Boston Consulting Group

1. Brief History

The Boston Consulting Group was started up in 1963 by Bruce Henderson and from its inception sought to establish itself in the planning and was considered the pioneer of Business Strategy analysis. In the late 1960’s a consultant for the Boston Consulting Group presented his ideas about ‘cash deficient’ and ‘growth deficient’ businesses and the need for a balance between cash generators and cash users.

In the late 1960’s the Boston Consulting Group developed a portfolio business model based on this thinking. The model, the BCG matrix or growth/share matrix, was based on the Boston Consulting Group’s knowledge and work in the area of the experience curve and of the product life cycle and how they relate to cash generation and cash requirements.

The growth-share matrix was intended to analyse a portfolio from a corporate perspective because it is only at that level that cash balance is meaningful. A business may, however, be segmented further using this diagnostic tool to understand the positions of its various product lines or market segments. This portfolio can therefore be made up of products in a multiproduct company, divisions in a multidivisional company and companies in a conglomerate.

2. Strategic Emphasis

The Boston Consulting Group devised the simple matrix, which views the company as a portfolio of businesses, each contributing to the overall growth and profitability of the company. Its focus was on a corporations prime areas of concern – the market and the corporation’s competitive position in that market. The growth-share matrix is useful to a company in three ways

  • The graphic display gives an effective and efficient illustration of the product/businesses (SBU’s) in the company’s portfolio
  • It identifies the capacity of the SBU’s to generate cash and the requirements for cash assisting in balancing the company’s cash flow status
  • The matrix identifies the separate characteristics of each product/SBU and can suggest the strategic direction for each business

To be successful, a company should have a portfolio of products/businesses with different growth rates and different market shares. The portfolio composition is a function of the balance between cash flows. High growth products require cash inputs to grow while low growth products should generate cash (as long as they have a high relative market share)


3. The Approach

Relative market share was used because it was seen to be an indicator of the product’s ability to generate cash; this axis correlates with the experience curve. Market growth forms the other axis, correlating with the stages of the life cycle and was used as an indicator of the products cash requirements. This matrix has meaningful implications for the company especially in respect of cash flow.

Relative Market Share

Relative market share was used on the one axis for two reasons.

  • Firstly a firm with a relative market share of greater than 1.0 will move along the experience curve at a faster rate than its competitors and therefore gain a long-term cost advantage.

·  Secondly studies have suggested that long-term profitability is related to market share (PIMS)

The Experience Curve

In the earlier sixties, a large number of industries were surveyed in terms of their costs and the cumulative production outputs that they achieved. It was found that there was a relationship between cost reduction and cumulative output. Dramatic cost reductions were observed (up to 15%) every time overall output doubled. I.e. more experience lowers unit costs.

These effects can be seen at an industry level as well as at a company level. At the company level, the market leader will have produced more product that any other company and will therefore have a cost advantage over the competitors. At industry level costs are reduced as the industry produces more and every company will benefit from the knowledge that is circulated within the industry.

The Boston Consulting Group considers the experience effect to be a demonstration of the way in which a company conducts its whole business.

In the BCG matrix, the experience curve effect requires that market share is increased to be able to drive down costs in the long run and that a company with a dominant market share will inevitably have a cost advantage over competitor companies because they have the biggest volume. Market share is correlated with experience. High market share means high experience and lower costs, implying high margins and profitability. It implies improved cash flows whereas a lower market share implies the unavailability of cash and profits.

Market Growth
Market growth was used on the second axis for the following reasons.
  • It is easier to gain market share in a high growth market where competitor activity is usually lower
  • High growth markets are usually less price competitive as it is here that demand exceeds supply
  • Market growth is often used as an indicator of the stage in the business/product life where positive growth indicates a growing or mature market and a negative growth indicates a declining market. The stages of the life cycle play a role in decision-making and the matrix is a quick method of showing where the business/products stand in their life cycle. Growth therefore also indicates attractiveness

4. Plot Configuration

The Vertical Axis

The market growth rate is plotted on the vertical axis; the relative market share on the horizontal axis and the size of the SBU/division/product is plotted as the area within the circles of the matrix.

Market Growth Vertical Axis.

The market growth rate in volume is used as an alternative for the market attractiveness and provides a measure of attractiveness for the total industry without regard for the position of a certain firm/SBU etc.

It is calculated as follows:

Total Market 2000 – Total Market 1999

Total Market 1999

Market Growth =        X 100

Rate 2000

This axis uses a simple percentage scale.

The mid-point on this axis is dependant on the industry or segments growth or decline. (if all the business/products etc. belong to one industry) If they are not in the same industry then the growth of the gross national product is usually used or a weighted average of all of the industries can also be used. The original classical matrix used a mid point of 10%, which was seen as the company investment threshold cut-off rate.

