BCG Matrix

Boston Consulting Group (BCG) Matrix is a four celled matrix (a 2 * 2 matrix) developed by BCG, USA. It provides a graphic representation for an organization to examine different businesses in it’s portfolio on the basis of their related market share and industry growth rates.

In this approach of strategic portfolio analysis, General Electric and Boston Consulting Group made pioneering contributions. General Electric introduced the concept of dividing business activities into SBU’s with like characteristics, related to the life cycles of the products.

Boston Consulting Group (BCG) deserve much of the credit for developing and popularising this analytical technique, BCG approach consisted of a wide variety of products in different growth rates, and market shares, search for investment strategies to allocate resources among them to optimise company’s long-run profits.

At the heart of strategic portfolio theory is the growth-share matrix shown below:

The above matrix provides a scheme for broadly classifying a company’s businesses according to their strategic needs (including cash requirements).

It is a two dimensional analysis on management of SBU’s (Strategic Business Units). In other words, it is a comparative analysis of business potential and the evaluation of environment. The horizontal axis shows the relative market share held by the various SBUs, expressed as a ratio of each SBU’s share held by the leading competitor in its particular market. The vertical axis depicts the growth rate of the various markets in which the businesses compete.

BCG’s Growth-Share Matrix BCG’s Portfolio Analysis is based on the premise that majority of the companies carry out multiple business activities in a number of different product-market segments. Together these different businesses form the Business Portfolio which can be characterised by two parameters:

1) Company’s relative market share for the business, representing the firms competitive positions; and

2) The overall growth rate of that business.

According to this matrix, business could be classified as high or low according to their industry growth rate and relative market share.

Relative Market Share = SBU Sales this year leading competitors sales this year.

Market Growth Rate = Industry sales this year - Industry Sales last year.

BCG matrix has four cells, with the horizontal axis representing relative market share and the vertical axis denoting market growth rate. The mid-point of relative market share is set at 1.0. If all the SBU’s are in same industry, the average growth rate of the industry is used. While, if all the SBU’s are located in different industries, then the mid-point is set at the growth rate for the economy.

Relative Market Share is defined as the market share of the relevant business divided by the market share of its largest competitor. Thus, if Company X has 10 per cent, Company Y has 20 per cent, and Company Z has 60 per cent share of the market, then X’s Relative Market Share is 1/6m, Y’s Relative Market Share is 1/3, and Z’s Relative Market Share 60/20 = 3. Company Z has Company Y as its leading competitor, whereas Companies X and Y have Company Z as their lead competitor. The selection of the Rate of Growth of the associated industry is based on the understanding that an industrial segment with high growth rate would facilitate expansion of the operations of the participating company. It will also be relatively easier for the company to increase its market share, and have profitable investment opportunities. High growth rate business provides opportunities to plough back earned cash into the business and further enhance the return on investment. The fast growing business, however, demands more cash to finance its growth. If an industrial sector is not growing, it would be more difficult for the participating company to have profitable investments in that sector. In a slow growth business, increase in the market share of a company would generally come from corresponding reduction in the competitors’ market share. The BCG matrix classifies the business activities along the vertical axis according to the ‘Business Growth Rate” (meaning growth of the market for the product), and the ‘Relative Market Share’ along the horizontal axis. The two axes are divided into Low and High sectors, so that the BCG matrix is divided into four quadrants

The analysis requires that both measures be calculated for each SBU. The dimension of business strength, relative market share, will measure comparative advantage indicated by market dominance. The key theory underlying this is existence of an experience curve and that market share is achieved due to overall cost leadership.

Resources are allocated to the business units according to their situation on the grid. The four cells of this matrix have been called as stars, cash cows, question marks and dogs. Each of these cells represents a particular type of business.

