Portfolio Management using the BCG-Matrix - Revision history

Tkokotas at 12:32, 18 December 2018

2018-12-18T12:32:27Z

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			''Developed by Alexander Michel''


	'''The Boston Consulting Group (BCG) matrix''', also known as growth share matrix, is a tool to manage a company's business portfolio and derive appropriate actions towards a higher total performance. Depending on the growth rate and market share, each business is individually assigned to one of the four clusters inside the two-dimensional matrix. Based on that, the optimal combination of individual business strategies is developed to manage a company's business portfolio in such a way, that it can make the most out of its opportunities.<ref name="Hedley"> Hedley, Barry (1977). ''Strategy and the "Business Portfolio",'' p. 9-15.		'''The Boston Consulting Group (BCG) matrix''', also known as growth share matrix, is a tool to manage a company's business portfolio and derive appropriate actions towards a higher total performance. Depending on the growth rate and market share, each business is individually assigned to one of the four clusters inside the two-dimensional matrix. Based on that, the optimal combination of individual business strategies is developed to manage a company's business portfolio in such a way, that it can make the most out of its opportunities.<ref name="Hedley"> Hedley, Barry (1977). ''Strategy and the "Business Portfolio",'' p. 9-15.
	'''Annotation''': Hedley, a director of BCG at the time, describes the importance of portfolio management and how the growth share matrix can be used to increase a company's performance.</ref>		'''Annotation''': Hedley, a director of BCG at the time, describes the importance of portfolio management and how the growth share matrix can be used to increase a company's performance.</ref>

Tkokotas at 13:13, 27 November 2018

2018-11-27T13:13:55Z

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	[[Category:Portfolio Management]]		[[Category:Portfolio Management]]
	[[Category:Complexity]]		[[Category:Complexity]]
			[[Category:Case Studies]]

Alexm at 19:30, 26 September 2016

2016-09-26T19:30:44Z

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	<references />		<references />


			{{DEFAULTSORT:Portfolio Management using the BCG-Matrix}}
			[[Category:Portfolio Management]]
			[[Category:Complexity]]