If a company is analysing its different business units then the overall company growth can be used as the mid point on the vertical axis.

Businesses above this level are in the embryonic/introductory stage or growth stage of their life cycle while those falling below this level are in the maturity or aging/decline stage of their life cycle.

Relative Market Share – Horizontal Axis

The horizontal axis of this plot measures the relative market share of the business unit/product etc. i.e. this is a comparative market share measurement between the unit being analysed and the competitors.

The Horizontal Axis

Business Sales 2000

Leading Competitor Sales 2000

Relative Market Share 2000 =

This axis illustrates the ratio of sales for a business against those of its most important competitor. A relative market share of 2 indicates that the business’ sales are two times larger than the sales of its most important competitor whilst a relative share of 0.5 shows sales that are only half that of the most important competitor.

The relative market share of each unit to be analysed is plotted in the growth share matrix in a semi-log scale. The reason for doing this is that market share is linked to accumulated volume and this in turn is related to the experience curve.

The decline of costs according to the experience curve is plotted as a straight line in a semi-log scale. A higher market share implies higher accumulated volumes, which in turn implies lower costs and higher profitability.

Midpoint

The midpoint or cut off point on this matrix was determined to be 1.0 by the Boston Consulting Group. The market leader, which is a business/product with a relative market share greater than one, has a significant strength. Some companies use a cut off point of 1.5 because a positioning above this determines that a business/product can truly dominate an industry.

The Third Dimension Circle Size

A third parameter is used to illustrate the contribution of the business whether it is a division or product, to the overall company.

On the BCG matrix the size of the circles represents the turnover or size of the business/product. Sales figures are usually used as they allow easy comparisons with competitors. Asset values can also be used.

This technique facilitates the visual comparison of business/products with a range of volumes

5. Model Use and Applicability

The Boston Consulting Group identified four major strategic thrusts in terms of market share.

Once the products have been plotted, the planner then has to decide on a strategy for that product. There are 4 major strategies that can be followed.

Build

The product or SBU’s market share needs to be increased to strengthen its position. Short-term earnings and profits are deliberately forfeited because it is hoped that the long-term gains will be higher than this.

This strategy is suited to Question Marks.

Hold

The objective is to maintain the current share position and this strategy is often used for Cash Cows so that they continue to generate large amounts of cash.

Harvest

Here management tries to increase short-term cash flows as far as possible (e.g. price increase, cutting costs) even at the expense of the products or SBU’s longer-term future.

It is a strategy suited to weak Cash Cows or Cash Cows that are in a market with a limited future.

Harvesting is also used for Question Marks where there is no possibility of turning them into Stars, and for Dogs.

Divest

The objective of this strategy is to rid the organisation of the products or SBUs that are a drain on profits and to utilize these resources elsewhere in the business where they will be of greater benefit. This strategy is typically used for Question Marks that will not become Stars and for Dogs.

6. Best Use of BCG Matrix

  • Although the BCG matrix is the oldest of all the matrices, it is still the best known and the most common portfolio matrix to be taught around the world.
  • Comparisons can be made using the matrix to assess the relative growth rate of businesses against the industry average and to check the portfolio for financial balance.
  • The BCG matrix is simple and elegant. As a graphic device; it is fun to use and drives decision-making.
  • The principles of portfolio planning are correct and applicable at SBU and segment level within business units
  • Combining portfolio planning with shareholder value at SBU level is strongly recommended
  • The BCG matrix complements further portfolio analysis
  • It remains a useful and quick guide to resource allocation by market or product for a company or competitors.
  • The matrix is a simplifier of a host of business factors by selecting two as the main focus – growth and market share and shows simply and vividly how to apply them to develop strategies.

7. Model weaknesses

Various limitations and criticisms have been made of the BCG matrix especially as it was the first of a number of matrices developed to assist in strategic planning. Many have published comprehensive summaries of these limitations. He says that numerous factors must be taken into consideration with the growth-share matrix, which depends on the relationship between cash flow and the two variables of relative market share and market growth.

Market Share may not be Correlated with Cash Flow begging the fact that the BCG calls for the desirability of high market shares. The relationship between cash flow and market share may be weak due to a number of factors including:

  • Experience effects may be very small
  • Competitors may have access to lower cost materials unrelated to their relative share position
  • Low market share producers may be on steeper experience curves due to superior production technology
  • Differences in experience on costs may have little impact on costs being reduced as other companies may easily and quickly adopt innovations in production technology
  • Strategic factors other than relative market share may affect profit margins.

