BCG Matrix in Portfolio Management

Abstract

The growth share matrix, also known as the product portfolio matrix or Boston Consulting Group matrix, was developed through the collaborative efforts of BCG partners. Alan Zakon initiated the concept and subsequently refined it with his colleagues. BCG's founder, Bruce D. Henderson, popularized the matrix in his essay titled "The Product Portfolio" published in BCG's Perspectives in 1970 .

The matrix serves as a tool to aid organizations and businesses in analysing their product/services portfolio, enabling them to allocate resources effectively. It is commonly used as an analytical tool in strategic management, brand marketing, product management, and portfolio analysis.

This article will provide a comprehensive explanation of each component of the matrix and its significance, accompanied by a pertinent study case as an example. Additionally, a critical assessment of the matrix will be presented by examining its strengths, appropriate use, limitations, and misuses in the industry. Lastly, a comparison will be made between this matrix and other comparable matrices employed in portfolio management, such as the McKinsey matrix.

The fundamental elements and underlying assumptions of BCG Matrix

The BCG Matrix evaluates a company's product portfolio through an evaluation of the relative strength of each business product and the growth rate of its associated market or industry. This analytical approach yields a comprehensive analysis of the company's product portfolio, which facilitates informed decision-making. Furthermore, the BCG Matrix has the capacity to communicate corporate decisions to subsidiary companies. Henderson, in his commentary on the Matrix at the time of its creation, stated::

"Such a single chart with a projected position five years out is sufficient alone to tell a company's profitability, debt capacity, growth potential, dividend potential and competitive strength".

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Categorization of businesses into four distinct portfolio groups

Figure 1. - BCG-Matrix with growth/share axis and the four portfolio categories.

The Matrix is partitioned into four quadrants, each highlighting a distinct type of business unit: cash cows, dogs, question marks, and stars. To evaluate the business products in a portfolio, the BCG Matrix necessitates the use of a scatter graph with metrics like market share and growth rate. This approach enables analysts to appraise the overall product portfolio of the company. By visually representing the units, the Matrix identifies the units that are performing well and those that require attention.

1. Cash cows

   Cash cows denote to products that hold a supreme position in a mature industry and yield significant profits for the company. These products are meant to be "milked" with minimal investment since the industry's growth is slow.

2. Dogs

   Dogs, also called sometimes as pets, refer to products with a significant market share in a mature industry. These products generate just enough revenue to compete and break-even.

3. Question marks

   Question marks refer to products with a low market share in a developing market, serving as a starting point for most companies. Question marks has the potential to gain market share and become stars, eventually transitioning to cash cows when the market growth slows down. If question marks don't succeed in becoming a market leader, they will turn into dogs.

4. Stars

   Stars denote products with a leading market share in a developing industry. They are previously question marks with an established market share.

The fundamental assumption underlying the BCG Matrix is that market growth and investment opportunities are inherently interconnected. As a market expands, it presents a potentially lucrative avenue for investment, as the funds allocated to it have the potential to compound over time and yield greater returns in the future. However, as a market grows, the need for cash to maintain market share and competitive position increases as well, lest products become dogs due to low relative market share. In the BCG Matrix, market growth is the primary driver of market attractiveness.

Product life cycle

The BCG Matrix segments can be related to the different stages of the product life cycle. Question marks represent products in the introduction phase, with high costs and low sales and profits. Investment strategies are needed to increase market share in a growing market. Successful management leads to the growth phase and profitability increases. However, increased competition may cause price decreases and reduce profits. In the maturity stage, the highest relative market share provides a significant advantage, and the company can harvest profits due to the experience curve effect. These products are the cash cows. In the saturation and decline stage, sales and profits decrease, and the market becomes unattractive, leading to divestment strategies, similar to how dogs are treated.

Matrix best practices

To enhance the representation of business units on the Matrix, a portfolio analysis is conducted, which evaluates various Strategic Business Units (SBUs) and their corresponding product markets. SBUs are businesses that concentrate on a specific combination of products and markets, and they need some degree of autonomy while sharing similar resources and structures. This allows each SBU to make autonomous decisions without affecting other units in the portfolio. However, determining SBUs can be challenging because products within an SBU may have differing market growth rates and relative market shares. The Matrix represents the relative importance of each SBU by scaling the size of a circle proportionally to either sales or assets.