Alexm: /* Limitations and Critical Reflection */

2016-09-26T19:27:10Z

Limitations and Critical Reflection

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	#'''Strategic Business Units and Product Markets:''' A core assumption of the matrix is that SBUs can be seen independently from each other. This neglects synergies between the products, as a cash cow may profit from a dog. Furthermore, these synergies are often seen as a reason to bundle different products within a company’s business portfolio.		#'''Strategic Business Units and Product Markets:''' A core assumption of the matrix is that SBUs can be seen independently from each other. This neglects synergies between the products, as a cash cow may profit from a dog. Furthermore, these synergies are often seen as a reason to bundle different products within a company’s business portfolio.
	#'''Relative Market Share and Cash Generation:''' Measuring a company’s profitability through its relative market share solely focuses on a strategy of overall [https://en.wikipedia.org/wiki/Porter%27s_generic_strategies cost leadership] and neglects other strategies such as differentiation or focus. However, these might be more profitable. Even BCG admits that nowadays market share is no longer a strong predictor of performance.<ref name="Reeves"></ref>		#'''Relative Market Share and Cash Generation:''' Measuring a company’s profitability through its relative market share solely focuses on a strategy of overall [https://en.wikipedia.org/wiki/Porter%27s_generic_strategies cost leadership] and neglects other strategies such as differentiation or focus. However, these might be more profitable. Even BCG admits that nowadays market share is no longer a strong predictor of performance.<ref name="Reeves"></ref>
	#'''Market Growth and Cash Use:''' Inside the matrix market growth is the only indicator for the attractiveness of a market. This might be not always the case, as other indicators such as competitiveness, regulation or innovation are not considered. In a case study about the airline industry the author concludes ''Growth tells little about attractiveness.''<ref name="Thomas"> Thomas, Mike and Lange, Peter (1997). ''A Portfolio Management Approach to Strategic Airline Planning.'' Europäischer Verlag der Wissenschaften, Bern. '''Annotation''': The authors analyze different strategic portfolio tools, such as the BCG Matrix, and apply these in the airline industry. For the BCG Matrix the authors identify several weaknesses and its non-applicability for the airline industry</ref> The airline market is known for its strong growth over decades but also for its low profitability and high competition.		#'''Market Growth and Cash Use:''' Inside the matrix market growth is the only indicator for the attractiveness of a market. This might be not always the case, as other indicators such as competitiveness, regulation or innovation are not considered. In a case study about the airline industry the author concludes ''Growth tells little about attractiveness.''<ref name="Thomas"> Thomas, Mike and Lange, Peter (1997). ''A Portfolio Management Approach to Strategic Airline Planning.'' Europäischer Verlag der Wissenschaften, Bern. '''Annotation''': The authors analyze different strategic portfolio tools, such as the BCG Matrix, and apply these in the airline industry. For the BCG Matrix the authors identify several weaknesses and its non-applicability for the airline industry.</ref> The airline market is known for its strong growth over decades but also for its low profitability and high competition.
	#'''Balance of Cash Flows:''' Inside the matrix each quadrant is a positive or negative cash flow assigned. However, case studies showed that ''actual cash flow patterns can deviate from those supposed by the BCG.''<ref name="Thomas"></ref> The assumption that the market leader in a slowly growing market (cash cow) always has the highest profitability and is generating a net cash flow can therefore not hold.<ref name="Drews"></ref> Furthermore, the matrix implies to reach a balance of cash flows but this excludes the possibility of external investment. In the matrix funds are only generated inside the company.		#'''Balance of Cash Flows:''' Inside the matrix each quadrant is a positive or negative cash flow assigned. However, case studies showed that ''actual cash flow patterns can deviate from those supposed by the BCG.''<ref name="Thomas"></ref> The assumption that the market leader in a slowly growing market (cash cow) always has the highest profitability and is generating a net cash flow can therefore not hold.<ref name="Drews"></ref> Furthermore, the matrix implies to reach a balance of cash flows but this excludes the possibility of external investment. In the matrix funds are only generated inside the company.
	#'''Product Life-Cycle Stages:''' The link of the four quadrants is criticized as opportunistic, as BCG only tried to implement a popular theory (product life-cycle stages) at the time into their matrix.<ref name="Morrison and Wensley"></ref> Life-cycle stages can vary in their length and the proposed strategies by BCG may even harm current businesses. Studies have shown that at least the proposed strategies for dogs often failed to be successful.<ref name="Drews"></ref>		#'''Product Life-Cycle Stages:''' The link of the four quadrants is criticized as opportunistic, as BCG only tried to implement a popular theory (product life-cycle stages) at the time into their matrix.<ref name="Morrison and Wensley"></ref> Life-cycle stages can vary in their length and the proposed strategies by BCG may even harm current businesses. Studies have shown that at least the proposed strategies for dogs often failed to be successful.<ref name="Drews"></ref>

