Jagdish Sheth, Charles H Kellstadt professor of marketing, Goizueta Business School, Emory University, often predicts business trends much before others spot them. Sheth, 71, and his colleague Rajendra Sisodia propounded a theory that natural competitive forces shape the vast majority of companies under “the rule of three" in their book The Rule of Three: Surviving and Thriving in Competitive Markets .

Power of three: Jagdish Sheth says the third firm in a market is usually the most innovative. Kaushik Chakravorty / Mint

Tell us about ‘Rule of Three’ and why you believe in this theory.

The earlier theory of competition was that industries always become oligopolies. A handful of players dominate the market. Financial data proved that the greater the market share, the better the financial performance. My observation was that small boutique firms often outperformed large conglomerates. This led to the discovery that all industries get organized into one type of competition that is called the oligopoly or another type of competition that is called monopolistic competition. It means (that) when one has a segmental monopoly, it enables one to get abnormal profits. I found all industries are part-oligopoly and part-monopolistic competition.

Every shopping mall in America has volume-driven anchor stores such as the Sears and the JCPenney, but they also have next to it some lifestyle store or a specialist retailer. I found that while they are only 100ft apart, the price points are not the same. A speciality retailer in the same shopping mall can command 50% premium. That is a monopoly price. These retailers add value, service and offer more variety. I discovered that most industries that evolve through competition ultimately end up as two extreme players. Those that are volume-driven big players and those that are margin-driven niche players. But the worst place is to be in the middle.

Can you cite examples of how this theory works?

The third company is normally the most innovative, not the No. 1 or (No.) 2 in the segment. No. 3 changes the paradigm of the industry. Coca-Cola, Pepsi-Cola and there was RC Cola (Royal Crown Cola), which was the first to create a diet drink. Same was the case with aircraft manufacturers. There was the Boeing Co., Macdonald Douglas (Co.) and Lockheed Martin (Corp.)—the last was always the change agent. With telecom service providers, AT&T, MCI (Communication Corp.) and Sprint (now Sprint Nextel Corp.). Again, Sprint turned out to be the most innovative, in their advertisements, in their pricing points and the way they brought distribution arrangements.

But in India as well as globally, there are more than three firms in each sector. How do you explain this and what happens to the rest?

The third company is the most important to watch for change. We had in the automobile industry, in the early days (1900s), 225 car makers. All industries start with lots of players and then they begin to reduce. When Model T (Ford) came, it destroyed many companies and the Great Depression destroyed even more companies. Ultimately, the industry consolidated into three players—General Motors (Corp.), Ford Motor (Co.) and Chrysler Corporation (now Chrysler Group Llc). Chrysler, the third-ranking US auto maker, was always the innovator. It was uncanny. The company which was No. 2 became No. 3 and it becomes more innovative. It is counter-intuitive and counter theory. In the centre is what I call the ditch. The No. 3 company is more likely to fall in the ditch when there is a fight for market share. When GM (General Motors) and Ford fought for market share in the late 1970s, Chrysler collapsed. When AT&T and MCI started to fight for market share, Sprint collapsed. So you decide whether you want to be a volume-driven company or a niche company. You can’t be both.

Does this rule apply only to domestic companies? Or can this theory hold ground globally?

When the industry is domestic then the rule of three is domestic. If the industry is global then the rule of three applies globally. For instance, the tyre industry in the US has Goodyear (Tire and Rubber Co.), Firestone and BF Goodrich. Europe had three players: Michelin (Tyres), Pirelli (and C SPA) and Dunlop (Tires). Japan had one: Bridgestone (Corp.). When the industry became global, only three companies survived, which is Bridgestone, Michelin and Goodyear. Since the 1990s, globalization has been common and the rule of three applied on a global basis.

How will this theory pan out in the global automobile industry?

The industry is going through significant changes. There will be global consolidation. The largest market is no longer America it is China. The forecast is that in number of units, if not in value, the second largest market will be India. So industries such as automobile and components will become Asia-centric as opposed to being America-centric.

How do you see the telecom sector evolving?

The biggest issue for telecom from the globalization perspective is not the market but the buying power. The more they buy, the greater the volume advantage. The handset suppliers, including smartphone makers such as BlackBerry (and) Apple’s iPhone, will give huge volume discounts. The size of the user base is so large that the telecom service providers will have to keep upgrading the software. The portability of numbers and the handsets going obsolete sooner than before will add to the burden. Constant costs for upgrades will make size imperative. Global consolidation is inevitable. We see mobile operators such as China Mobile (Ltd) and Bharti Airtel becoming large players on a global basis. They will make moves to buy out foreign companies or foreign companies do a reverse merger with them. Consolidation will happen with three major global operators and we’ll see a bunch of regional players who’ll remain niche market players. The Indian government should facilitate mergers. Without having domestic scale of operations, no business can go global. They should consolidate to three-four players.