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. Portfolio Planning
One of the most famous portfolio planning matrices is referred to as the growthshare matrix. This was developed by the Boston Consulting Group (BCG), principally to help senior managers identify the cash flow requirements of different businesses in their portfolio and to help determine whether they need to change the mix of businesses in the portfolio. We review the growth-share matrix in order to illustrate both the value and the limitations of portfolio planning tools. The growth-share matrix has three main steps: (1) dividing a company into strategic business units (SBUs); (2) assessing the prospects of each SBU and comparing them against each other by means of a matrix; and (3) developing strategic objectives for each SBD.

Identifying SBUs According to the BCG, a company must create an SBU for each economically distinct business area that it competes in. Normally, a company defmes its SBUs in terms of the product markets they are competing in. For example, Ciba Geigy, Switzerland's largest chemical and pharmaceutical company and an active user of portfolio planning techniques, has identified thirty-three strategic business units in areas such as proprietary pharmaceuticals, generic pharmaceuticals, seed treatments, reactive dyes, detergents, resins, paper chemicals, diagnostics, and composite materials (see Strategy in Action 10.1). Assessing and Comparing SBUs Having defined SBUs, top managers then assess each according to two criteria: (1) the SBU's relative market share and (2) the growth rate of the SBU's industry. Relative market share is the ratio of an SBU's market share to the market share held by the largest rival company in its industry. If SBU X has a market share of 10 percent and its largest rival has a market share of 30 percent, SBU X's relative market share is 10/30, or 0.3. Only if an SBU is a market le~der in its industry will it have a relative market share greater than 1.0. For example, if SBU Y has a market share of 40 percent and its largest rival has a market share of 10 percent, then SBU Y's relative market share is 40/10, or 4.0. According to the BCG, market share gives a company cost advantages from economies of scale and learning effects. An SBU with a relative market share greater than 1.0 is assumed to be farther down the experience curve and therefore to have a significant cost advantage over its rivals. By similar logic, an SBU with a relative market share smaller than 1.0 is assumed to lack the scale economies and low-cost position of the market leader. The growth rate of an SBU's industry is assessed according to whether it is faster or slower than the growth rate of the economy as a whole. BCG's position is that high-growth industries offer a more favorable competitive environment and better long-term prospects than slow-growth industries. Given the relative market share and industry growth rate for each SBU, management compares SBUs against each other by way of a matrix similar to that illustrated in Figure 10.1. The horizontal dimension of this matrix measures relative market share; the vertical dimension measures industry growth rate. The center of each circle corresponds to the position of an SBU on the two dimensions of the matrix. The size of each circle is proportional to the sales revenue generated by each business in the company's portfolio. The bigger the circle, the larger is the SBU's revenue relative to total corporate revenues.

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10.1

portfolio Planningat Ciba-Geigy

iba-Geigy isalarge Swiss-based company
with interests chemicalsandpharmaceutiin calsandannualrevenues excess $25 in of billion. Since1984,the company hasbeen usingportfolio planningtechniques asa tool to assistcorplanning, poratemanagement theprocessof strategic in resourceallocation,andperformanceassessment. Althoughthecompanylookedcloselyat the growth-share matrix devised theBostonConsulting by Group,it decided to developa customized portfolio planningtool that would bettersuitits needs. ciba haddividedthe company into thirty-threeseparatestrategicbusiness units, suchasproprietarypharmaceuticals,genericpharmaceuticals, seedtreatments, reactivedyes,detergents,esins,paperchemicals, iagr d nostks, andcompositematerials.At Ciba,eachSBUis assessed accordingtotwomaincriteria: the likely future growthrateof its industry,andthe competitive positionof the SBUrelativeto its rivals.In derivinga measure of competitive position,Cibalooks at relativemarketshare, but unlike the originalBCGgrowth-share matrix,the companyalsoconsidersa rangeof othercompetitive factors, suchascoststructure,productquality,corecompetencies,andrelativeprofitability. Usingthesedata,Cibaclassifies SBUs oneof its into fivecategories: evelopment, d growth,pillar, niche,and core.Development businesses rein the earlystage a of their life cycleandusuallyrequiresubstantial &DinvestR ments.Growthbusinessesre competitive a SBUs based in largeand/orgrowingmarkets.Cibawillcommitsubstantial funds in order to build the competitive position of such a business. Pillar businesses are market leaders that are R&Dfundingand resource allocation in order to maintain their pillar status. Niche businesses are market leaders
that are constrained becausethey serve a relativelysmall market (Ciba'sanimal health business, for example, was defined as a niche business). Core businesses are large SBUs that compete in mature industries (Ciba's dyes, polymers, and pigments SBUs are all classified as core). Core businesses are seen as generating excess cash that can be used to fund investments elsewhere within the company. What is interesting about Ciba's approach is that these classifications arenot takenas gospel.The company is quite willing to violate the investment rules associated with the different categories if that seems appropriate. For example, in 1994 Ciba committed itself to major new in-