Alexm: /* Limitations and Critical Reflection */

2016-09-26T19:24:35Z

Limitations and Critical Reflection

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	#'''Relative Market Share and Cash Generation:''' Measuring a company’s profitability through its relative market share solely focuses on a strategy of overall [https://en.wikipedia.org/wiki/Porter%27s_generic_strategies cost leadership] and neglects other strategies such as differentiation or focus. However, these might be more profitable. Even BCG admits that nowadays market share is no longer a strong predictor of performance.<ref name="Reeves"></ref>		#'''Relative Market Share and Cash Generation:''' Measuring a company’s profitability through its relative market share solely focuses on a strategy of overall [https://en.wikipedia.org/wiki/Porter%27s_generic_strategies cost leadership] and neglects other strategies such as differentiation or focus. However, these might be more profitable. Even BCG admits that nowadays market share is no longer a strong predictor of performance.<ref name="Reeves"></ref>
	#'''Market Growth and Cash Use:''' Inside the matrix market growth is the only indicator for the attractiveness of a market. This might be not always the case, as other indicators such as competitiveness, regulation or innovation are not considered. In a case study about the airline industry the author concludes ''Growth tells little about attractiveness.''<ref name="Thomas"> Thomas, Mike and Lange, Peter (1997). ''A Portfolio Management Approach to Strategic Airline Planning.'' Europäischer Verlag der Wissenschaften, Bern. '''Annotation''': The authors analyze different strategic portfolio tools, such as the BCG Matrix, and apply these in the airline industry. For the BCG Matrix the authors identify several weaknesses and its non-applicability for the airline industry</ref> The airline market is known for its strong growth over decades but also for its low profitability and high competition.		#'''Market Growth and Cash Use:''' Inside the matrix market growth is the only indicator for the attractiveness of a market. This might be not always the case, as other indicators such as competitiveness, regulation or innovation are not considered. In a case study about the airline industry the author concludes ''Growth tells little about attractiveness.''<ref name="Thomas"> Thomas, Mike and Lange, Peter (1997). ''A Portfolio Management Approach to Strategic Airline Planning.'' Europäischer Verlag der Wissenschaften, Bern. '''Annotation''': The authors analyze different strategic portfolio tools, such as the BCG Matrix, and apply these in the airline industry. For the BCG Matrix the authors identify several weaknesses and its non-applicability for the airline industry</ref> The airline market is known for its strong growth over decades but also for its low profitability and high competition.
	#'''Balance of Cash Flows:''' Inside the matrix each quadrant is a positive or negative cash flow assigned. However, case studies showed that ''actual cash flow patterns can deviate from those supposed by the BCG.''<ref name="Thomas"></ref> The assumption that the market leader in a ~~slow~~ growing market (cash cow) always has the highest profitability and is generating a net cash flow can therefore not hold.<ref name="Drews"></ref> Furthermore, the matrix implies to reach a balance of cash flows but this excludes the possibility of external investment. In the matrix funds are only generated inside the company.		#'''Balance of Cash Flows:''' Inside the matrix each quadrant is a positive or negative cash flow assigned. However, case studies showed that ''actual cash flow patterns can deviate from those supposed by the BCG.''<ref name="Thomas"></ref> The assumption that the market leader in a slowly growing market (cash cow) always has the highest profitability and is generating a net cash flow can therefore not hold.<ref name="Drews"></ref> Furthermore, the matrix implies to reach a balance of cash flows but this excludes the possibility of external investment. In the matrix funds are only generated inside the company.
	#'''Product Life-Cycle Stages:''' The link of the four quadrants is criticized as opportunistic, as BCG only tried to implement a popular theory (product life-cycle stages) at the time into their matrix.<ref name="Morrison and Wensley"></ref> Life-cycle stages can vary in their length and the proposed strategies by BCG may even harm current businesses. Studies have shown that at least the proposed strategies for dogs often failed to be successful.<ref name="Drews"></ref>		#'''Product Life-Cycle Stages:''' The link of the four quadrants is criticized as opportunistic, as BCG only tried to implement a popular theory (product life-cycle stages) at the time into their matrix.<ref name="Morrison and Wensley"></ref> Life-cycle stages can vary in their length and the proposed strategies by BCG may even harm current businesses. Studies have shown that at least the proposed strategies for dogs often failed to be successful.<ref name="Drews"></ref>
	Taking into account the deficits one should be aware of the limitations this tool has. So far there is no empirical study that supports the usage of the BCG Matrix,<ref name="Drews"></ref> yet it is still applied in industry. But instead of banning it from the syllabus, the matrix limitations should be shown to prevent its misuse and application at all. Ultimately, the BCG Matrix success can be seen as ''a case history in successful innovation and diffusion of a particular analytical framework.''<ref name="Morrison and Wensley"></ref>		Taking into account the deficits one should be aware of the limitations this tool has. So far there is no empirical study that supports the usage of the BCG Matrix,<ref name="Drews"></ref> yet it is still applied in industry. But instead of banning it from the syllabus, the matrix limitations should be shown to prevent its misuse and application at all. Ultimately, the BCG Matrix success can be seen as ''a case history in successful innovation and diffusion of a particular analytical framework.''<ref name="Morrison and Wensley"></ref>

Alexm: /* Relevance in Industry */

2016-09-26T19:23:05Z

Relevance in Industry

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	#The strong bonds between BCG and industry. So was the director of Mead Paper, where the first successful study was carried out, also chairman of BCG’s parent company.		#The strong bonds between BCG and industry. So was the director of Mead Paper, where the first successful study was carried out, also chairman of BCG’s parent company.
	#The successful praise of the tool by BCG and the debate in business and academia increased its publicity and level of application even further.		#The successful praise of the tool by BCG and the debate in business and academia increased its publicity and level of application even further.
	However, academic evaluation of the matrix and criticism lead towards a decrease in application. As an example Kotler and Keller decided to delete the BCG Matrix (and other Portfolio Management Tools) in their 12th Edition from their popular ''Marketing Management''.<ref name="Drews"></ref>		However, academic evaluation of the matrix and criticism lead towards a decrease in application. As an example Kotler and Keller decided to delete the BCG Matrix (and other Portfolio Management Tools) in their 12th Edition from their popular ''Marketing Management'' book.<ref name="Drews"></ref>