 

1. Stars- Stars represent business units having large market share in a fast growing industry. They may generate cash but because of fast growing market, stars require huge investments to maintain their lead. Net cash flow is usually modest. SBU’s located in this cell are attractive as they are located in a robust industry and these business units are highly competitive in the industry. If successful, a star will become a cash cow when the industry matures.
2. Cash Cows- Cash Cows represents business units having a large market share in a mature, slow growing industry. Cash cows require little investment and generate cash that can be utilized for investment in other business units. These SBU’s are the corporation’s key source of cash, and are specifically the core business. They are the base of an organization. These businesses usually follow stability strategies. When cash cows loose their appeal and move towards deterioration, then a retrenchment policy may be pursued.
3. Question Marks- Question marks represent business units having low relative market share and located in a high growth industry. They require huge amount of cash to maintain or gain market share. They require attention to determine if the venture can be viable. Question marks are generally new goods and services which have a good commercial prospective. There is no specific strategy which can be adopted. If the firm thinks it has dominant market share, then it can adopt expansion strategy, else retrenchment strategy can be adopted. Most businesses start as question marks as the company tries to enter a high growth market in which there is already a market-share. If ignored, then question marks may become dogs, while if huge investment is made, then they have potential of becoming stars.
4. Dogs- Dogs represent businesses having weak market shares in low-growth markets. They neither generate cash nor require huge amount of cash. Due to low market share, these business units face cost disadvantages. Generally retrenchment strategies are adopted because these firms can gain market share only at the expense of competitor’s/rival firms. These business firms have weak market share because of high costs, poor quality, ineffective marketing, etc. Unless a dog has some other strategic aim, it should be liquidated if there is fewer prospects for it to gain market share. Number of dogs should be avoided and minimized in an organization.In terms of PLC, the dogs are usually products in late maturity or a declining stage.  Retrenchment strategies are normally suggested for this stage.

 

Strategic Implications

Most companies will have different segments scattered across the four quadrants of BCG matrix, corresponding to Cash Cow, Dog, Question Mark and Star businesses. The general strategy of a company with diverse portfolio is to maintain its competitive position in the Cash Cows, but avoid over-investing. The surplus cash generated by Cash Cows should be invested first in Star businesses, if they are not self-sufficient, to maintain their relative competitive position. Any surplus cash left with the company may be used for selected Question Mark businesses to gain market share for them. Those businesses with low market share, and which cannot adequately be funded, may be considered for divestment. The Dogs are generally considered as the weak segments of the company with limited or now new investments allocated to them. The BCG Growth-share matrix links the industry growth characteristic with the company’s competitive strength (market share), and develops a visual display of the company’s market involvement, thereby indirectly indicating current resource deployment. (The sales to asset ratio is generally stable over time across industries). The underlying logic is that investment is required for growth while maintaining or building market share. But, while doing so, a strong competitive business in an industry with low growth rate will provide surplus cash for deployment elsewhere in the Corporation. Thus, growth uses cash whereas market competitive strength is a potential source of cash. In terms of BCG classification, the cash position of various types of businesses can be visualised as in Table below:

 A corporation, at any given time, may be comprised of several SBUs that fit into each of the four categories shown in the above matrix. Since the STARS are growing rapidly and have the advantage of already having achieved a high share of the market, they provide the firm’s best profit and growth opportunities.

The BCG believes that the only two viable strategies exist for QUESTION MARK SBU: growing the SBU into a star or divesting (getting rid of it). Since DOGS (our apologies to fellow dog lovers) hold little promise for the future and may not even pay their own way, they are prime candidates for divestiture.

In contrast, because of their high share positions in a low growth area CASH COWS are ideal for providing the funds needed to pay dividends and debts, recover overheads, and supply the funds for investment in other growth areas.

For a balanced portfolio, the cash needed by question marks must roughly equal the cash generated by cows. This equilibrium places a limit on the number of question marks a portfolio should contain.

Strategic portfolio analysis has many variants other than BCG matrix. These are profit impact on market strategy (PIMS), Experience or Learning Curve, Nine-cell General Electric matrix, Life Cycle Portfolio matrix, McKinsey’s Framework, Directional Policy matrix (DPM), Risk matrix, DPM and Risk matrix (combined three-dimensional matrix, portfolio plus risk), etc.

Strategic portfolio planning is useful in establishing performance objectives for different business units. The theory suggests that the four kinds of businesses in the growth- share matrix should be evaluated quite differently with respect to growth and profitability. It helps guide the selection of managers to head up the businesses in a company’s portfolio.

