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BCG matrix

Page history last edited by Brian D Butler 1 year, 5 months ago

 

Table of Contents:


 

 

 

BCG Matrix

 

The BCG matrix method is based on the product life cycle theory that 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. It has 2 dimensions: market share and market growth. The basic idea behind it is that the bigger the market share a product has or the faster the product's market grows the better it is for the company.

 

Placing products in the BCG matrix results in 4 categories in a portfolio of a company.  To use the chart, analysts plot a scatter graph to rank the business units (or products) on the basis of their relative market shares and growth rates.

 

 

 

 

 

 

 

 

 

1. Stars

(=high growth, high market share)

- use large amounts of cash and are leaders in the business so they should also generate large amounts of cash.

- frequently roughly in balance on net cash flow. However if needed any attempt should be made to hold share, because the rewards will be a cash cow if market share is kept.

 

Stars are units with a high market share in a fast-growing industry. The hope is that stars become the next cash cows. Sustaining the business unit's market leadership may require extra cash, but this is worthwhile if that's what it takes for the unit to remain a leader. When growth slows, stars become cash cows if they have been able to maintain their category leadership, or they move from brief stardom to dogdom.

 

 

2. Cash Cows

 

(=low growth, high market share)

- profits and cash generation should be high , and because of the

low growth, investments needed should be low. Keep profits high

- Foundation of a company

 

Cash cows are units with high market share in a slow-growing industry. These units typically generate cash in excess of the amount of cash needed to maintain the business. They are regarded as staid and boring, in a "mature" market, and every corporation would be thrilled to own as many as possible. They are to be "milked" continuously with as little investment as possible, since such investment would be wasted in an industry with low growth.

 

 

 

3. Dogs

 

(=low growth, low market share)

- avoid and minimize the number of dogs in a company.

- beware of expensive ‘turn around plans’.

- deliver cash, otherwise liquidate

 

Dogs, or more charitably called pets, are units with low market share in a mature, slow-growing industry. These units typically "break even", generating barely enough cash to maintain the business's market share. Though owning a break-even unit provides the social benefit of providing jobs and possible synergies that assist other business units, from an accounting point of view such a unit is worthless, not generating cash for the company. They depress a profitable company's return on assets ratio, used by many investors to judge how well a company is being managed. Dogs, it is thought, should be sold off.

 

 

 

 

4. Question Marks

 

(= high growth, low market share)

- have the worst cash characteristics of all, because high demands and low returns due to low market share

- if nothing is done to change the market share, question marks will simply absorb great amounts of cash and later, as the growth stops, a dog.

- either invest heavily or sell off or invest nothing and generate whatever cash it can. Increase market share or deliver cash

 

Question marks are growing rapidly and thus consume large amounts of cash, but because they have low market shares they do not generate much cash. The result is a large net cash consumption. A question mark (also known as a "problem child") has the potential to gain market share and become a star, and eventually a cash cow when the market growth slows. If the question mark does not succeed in becoming the market leader, then after perhaps years of cash consumption it will degenerate into a dog when the market growth declines. Question marks must be analyzed carefully in order to determine whether they are worth the investment required to grow market share.

 

 

 

Lessons

 

 

As a particular industry matures and its growth slows, all business units become either cash cows or dogs.

 

The overall goal of this ranking was to help corporate analysts decide which of their business units to fund, and how much; and which units to sell. Managers were supposed to gain perspective from this analysis that allowed them to plan with confidence to use money generated by the cash cows to fund the stars and, possibly, the question marks. As the BCG stated in 1970:


Only a diversified company with a balanced portfolio can use its strengths to truly capitalize on its growth opportunities. The balanced portfolio has:
  • stars whose high share and high growth assure the future;
  • cash cows that supply funds for that future growth; and
  • question marks to be converted into stars with the added funds.

 

The BCG Matrix method can help understand a frequently made strategy mistake: having a one-size-fits-all-approach to strategy, 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:

 

A.   Cash Cows Business Units will beat their profit target easily; their management have an easy job and are often praised anyhow. Even worse, they are often allowed to reinvest substantial cash amounts in their businesses which are mature and not growing anymore.