	== Limitations and Critical Reflection ==		== Limitations and Critical Reflection ==

Alexm: /* Exemplary Use and Strategic Implications */

2016-09-26T19:21:51Z

Exemplary Use and Strategic Implications

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	*''Stars:'' Keep (and expand) current market share.		*''Stars:'' Keep (and expand) current market share.
	*''Question marks:'' Invest in some to gain market share and sell others for cash.		*''Question marks:'' Invest in some to gain market share and sell others for cash.
	Especially the strategy for the question marks is of extraordinary importance. If the company chooses to invest in all of them, current funds will be not sufficient to develop them towards stars and further on to cash cows. Finally, the company would have a large amount of dogs in their portfolio that failed to gain market share and suck the company’s cash without providing any net return. Henderson described this as the sequence of disaster.<ref name="Morrison and Wensley"></ref> Instead, the company should choose to invest in only a few promising question marks and cash out the remaining ones on time. This will lead to a success sequence<ref name="Morrison and Wensley"></ref> in which question marks provide the future net cash flow. Figures 3 (Success Sequence) and 4 (Disaster Sequence) show how the company could have developed from a three years’ perspective. The results can be described as followed:		Especially the strategy for the question marks is of extraordinary importance. If the company chooses to invest in all of them, current funds will be not sufficient to develop them towards stars and further on to cash cows. Finally, the company would have a large amount of dogs in their portfolio that failed to gain market share and suck the company’s cash without providing any net return. Henderson described this as the sequence of disaster (see Figure 4).<ref name="Morrison and Wensley"></ref> Instead, the company should choose to invest in only a few promising question marks and cash out the remaining ones on time. This will lead to a success sequence<ref name="Morrison and Wensley"></ref> in which question marks provide the future net cash flow. Figures 3 (Success Sequence) and 4 (Disaster Sequence) show how the company could have developed from a three years’ perspective. The results can be described as followed:
	*''Success Sequence:'' In the success sequence the company took the right decisions for managing the business portfolio. Product 2 (cash cow) provided sufficient funds to develop Product 3 (former star) towards a strong market leader. Although the market is slowing down, Product 3 takes advantage of its strong market position and emerged towards a cash cow. It even contributes more to the total sales than Product 2 now. In terms of the question marks, the company followed two approaches. Product 5 was promising but it required huge investment, so it was decided to sell it for a good share. It is no longer part of the business portfolio. Instead, Product 4 was developed with large amounts of cash towards the new star of the company. Although market growth slowed a bit down, it could significantly increase its market share. Through the cash out of Product 5 and the positive cash flow from the cash cows, the company even had enough funds to innovate and develop the new question marks, Products 6 and 7. Unfortunately, it was not possible to sell Product 1 (dog), so it was decided to cut investment down. This will lead to a ''slow death'' without compromising future success of the company.		*''Success Sequence:'' In the success sequence the company took the right decisions for managing the business portfolio. Product 2 (cash cow) provided sufficient funds to develop Product 3 (former star) towards a strong market leader. Although the market is slowing down, Product 3 takes advantage of its strong market position and emerged towards a cash cow. It even contributes more to the total sales than Product 2 now. In terms of the question marks, the company followed two approaches. Product 5 was promising but it required huge investment, so it was decided to sell it for a good share. It is no longer part of the business portfolio. Instead, Product 4 was developed with large amounts of cash towards the new star of the company. Although market growth slowed a bit down, it could significantly increase its market share. Through the cash out of Product 5 and the positive cash flow from the cash cows, the company even had enough funds to innovate and develop the new question marks, Products 6 and 7. Unfortunately, it was not possible to sell Product 1 (dog), so it was decided to cut investment down. This will lead to a ''slow death'' without compromising future success of the company.
	*''Disaster Sequence:'' Instead of developing and applying a customized strategy for each product, the company decided to distribute investments equally among the different products. ~~Ultimately~~, this ~~lead~~ into a disaster sequence. Although Product 2 is still the leading in its market, it suffered under poor management and lost some of its market share. Thus, it provided less net return to the company. Even worse the situation is for Product 3 (star). Competitors were more aggressive and gained market share. If no immediate action is taken, it will fall behind further and end up as a dog. This is what happened to Product 4 and 5 (former question marks). Management was not able to commit itself towards a clear strategy in which products to invest. So funds were shared among them, which resulted in a failed conversion towards a star for both of them. Even worse, they required so much cash that research and development expenses were cut down and no new products are in the pipeline. Even Product 1 (dog) received some investment, however it still requires more cash than it contributes. In the future it cannot be expected that the market growth will increase, but the current leader will rather take advantage of its strong position.		*''Disaster Sequence:'' Instead of developing and applying a customized strategy for each product, the company decided to distribute investments equally among the different products. According to the model, this leads ultimately into a disaster sequence. Although Product 2 is still the leading in its market, it suffered under poor management and lost some of its market share. Thus, it provided less net return to the company. Even worse the situation is for Product 3 (star). Competitors were more aggressive and gained market share. If no immediate action is taken, it will fall behind further and end up as a dog. This is what happened to Product 4 and 5 (former question marks). Management was not able to commit itself towards a clear strategy in which products to invest. So funds were shared among them, which resulted in a failed conversion towards a star for both of them. Even worse, they required so much cash that research and development expenses were cut down and no new products are in the pipeline. Even Product 1 (dog) received some investment, however it still requires more cash than it contributes. In the future it cannot be expected that the market growth will increase, but the current leader will rather take advantage of its strong position.
	This case study provides a good example in how to use the matrix right and which decisions should be taken in order to lead the company’s business portfolio in a success sequence and make the most out of its opportunities.		This case study provides a good example in how to use the matrix right and which decisions should be taken in order to lead the company’s business portfolio in a success sequence and make the most out of its opportunities.