vestments in its pigments SBUto upgrade its U.S. production facilities, eventhoughits portfolio planning categories suggest that this was a mature low-growth core business that should be used to generate funds for investment elsewhere within the company. iba's viewappears C
to be that the utility of portfolio planning lies not so much in its role as a guide to resource allocation, as it does in helping top managers set reasonable strategic expectations andobjectives the different SBUswithinthe comfor pany. Thus, Ciba's corporate managers will assign very different strategic and financial objectives to SBUs classified as growth businesses compared with those classified as pillars. Pillars would be expected to earu a higher re-

turn on assets, generate greater cash flow, and contribute

more of their earnings to the corporate bottom line than a growth business. By the same token, however, growth businesses would be expected to grow their revenues and earnings at a faster rate than pillars. The performance of managers running these SBUs is then compared against these different expectations.4 ~-,

basedin attractive industries,suchas Ciba's pharmaceutical businesses. Theytypicallyreceivea high priority in

~ ~' "._-~~

The matrix is divided into four cells. SBUsin cell 1 are defined as stars, in cell 2 as question marks, in cell 3 as cash cows, and in cell 4 as dogs. BCG argues that these different types of SBUshave different long-term prospects and different implications for cash flows. . Stars. The leading SBUsin a company's portfolio are the stars. Stars have a high relative market share and are based in high-growth industries. Accordingly, they offer attractive long-term profit and growth opportunities.

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FIGURE

10.1 High Celli: Stars Cell 2: Question Marks

The BCG Matrix

<II tC

a:: .c ""'
~ C) >. 10.

" C
Cell]: Cash Cows High Relative Market Share
Source:Perspectives, o. 66,"The Product Portfolio."Adapted by permission from The Boston Consulting N Group, Inc., 1970.

""' III :I

Low

Cell 4.: Dogs

~ Low

Question

marks. Question

marks are SBUs that are relatively weak in competi-

tive terms (they have low relative market shares) but are based in high-growth industries and thus may offer opportunities for long-term profit and growth. A question mark can become a star if nurtured properly. To become a market leader, a question mark requires substantial net injections of cash; it is cash hungry.The corporate head office has to decide whether a particular question mark has the potential to become a star and is therefore worth the capital investment necessary to achieve stardom. Cash cows. SBUsthat have a high market share in low-growth industries and a strong competitive position in mature industries are cash cows. Their competitive strength comes from being farthest down the experience curve. They are the cost leaders in their industries. BCG argues that this position enables such SBUsto remain very profitable. However, low growth implies a lack of opportunities for future expansion. As a consequence, BCG argues that the capital investment requirements of cash cows are not substantial, and thus they are depicted as generating a strong positive cash flow. Dogs. SBUsthat are in low-growth industries but have a low market share are dogs. They have a weak competitive position in unattractive industries and thus are viewed as offering few benefits to a company. BCG suggests that such SBUsare unlikely to generate much in the way of a positive cash flow and indeed may become cash hogs. Though offering few prospects for future growth in returns, dogs may require substantial capital investments just to maintain their low market share.