Relative Market Share

The experience curve concept introduced by Henderson in 1968 suggests that the company with the highest market share is likely to have the most substantial profit margin. This is because a company's relative position compared to its competitors is a critical factor in determining its profitability, with a stronger position typically leading to higher profits. To determine a company's competitive position, the most fundamental measure is relative market share, which is calculated by dividing the business's market share by its largest competitor's share. Thus, a higher relative market share indicates greater potential for cash generation by the company.

The aim of the matrix in decision making

The BCG-Matrix is centred around maintaining a balance of positive and negative cash flows across various businesses. It categorizes each quadrant as a net cash generator or cash user, making assumptions about the cash position of each quadrant critical to the concept's effectiveness. According to the matrix, companies should seek to have "stars" with high market share and growth to secure the company's future. "Cash cows" are also essential to provide capital for future investments and cover current expenses. A selected range of "question marks" is necessary since they can potentially transform into "stars" with some investment influx. On the other hand, "dogs" indicate failure and should be liquidated.

Case study

Figure 2. - Initial business portfolio of exemplary cases.

Despite its simplicity and illustrative approach, applying matrix does require some elements that need to be given special attention. To demonstrate the matrix ability to derive the right strategic decision, a case study will be presented and thoroughly discussed. Despite having discussed the core quadrants of the BCG-Matrix, careful attention must be given to the scaling of axes and the positioning of the horizontal and vertical dividing lines that create the four quadrants of the matrix. A continuous scale is used for the vertical axis (growth rate), and it is suggested in some literature to set the dividing line at the expected inflation-adjusted growth in gross national income (GNI). However, Henderson and Hedley recommended that the dividing line should be placed at a growth rate of 10%, as this is the discount rate that companies typically use during times of low inflation. Any growth above 10% is considered especially attractive for investment. It is vital to implement the appropriate scale for the vertical axis, as it can have significant implications for classifying a business as a star, cash cow, dog, or question mark. For the horizontal axis (relative market share), a logarithmic scale is used to be consistent with the experience curve effect. The dividing line is set at 1.0, as only the relative market share of the largest competitor can be left of this line, with all others falling below this value by definition. It should be noted that these guidelines serve only as an approximate guide, and that adaptations may need to be made to achieve accurate results and derive appropriate strategic decisions for the business portfolio. Once the matrix is constructed with its four quadrants, each SBU or product can be plotted within it based on its relevance in sales or assets.

Assumptions

Assuming a portfolio of a hypothetical company is depicted in the matrix in Figure below where it illustrates several business units and indicates their respective quadrant assignments. The area of each circle represents the volume of total sales. The portfolio is seen to possess a strong cash cow product 2 and a promising star, product 3. Additionally, the company holds several question marks, which are product 4 and 5 and a dog, product 1. It is essential to recognize that each business necessitates distinct strategic objectives to maximize opportunities. Prescribing a singular, overarching goal for all businesses would be erroneous. Therefore, the strategic implications are contingent on the individual characteristics of each business unit and must be carefully evaluated.

The management strategic decisions therefore would be:

1. Cash cows: Maintain, since they currently generate profitability.
2. Dogs: Expected to generate some profits, but may be divested soon.
3. Stars: Keep, hoping to expand its current market share.
4. Question marks: Invest in some to gain market share and sell others for cash.

Scenarios

Figure 3. - Success Sequence.

The strategy for the question marks is the most important, as investing in all of them could result in a lack of funds to develop them into stars and cash cows. As a result, the company's resources would be depleted while there would be no return. Henderson referred to this as the "sequence of disaster" (see Figure below). Instead, the company should invest in a few promising question marks and quickly divest the rest. This will result in a "success sequence" in which the question marks generate future net cash flow. The figures below depict how the company could have performed over a three-year period under this scenario (Success Sequence) and the previous one (Disaster Sequence). The two scenarios can be summarized as follows:

Figure 4. - Disaster sequence.