Alexm: /* Constructing the Matrix */

2016-09-26T19:18:48Z

Constructing the Matrix

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	=== Constructing the Matrix ===		=== Constructing the Matrix ===
	Despite the core elements of the matrix are already discussed, special attention has to be given to the scaling of axes and position of the horizontal and vertical line dividing the matrix into its four quadrants. For the vertical axis (growth rate) a continuous scale is used. According to Henderson and Hedley the line separating the vertical axis should be at a growth of 10%<ref name="Henderson"></ref>, as companies tend to use this figure as discount rate in times of low inflation. This means that any growth above 10% is the area where investment becomes especially attractive.<ref name="Hedley"></ref> However, in some literature it is recommended to set the line equal to the expected inflation adjusted growth in [https://en.wikipedia.org/wiki/Gross_national_income gross national income (GNI)].<ref name="Drews"></ref> One has to be cautious which scale to use, as it might have serious implications if a business is for example a star or a cash cow ~~or if it is~~ a dog or question mark.		Despite the core elements of the matrix are already discussed, special attention has to be given to the scaling of axes and position of the horizontal and vertical line dividing the matrix into its four quadrants. For the vertical axis (growth rate) a continuous scale is used. According to Henderson and Hedley the line separating the vertical axis should be at a growth of 10%<ref name="Henderson"></ref>, as companies tend to use this figure as discount rate in times of low inflation. This means that any growth above 10% is the area where investment becomes especially attractive.<ref name="Hedley"></ref> However, in some literature it is recommended to set the line equal to the expected inflation adjusted growth in [https://en.wikipedia.org/wiki/Gross_national_income gross national income (GNI)].<ref name="Drews"></ref> One has to be cautious which scale to use, as it might have serious implications if a business is for example a star, a cash cow, a dog or a question mark.
	For the horizontal axis (relative market share) a logarithmic scale is used to be consistent with the experience curve effect.<ref name="Hedley"></ref> It is separated at 1.0, as only the market share of the largest competitor can be left of this line and all others are below this value by definition.<ref name="Henderson"></ref>		For the horizontal axis (relative market share) a logarithmic scale is used to be consistent with the experience curve effect.<ref name="Hedley"></ref> It is separated at 1.0, as only the relative market share of the largest competitor can be left of this line and all others are below this value by definition.<ref name="Henderson"></ref>
	However, it has to be noted that these guidelines serve only as an approximate guide but turned out to work well in practice.<ref name="Hedley"></ref> Still, adaptations may have to be made to gain correct results and derive appropriate strategic decisions for the business portfolio.		However, it has to be noted that these guidelines serve only as an approximate guide but turned out to work well in practice.<ref name="Hedley"></ref> Still, adaptations may have to be made to gain correct results and derive appropriate strategic decisions for the business portfolio.
	After building up the matrix with its four quadrants each SBU or product can be plotted inside depending on its relevance in sales or assets.		After building up the matrix with its four quadrants each SBU or product can be plotted inside depending on its relevance in sales or assets.