B.   Dogs Business Units fight an impossible battle and, even worse, investments are made now and then in hopeless attempts to 'turn the business around'.

C.   As a result (all) Question Marks and Stars Business Units get mediocre size investment funds. In this way they are unable to ever 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 a cash cow (or star), or otherwise companies are advised to disinvest and try to get whatever possible cash out of the question marks that were not selected.

 

 

Limitations

 

Some limitations of the Boston Consulting Group Matrix include:

  • 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

Book: Carl W. Stern, George Stalk - Perspectives on Strategy from The Boston Consulting Group

 

 

 

Practical Use of the BCG Matrix

For each product or service the 'area' of the circle represents the value of its sales. The BCG Matrix thus offers a very useful 'map' of the organization's product (or service) strengths and weaknesses (at least in terms of current profitability) as well as the likely cashflows.

 

The need which prompted this idea was, indeed, that of managing cash-flow. It was reasoned that one of the main indicators of cash generation was relative market share, and one which pointed to cash usage was that of market growth rate.

 

Derivatives can also be used to create a 'product portfolio' analysis of IS services. So IS services can be treated accordingly.

 

 

 

Relative market share

This indicates likely cash generation, because the higher the share the more cash will be generated. As a result of 'economies of scale' (a basic assumption of the BCG Matrix), it is assumed that these earnings will grow faster the higher the share. The exact measure is the brand's share relative to its largest competitor. Thus, if the brand had a share of 20 percent, and the largest competitor had the same, the ratio would be 1:1. If the largest competitor had a share of 60 percent, however, the ratio would be 1:3, implying that the organization's brand was in a relatively weak position. If the largest competitor only had a share of 5 percent, the ratio would be 4:1, implying that the brand owned was in a relatively strong position, which might be reflected in profits and cashflow. If this technique is used in practice, this scale is logarithmic, not linear.

 

On the other hand, exactly what is a high relative share is a matter of some debate. The best evidence is that the most stable position (at least in FMCG markets) is for the brand leader to have a share double that of the second brand, and triple that of the third. Brand leaders in this position tend to be very stable - and profitable; the Rule of 123 [1].

 

The reason for choosing relative market share, rather than just profits, is that it carries more information than just cashflow. It shows where the brand is positioned against its main competitors, and indicates where it might be likely to go in the future. It can also show what type of marketing activities might be expected to be effective.

 

 

Market growth rate

Rapidly growing brands, in rapidly growing markets, are what organizations strive for; but, as we have seen, the penalty is that they are usually net cash users - they require investment. The reason for this is often because the growth is being 'bought' by the high investment, in the reasonable expectation that a high market share will eventually turn into a sound investment in future profits. The theory behind the matrix assumes, therefore, that a higher growth rate is indicative of accompanying demands on investment. The cut-off point is usually chosen as 10 per cent per annum. Determining this cut-off point, the rate above which the growth is deemed to be significant (and likely to lead to extra demands on cash) is a critical requirement of the technique; and one that, again, makes the use of the BCG Matrix problematical in some product areas. What is more, the evidence [2], from FMCG markets at least, is that the most typical pattern is of very low growth, less than 1 per cent per annum. This is outside the range normally considered in BCG Matrix work, which may make application of this form of analysis unworkable in many markets.

 

Where it can be applied, however, the market growth rate says more about the brand position than just its cashflow. It is a good indicator of that market's strength, of its future potential (of its 'maturity' in terms of the market life-cycle), and also of its attractiveness to future competitors. It can also be used in growth analysis.

 

 

 

Risks and criticisms

The BCG growth-share matrix ranks only market share and industry growth rate, and only implies actual profitability, the purpose of any business. (It is certainly possible that a particular dog can be profitable without cash infusions required, and therefore should be retained and not sold.) The matrix also overlooks other elements of industry attractiveness and competitive advantages. Another matrix evaluation scheme that attempts to mend these problems has been the G.E. multi factoral analysis (also known as the GE McKinsey Matrix).