Strategic Implications The objective of the BCG portfolio matrix is to identify how corporate cash resources can best be used to maximize a company's future growth and profitability. BCG recommendations include the following:

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The cash surplus from any cash cows should be used to support the development of selected question marks and to nurture stars. The long-term objective is to consolidate the position of stars and to turn favored question marks into stars, thus making the company's portfolio more attractive. Question marks with the weakest or most uncertain long-term prospects should be divested to reduce demands on a company's cash resources. The company should exit from any industry where the SBUis a dog. If a company lacks sufficient cash cows, stars, or question marks, it should consider acquisitions and divestments to build a more balanced portfolio. A portfolio should contain enough stars and question marks to ensure a healthy growth and profit outlook for the company and enough cash cows to support the investment requirements of the stars and question marks.

. . .

. Limitations of Portfolio Planning

Though portfolio planning techniques may sound reasonable, if we take the BCG matrix as an example, there at least four main flaws. First, the model is simplistic. An assessment of an SBU in terms of just two dimensions, market share and industry growth, is bound to be misleading, for a host of other relevant factors should be taken into account. Although market share is undoubtedly an important determinant of an SBU's competitive position, companies can also establish a strong competitive position by differentiating their product to serve the needs of a particular segment of the market. A business having a low market share can be very profitable and have a strong competitive position in certain segments of a market. The auto manufacturer BMW is in this position, yet the BCG matrix would classify BMWas a dog because it is a low-market-share business in a low-growth industry. Similarly,ni dustry growth is not the only factor determining industry attractiveness. Manyfactors besides growth determine competitive intensity in an industry and thus its attractiveness. Second, the connection between relative market share and cost savings is not as straightforward as BCG suggests. High market share does not always give a company a cost advantage. In some industries-for example, the U.S. steel industry-Iowmarket-share companies using a low-share technology (minimills) can have lower production costs than high-market-share companies using high-share technologies (integrated mills). The BCG matrix would classify minimill operations as the dogs of the U.S. steel industry, whereas in fact their performance over the last decade has characterized them as star businesses. Third, a high market share in a low-growth industry does not necessarily result in the large positive cash flow characteristic of cash cow businesses. The BCGmatrix would classify General Motors' auto operations as a cash cow. However,the capital investments needed to remain competitive are so substantial in the auto industry that the reverse is more likely to be true. Low-growth industries can be very competitive, and staying ahead in such an environment can require substantial cash investments. To be fair, several companies and management consulting enterprises have recognized the limitations of the BCG approach and developed alternative approaches that address the weaknesses noted above. For example, Ciba-Geigy,whose use of
portfolio planning techniques is reviewed in Strategy in Action 10.1, has devised a

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planning approach that recognizes a wider range of competitive factors needed to be taken into consideration when assessing an SBD'sposition. Similarly,the management consultants McKinsey and Company developed a portfolio matrix that uses a much wider range of factors to assess the attractiveness of an industry in which an SBD competes, as well as the competitive position of an SBD (see FigurelO.2). Included in the assessment of industry attractiveness are factors such as industry size, growth, cyclicality, competitive intensity, and technological dynamism. The assessment of competitive position relies on factors such as market share and an SBD's relative position with regard to production costs, product quality,price competitiveness, distribution, and innovation. Although there is no doubt that the approaches adopted by Ciba and McKinsey represent a distinct improvement over the original BCG model, in general all portfolio planning techniques suffer from significant flaws. Most important, they fail to pay attention to the source of value creation from diversification. They treat business units as independent, whereas in fact they may be linked by the need to transfer skills and competencies or to realize economies of scope. Moreover, portfolio planning approaches tend to trivialize the process of managing a large diversified company. They suggest that success is simply a matter of putting together the right portfolio of businesses, whereas in reality it comes from managing a diversified portfolio to create value, whether by leveraging distinctive competencies across business units, by sharing resources to realize economies of scope, or by achieving

GURE 10.2
e McKinsey Matrix

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Winner

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> -.p U III
III III QI C QI

Loser

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"0

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Medium

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Loser

Low
Good ~ ~ Medium ~ ~ Poor

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Position