1. The company made "the best" decisions in managing its business portfolio in the Success sequence. First, the cash cow, Product 2, provided enough funds to develop Product 3, a former star, into a strong market leader. Despite the market slowing, Product 3 capitalized on its market position and became a cash cow, contributing more to total sales than Product 2. Concerning the question marks, the company pursued two approaches. Product 5 demonstrated promise but required significant investment, so it was sold for a good price and is no longer in the portfolio. While product 4 was developed with significant cash investment and became the company's new star. Despite a slowing in market growth, product 4 increased its market share significantly. The company had enough funds to innovate and develop new question marks, products 6 and 7, through the cash out of product 5 and the positive cash flow from the cash cows. However, the company could not sell product 1, which was a dog, so investment was reduced to allow for a slow death without compromising future success of the company.
2. On the other hand, the Disaster Sequence, the company distributed investments equally among all its products instead of developing customized strategies for each. This ultimately result poor management and a decline in market share for product 2 (cash cow), leading to less net return for the company. Furthermore, product 3 (star) lost market share due to aggressive competition and may soon become a dog if immediate action is not taken. The company's inability to commit to a clear strategy also affected products 4 and 5 (former question marks), which failed to convert into stars despite receiving investment funds, draining the company's resources without providing any returns. In addition, the company invested in product 1 (dog), which continues to require more cash than it generates. With the market growth not expected to increase, the company's current leader is likely to maintain its strong position, making it difficult for product 1 to succeed.

Strengths and limitations

“A company should have a portfolio of products with different growth rates and different market shares. The portfolio composition is a function of the balance between cash flows.… Margins and cash generated are a function of market share.”

— Bruce Henderson, “The Product Portfolio,” 1970.

One of the strengths of the BCG matrix is that it provides a simple framework for understanding a company's product portfolio. The matrix is easy to understand and provides a visual representation of a company's products. It helps companies identify where to focus their resources by highlighting areas of the portfolio that require investment and areas that can be "milked" for revenue. The matrix also helps companies identify products that may need to be divested or discontinued.

However, the BCG matrix has several limitations. First, the matrix is based solely on market share and market growth, ignoring other important factors such as competition and customer demand. Second, the matrix assumes that high market share and high growth are always desirable, which is not always the case. Third, the matrix is static and does not account for changes in the market over time. Products can move between categories over time, but the matrix does not provide a framework for this.

Despite its theoretical usefulness and widespread use, the efficacy of the growth-share matrix in contributing to business success has been investigated by several academic studies, resulting in its removal from some significant marketing textbooks. In 1992, a study was conducted by Slater and Zwirlein where they examined 129 firms that used the BCG matrix in their portfolio planning models. The study has shown that those firms tend to have lower shareholder returns. Furthermore, the BCG matrix has been criticized on several other grounds. For instance, it categorizes dogs as entities with low market share and relatively low market growth rate.

Comparison to other matrices

Alternatively, there are several methods in portfolio management that can offer a similar view on the growth share of a company. The most widely used method is developed by McKinsey and it is called – you guessed it, McKinsey matrix, also known as the directional policy matrix.

McKinsey matrix categorises business organizations into those with good prospects and those with less good prospects. It places business organizations according to two aspects:

- how attractive the relevant market is in which they are operating

- the competitive strength of the strategic business unit in that market.

The attractiveness can be measured by PESTEL or five forces analyses, while business unit strength can be defined by competitor analysis (for instance, the strategy canvas). For instance, managers in an organization with the portfolio shown in Figure will be concerned that they have relatively low shares in the largest and most attractive market, whereas their greatest strength is in a market with only medium attractiveness and smaller markets with little long-term attractiveness.

The matrix also offers strategy guidelines given the positioning of the business units. It suggests that the businesses with the highest growth potential and the greatest strength are those in which to invest for growth. Those that are the weakest and in the least attractive markets should be divested or ‘harvested’ (i.e. used to yield as much cash as possible before divesting). The directional policy matrix is more complex compared to the BCG matrix. However, it can have two advantages. First, unlike the simpler four-box BCG matrix, the nine cells of the directional policy matrix acknowledge the possibility of a difficult middle ground.