Alexm: /* Product Life-Cycle Stages */

2016-09-26T19:15:37Z

Product Life-Cycle Stages

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	=== Product Life-Cycle Stages ===		=== Product Life-Cycle Stages ===
	Besides an actual cash situation of each segment, these can also be linked to a specific product life-cycle stage. Question marks correlate to products in the introduction phase, where costs are high but sales and profits are low. This implies a strategy of investing in order to gain customer attention and increase market share in an overall growing market. If successfully managed, products enter the growth phase and become stars, where profitability begins to rise ~~though~~ economies of scale and a massive increase in sales. However, more and more competitors enter the market which ultimately leads to price decreases and may pushes profits down. In the third stage, the maturity stage, sales volume peaks and especially the company with the biggest relative market share has a huge advantage. Based on the experience curve effect, a company can harvest profits as it has the highest production volumes and is leading the market. Products in this stage are the cash cows. Lastly, the fourth stage is the saturation and decline stage where sales and profits decrease. The market is rather unattractive and products may get phased out. ~~Company’s~~ seek for a squeeze out and divestment strategy, such as dogs are treated.		Besides an actual cash situation of each segment, these can also be linked to a specific product life-cycle stage. Question marks correlate to products in the introduction phase, where costs are high but sales and profits are low. This implies a strategy of investing in order to gain customer attention and increase market share in an overall growing market. If successfully managed, products enter the growth phase and become stars, where profitability begins to rise through economies of scale and a massive increase in sales. However, more and more competitors enter the market which ultimately leads to price decreases and may pushes profits down. In the third stage, the maturity stage, sales volume peaks and especially the company with the biggest relative market share has a huge advantage. Based on the experience curve effect, a company can harvest profits as it has the highest production volumes and is leading the market. Products in this stage are the cash cows. Lastly, the fourth stage is the saturation and decline stage where sales and profits decrease. The market is rather unattractive and products may get phased out. Companys seek for a squeeze out and divestment strategy, such as dogs are treated.

	== Application in Practice ==		== Application in Practice ==

Alexm: /* Classification of Businesses into four Portfolio Categories */

2016-09-26T19:11:18Z

Classification of Businesses into four Portfolio Categories

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	'''Annotation''': Drews gives a short overview of the BCG Matrix and examines empirical research about the matrix. Based on academic papers and a self-conducted case study on the German airline Lufthansa, he concludes that due to its limitations the BCG Matrix should not be applied.</ref> A basic model of the matrix is shown in Figure 1 which serves as an illustration for further discussion.		'''Annotation''': Drews gives a short overview of the BCG Matrix and examines empirical research about the matrix. Based on academic papers and a self-conducted case study on the German airline Lufthansa, he concludes that due to its limitations the BCG Matrix should not be applied.</ref> A basic model of the matrix is shown in Figure 1 which serves as an illustration for further discussion.

	=== Classification of Businesses into ~~four~~ Portfolio Categories ===		=== Classification of Businesses into Four Portfolio Categories ===
	[[File:BCG-Matrix.jpg\|400px\|thumb\|right\|Figure 1. - BCG-Matrix with growth/share axis and the four portfolio categories.]]		[[File:BCG-Matrix.jpg\|400px\|thumb\|right\|Figure 1. - BCG-Matrix with growth/share axis and the four portfolio categories.]]
	Henderson defines the four categories according to their potential for cash generation and cash requirement. These are defined as followed:<ref name="Henderson"></ref>		Henderson defines the four categories according to their potential for cash generation and cash requirement. These are defined as followed:<ref name="Henderson"></ref>