Methodology for Building BCG Matrix

The Boston Consulting Group suggests the following step-by-step procedure to develop the business portfolio matrix and identify the appropriate strategies for different businesses.

·          Classify various activities of the company into different business segments or Strategic Business Units (SBUs).

·          For each business segment determine the growth rate of the market. This is later plotted on a linear scale.

·          Compile the assets employed for each business segment and determine the relative size of the business within the company.

·          Estimate the relative market shares for the different business segments. This is generally plotted on a logarithmic scale.

·          Plot the position of each business on a matrix of business growth rate and relative market share.

Limitations of BCG Matrix

The BCG Matrix produces a framework for allocating resources among different business units and makes it possible to compare many business units at a glance. But BCG Matrix is not free from limitations, such as-

1. BCG matrix classifies businesses as low and high, but generally businesses can be medium also. Thus, the true nature of business may not be reflected.
2. Market is not clearly defined in this model.
3. High market share does not always leads to high profits. There are high costs also involved with high market share.
4. Growth rate and relative market share are not the only indicators of profitability. This model ignores and overlooks other indicators of profitability.
5. At times, dogs may help other businesses in gaining competitive advantage. They can earn even more than cash cows sometimes.
6. This four-celled approach is considered as to be too simplistic.

Predicting Profitability from Growth and Market Share

BCG analysis assumes that profits depend on growth and market share. The attractiveness of an industry may be different from its simple growth rate, and the firm’s competitive position may not be reflected in its market share. Some other sophisticated approaches have been evolved to overcome such limitations.

There have been specific research studies which illustrate that the well-managed Dog businesses can also become good cash generators. These organizations relying on high-quality goods, with medium pricing and judicious expenditure on R & D and marketing, can still provide impressive return on investment of above 20 per cent.

Difficulty in Determining Market Share

There is a heavy dependence on the market share of a business as an indicator of its competitive strength. The calculation of market share is strongly influenced by the way the business activity and the total market are defined. For instance, the market for helicopters may encompass all types of helicopters, or only heavy helicopters or only heavy military helicopters. Furthermore, from geographical point of view the market may be defined on worldwide, national or an even regional bases. In case of complex and interdependent industries, it may also be quite difficult to determine the market share based on the sales turnover of the final product only.

No Consideration for Experience Curve Synergy

In the BCG approach, businesses in each of the different quadrants are viewed independently for strategic purposes. Thus, Dogs are to be liquidated or divested. But, within the framework of the overall corporation, useful experiences and skills can be acquired by operating low-profit Dog businesses which may help in lowering the costs of Star or Cash Cow businesses. And this may contribute to higher corporate profits.

Disregard for Human Aspect

The BCG analysis, while considering different businesses does not take into consideration the human aspects of running an organization. Cash generated within a business unit may come to be symbolically associated with the power of the concerned manager. As such managing a Cash Cow business may be reluctant to part with the surplus cash generated by his unit. Similarly, the workers of a Dog business which has been decided to be divested may react strongly against changes in the ownership. They may deem the divestiture as a threat to their livelihood or security. Thus, BCG analysis could throw up strategic options which may or may not be easy to implement.

BCG Modifications

It was in 1981 that the Boston Consulting Group realized the limitations of equating market share with the competitive strength of the company. They have admitted that the calculation of market share is strongly influenced by the way business activity and the total market domain are defined. A broadly defined market will give lower market share, whereas a narrow market definition will result in higher market share resulting in the company as the leader. It was, therefore, recommended that products should be regrouped according to the manufacturing process to highlight the economies of scale manufacturing, instead of stressing the market leadership. On the other hand, BCG still maintain that for branded goods it is important to be the market leader so that the advantages of economies of scale and price leadership can be fully utilised. But they also concede that such advantages may still be achieved even if the company is not the largest producer in the industry. Some other verions of portfolio analysis have however developed much beyond these minor modifications of BCG analysis.

Those who read this, also read:

1. Organizational Capability Profile

2. Competitor Analysis