The growth-share matrix is based on the assumption that high rates of growth use large cash resources and that maturity of the life cycle brings about the expected profit returns. This may be incorrect due to various reasons:

  • Capital intensity may be low and the business/product could be grown without major cash outlay
  • High entry barriers may exist so margins may be sustainable and big enough to produce a positive cash flow and a growth at the same time.
  • Industry overcapacity and price competition may depress prices in maturity.
  • Legal restrictions may reduce profitability
  • Seasonal or cyclical patterns could cause imbalances in profitability and cash flow
  • Market growth is not the only factor or necessarily the most important factor when assessing the attractiveness of a market.
  • A fast growing market is not necessarily an attractive one. Growth markets attract new entrants and if capacity exceeds demand then the market may become a low margin one and therefore unattractive. A high growth market may lack size and stability.
  • High market share is only one measure of the strength of a business/product. Other factors may be more important
  • If the market is defined too narrowly the business inevitably ends up being a market leader on the matrix and if it is defined too broadly the business is represented as being weak. Proper market definition is essential.
Market Growth Limitations
Relative Market Share Limitations
Accuracy of Market Definition is Essential

8. Tips and Traps

Inflation Clouds the Picture

Market growth rate should be stated in terms of units to avoid the influence of inflation. The original BCG matrix advocated the use of volume for growth rates but many companies use value growth instead. This must be used with caution.

Motivational Problems May Occur after a BCG analysis.

Strategic labels can cause misconceptions. When a business/product is seen to be run down and in a ‘dog position’ and the recommendations are to eliminate it from the portfolio it is often difficult to get acceptance from the managers concerned. A ‘dog’ to one may not be a dog to another.

Cash Flow Reallocation

In many companies where one business unit/product has brought in most of the profit, management resents being asked to pass on this cash to new businesses for which they do not see the logic

ubsequent Adaptations/Improvements

It can safely be said that the BCG was the cause of a rush of different matrices to be developed for use in portfolio analysis and planning.

In the 80’s the Boston Consulting Group updated their original growth-share matrix. The new revised BCG matrix maintains that a company has to achieve a competitive advantage to enjoy sustained profitability and that the means for achieving such advantage are conditioned by the way in which industries evolve.

The new BCG is a two by two matrix with the number of approaches on the vertical axis. This number of approaches refers to the number of different unique ways that advantage can be achieved.

The horizontal axis represents the size of the competitive advantage. The resulting matrix and the four-quadrant grid recognises four different types of business – Volume, Stalemate, Fragmented and Specialisation.

The New BCG Matrix

Businesses falling in these quadrants have different characteristics (Hax & Majluf 1983). The horizontal axis (size of advantage) is linked to barriers of entry; only with high barriers of entry can a firm sustain a long-term defensible advantage over competitors. The vertical axis (number of approaches) is linked to differentiation. At one extreme of the range of differentiation are the commodity products with the speciality products at the other.

1. Volume

In a Volume business, there are only a few ways to obtain an advantage but if obtained, high volume is generated because of the size of the advantage. In this category, market share and profitability are closely associated.

2. Stalemate

There are a few ways to obtain advantage and the size of the advantage is small for businesses in the Stalemate quadrant. Profitability in this quadrant is low for all competitors regardless of size. There is a small difference between the most profitable and least profitable firms.

3. Fragmented

Businesses in this quadrant have many ways of achieving competitive advantage but the advantage is minimal. The profitability of businesses in this sector is not correlated with market share. Poor performers can be large or small and good performers are also independent of size. They differ in the large number of ways they choose to achieve a competitive advantage.

4. Speciality

In this quadrant there are many ways to obtain an advantage and once it is obtained, it is large. The largest profitability is enjoyed by small businesses able to distinguish themselves among their competitors by following a focused strategy.

9. Summary of the BCG Matrix/Growth Share Matrix

  • The BCG matrix was introduced in the late 1960’s and it attempted to facilitate the allocation of resources for a portfolio of companies, SBU’s or products.
  • The concepts underlying this matrix are those of the experience curve (x-axis measures relative market share) and the product life cycle (y-axis measures market growth).
  • It assists with the optimisation of the benefits associated with relative market share (competitive cost position) and the impact of the growth rate of the market (position on the product life cycle).
  • The matrix is made up of four quadrants and the circle size lends a third dimension – turnover.
  • Cash cows are cash generators and require an invest or hold strategy while maximising cash flow.
  • Stars are potential cash cows and require adequate funding to establish a dominant position before the market growth rate slows down and they become cash cows.
  • Question marks do not have market share on their side. They are found in growing markets and require funding if they are to become stars. If not withdrawal is possible.
  • Dogs are neither cash generators nor in many instances cash drains. They can be left alone or removed from the portfolio.
  • The aim is to achieve a balanced portfolio, sustaining or holding the Cash Cows, investing in the Stars and some select Question Marks and divesting or holding Dogs. If necessary, Questions marks could also be divested if they do not have a chance of becoming a Star.

There has been a lot of criticism regarding the growth – share matrix and many subsequent matrices have been designed to try to overcome these deficiencies.

This entry was posted in Knowledge. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s