They further argued that a non-linear relationship between market share and profitability exists in these structures, such that small- and large-share firms (within boundary conditions) can achieve high profitability, while midsized firms are destined to languish.
While the Rule of Three seemed intuitively true in some respects, my cynicism and I slept well at night knowing it was at odds with several other conventional wisdoms of the day, and that it had never been subject to independent evaluation and testing – if it sounds too good to be true, it is! Or so I thought, until researchers Uslay, Alting and Winsor subjected The Rule of Three to empirical examination and published their findings in the Journal of Marketing in March 2010.
I’ve been sleeping a touch less soundly ever since – their findings, from more than 160 industries, supported the Rule of Three. They were also able to provide the following five key insights:
- There appears to be a prevalent competitive structure for mature industries in which three “generalist” firms control the market.
- Industries that conform to this structure tend to perform better than industries with a fewer or greater number of generalists.
- Both “specialists” and generalists outperform firms that are “stuck in the middle”.
- The performance benefits of market leadership appear to diminish with excessive market share.
- The Rule of Three industry structure and its influence over firm profitability do not appear to be priced appropriately by financial markets.
So, what does this mean at a practical level? Uslay, Alting and Winsor outlined the implications of their research for the investor community, senior management, and for marketing managers. In the latter case they suggest a market leader approaching the upper limits of scale might best use marketing to expand the pie and protect rather than maximise market share. Large generalists, they believe, have much to gain from co-marketing with generalists in other industries or even with direct competitors (ie to recruit customers from non users rather than gaining them from competitors), or perhaps implementing an international strategy rather than trying to grow their domestic market.
Their finding that specialists generally perform better than what the authors call “ditch dwellers” also runs contrary to conventional wisdoms around the profit impact of market strategy, which typically views high performing small firms as mere exceptions. As the authors note, “This traditional view is myopic in that niche players have a collectively substantial role within the confines of differentiated markets. In contrast, we find high-performing, small market-share firms to be the rule rather than the exception.”
Uslay, Alting and Winsor believe their work supports Hamel and Prahalad’s earlier recommendations that specialist firms should focus on leveraging their core competencies, rather than diverting strategic attention to market share or firm size. Or in other words, dare I say, such firms should probably “stick to their knitting”!