 

With this or any other such analytical tool, ranking business units has a subjective element involving guesswork about the future, particularly with respect to growth rates. Unless the rankings are approached with rigor and skepticism, optimistic evaluations can lead to a dot com mentality in which even the most dubious businesses are classified as "question marks" with good prospects; enthusiastic managers may claim that cash must be thrown at these businesses immediately in order to turn them into stars, before growth rates slow and it's too late. Poor definition of a business's market will lead to some dogs being misclassified as cash bulls.

 

As originally practiced by the Boston Consulting Group [3], the matrix was undoubtedly a useful tool, in those few situations where it could be applied, for graphically illustrating cashflows. If used with this degree of sophistication its use would still be valid. However, later practitioners have tended to over-simplify its messages. In particular, the later application of the names (problem children, stars, cash cows and dogs) has tended to overshadow all else - and is often what most students, and practitioners, remember.

 

This is unfortunate, since such simplistic use contains at least two major problems:

 

'Minority applicability'. The cashflow techniques are only applicable to a very limited number of markets (where growth is relatively high, and a definite pattern of product life-cycles can be observed, such as that of ethical pharmaceuticals). In the majority of markets, use may give misleading results.

 

'Milking cash bulls'. Perhaps the worst implication of the later developments is that the (brand leader) cash bulls should be milked to fund new brands. This is not what research into the FMCG markets has shown to be the case. The brand leader's position is the one, above all, to be defended, not least since brands in this position will probably outperform any number of newly launched brands. Such brand leaders will, of course, generate large cash flows; but they should not be `milked' to such an extent that their position is jeopardized. In any case, the chance of the new brands achieving similar brand leadership may be slim - certainly far less than the popular perception of the Boston Matrix would imply.

 

Perhaps the most important danger [4] is, however, that the apparent implication of its four-quadrant form is that there should be balance of products or services across all four quadrants; and that is, indeed, the main message that it is intended to convey. Thus, money must be diverted from `cash cows' to fund the `stars' of the future, since `cash cows' will inevitably decline to become `dogs'. There is an almost mesmeric inevitability about the whole process. It focuses attention, and funding, on to the `stars'. It presumes, and almost demands, that `cash bulls' will turn into `dogs'.

The reality is that it is only the `cash bulls' that are really important - all the other elements are supporting actors. It is a foolish vendor who diverts funds from a `cash cow' when these are needed to extend the life of that `product'. Although it is necessary to recognize a `dog' when it appears (at least before it bites you) it would be foolish in the extreme to create one in order to balance up the picture. The vendor, who has most of his (or her) products in the `cash cow' quadrant, should consider himself (or herself) fortunate indeed, and an excellent marketer; although he or she might also consider creating a few stars as an insurance policy against unexpected future developments and, perhaps, to add some extra growth.

 

 

Alternatives

As with most marketing techniques there are a number of alternative offerings vying with the BCG Matrix; although this appears to be the most widely used (or at least most widely taught - and then probably 'not' used). The next most widely reported technique is that developed by McKinsey and General Electric; which is a three-cell by three-cell matrix - using the dimensions of `industry attractiveness' and `business strengths'. This approaches some of the same issues as the BCG Matrix, but from a different direction and in a more complex way (which may be why it is used less, or is at least less widely taught). Perhaps the most practical approach is that of the Boston Consulting Group's Advantage Matrix, which the consultancy reportedly used itself; though it is little known amongst the wider population.

 

 

 

Other uses

The initial intent of the growth-share matrix was to evaluate business units, but the same evaluation can be made for product lines or any other cash-generating entities. This should only be attempted for real lines that have a sufficient history to allow some prediction; if the corporation has made only a few products and called them a product line, the sample variance will be too high for this sort of analysis to be meaningful.

 

 

 

See also

 

 

 

References

 

 

 

 

 

 

 

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