Portfolio Management based on Market Share and Market Growth. Explanation of BCG Matrix. (’70)
The BCG Matrix method is the most well-known portfolio management tool. It is based on product life cycle theory. It was developed in the early 70s by the Boston Consulting Group. The BCG Matrix can be used to determine what priorities should be given in the product portfolio of a business unit. To ensure long-term value creation, a company should have a portfolio of products that contains both high-growth products in need of cash inputs and low-growth products that generate a lot of cash. The Boston Consulting Group Matrix has 2 dimensions: market share and market growth. The basic idea behind it is: if a product has a bigger market share, or if the product’s market grows faster, it is better for the company.
The four segments of the BCG Matrix
Placing products in the BCG matrix provides 4 categories in a portfolio of a company:
* Stars (high growth, high market share)
o Stars are using large amounts of cash. Stars are leaders in the business. Therefore they should also generate large amounts of cash.
o Stars are frequently roughly in balance on net cash flow. However if needed any attempt should be made to hold your market share in Stars, because the rewards will be Cash Cows if market share is kept.
* Cash Cows (low growth, high market share)
o Profits and cash generation should be high. Because of the low growth, investments which are needed should be low.
o Cash Cows are often the stars of yesterday and they are the foundation of a company.
* Dogs (low growth, low market share)
o Avoid and minimize the number of Dogs in a company.
o Watch out for expensive ‘rescue plans’.
o Dogs must deliver cash, otherwise they must be liquidated.
* Question Marks (high growth, low market share)
o Question Marks have the worst cash characteristics of all, because they have high cash demands and generate low returns, because of their low market share.
o If the market share remains unchanged, Question Marks will simply absorb great amounts of cash.
o Either invest heavily, or sell off, or invest nothing and generate any cash that you can. Increase market share or deliver cash.
the BCG Matrix and one size fits all strategies
The BCG Matrix method can help to understand a frequently made strategy mistake: having a one size fits all strategy approach, such as a generic growth target (9 percent per year) or a generic return on capital of say 9,5% for an entire corporation.
In such a scenario:
* Cash Cows Business Units will reach their profit target easily. Their management have an easy job. The executives are often praised anyhow. Even worse, they are often allowed to reinvest substantial cash amounts in their mature businesses.
* Dogs Business Units are fighting an impossible battle and, even worse, now and then investments are made. These are hopeless attempts to “turn the business around”.
* As a result all Question Marks and Stars receive only mediocre investment funds. In this way they can never become Cash Cows. These inadequate invested sums of money are a waste of money. Either these SBUs should receive enough investment funds to enable them to achieve a real market dominance and become Cash Cows (or Stars), or otherwise companies are advised to disinvest. They can then try to get any possible cash from the Question Marks that were not selected.
Other uses and benefits of the BCG Matrix
* If a company is able to use the experience curve to its advantage, it should be able to manufacture and sell new products at a price that is low enough to get early market share leadership. Once it becomes a star, it is destined to be profitable.
* BCG model is helpful for managers to evaluate balance in the firm’s current portfolio of Stars, Cash Cows, Question Marks and Dogs.
* BCG method is applicable to large companies that seek volume and experience effects.
* The model is simple and easy to understand.
* It provides a base for management to decide and prepare for future actions.
Limitations of the BCG Matrix
Some limitations of the Boston Consulting Group Matrix include:
* It neglects the effects of synergy between business units.
* High market share is not the only success factor.
* Market growth is not the only indicator for attractiveness of a market.
* Sometimes Dogs can earn even more cash as Cash Cows.
* The problems of getting data on the market share and market growth.
* There is no clear definition of what constitutes a “market”.
* A high market share does not necessarily lead to profitability all the time.
* The model uses only two dimensions – market share and growth rate. This may tempt management to emphasize a particular product, or to divest prematurely.
* A business with a low market share can be profitable too.
* The model neglects small competitors that have fast growing market shares.
Book: Carl W. Stern, George Stalk – Perspectives on Strategy from The Boston Consulting Group