Sunday, July 3, 2011

The 2 Dimensional Matrix: A Universal Analytical Tool

The essence of management is three fold: the first is to reduce the complex to simple so that the core of an issue can be crystallized and a customized solution developed, the second is to frame an issue in terms of key choices and priorities so that prioritized choices can be made, and the third is to make any analysis universal so that teams as a whole can grasp how issues are being analyzed and resolved. Over the years, management science has seen several applications of mathematics and statistics as well as information technology enabled heuristics for problem solving. These have, however, remained the preserve of the experts trained in such specific disciplines. Even today, professionals in any hierarchy, the most experienced senior levels or the most educated junior levels, find it abstract and time consuming to apply sophisticated management sciences for analysis of managerial or strategic issues.

There are correlation and regression techniques that can be deployed to predict performance of companies or estimate the outcomes of projects. These models can be related to a host of internal and external causative factors (independent variables) predicting the performance or outcome (dependent variable). Alternatively, a set of complex factors, whose behaviors can be assumed, can be used in a simulation model to predict interdependencies and outcomes. At another level, operations research techniques can be used to make choices and establish, given a set of optimization goals, constraints and resource requirements. All the above sophisticated models are data intensive and have a role in operational and business decision making but unfortunately are neither simple nor universal for grasp. In contrast, there exists a simple but effective model of two dimensions (each of them not correlated with each other), which the author would like to call as the "2D Matrix Model" that is extremely simple and effective in catering to the three faceted essence of management described at the beginning of this blog post.


The concept of 2D
The concept of 2D Matrix rests on the premise that there usually exist two primary dimensions that are the most important in assessing any business or operation. For example, a running business has revenue and profitability as the most important metrics. A new business has risk and reward as the two relevant critical dimensions. A manufacturing operation has production and cost as the two important dimensions. The 2D concept is not confined merely to metrics; it applies to processes as well. A business growth process can be essentially depicted in terms of the two dimensions of product and market. A time management process can be positioned in terms of importance and urgency. A customer satisfaction process can be assessed in terms of customer foot falls and dollar revenues. The impressive thing is that any activity or end state in the world lends itself elegantly to two dimensional mapping.

The core of the two dimensional framework is that each of the two dimensions (typically plotted as X-axis and Y-axis) would not be correlating with each other; rather they would represent choices that an analyst would need to make. This feature adds to the utility of the framework while retaining simplicity. For example, a revenue earning business need not necessarily be a profit making business, and vice versa. An important matter need not necessarily be an urgent matter, and an urgent matter need not necessarily be an important matter. The other feature is that the four quadrants of the 2D matrix do not necessarily represent strategic judgments of right or wrong positions. Rather, they represent four options that reflect a potential evolutionary journey based on certain attributes. For example, a company may desire to move from a high revenue-low profit model to a low revenue-high profit model deliberately. The 2D matrix essentially keeps strategy simple.
Best known models
The 2D model has been in existence for long. Two of the best known models have been the BCG Matrix and Blake & Mouton Leadership Grid. The BCG Matrix (attributed to Bruce Henderson, 1968) plots various businesses or products in terms of market growth and market share. The matrix effectively merges the concept of product life cycle within itself. The BCG Matrix leads to four quadrants. Star or Leader is a product with high market share in a high growth market,  providing high cash inflows and needing reinvestments to defend position. Star provides leadership and brand power to a corporation. Cash Cow has high market share in a low growth market. Surplus cash generated by a Cash Cow can be used for Research and Development and to support other SBUs that need investment. Question Mark is a product in a growth market with low market share which breaks even typically. There could be two ways to approach a question mark: convert it into a Star through investment and let it become a Dog with limited investments. Dog is a product with low market share in a low growth market. The Dog could be a net guzzler of cash. Most often, a product in this quadrant may have to be phased out to enable the corporation focus on converting promising Question Mark products into Stars. A corporation is expected to have a balanced portfolio of products in all the four quadrants.
The second model is the managerial grid model (1964) which is a behavioral leadership model developed by Robert R Blake and Jane Mouton. This model originally identified five different leadership styles based on the concern for production (X-axis) and the concern for people (Y-axis), each axis being scaled 1 to 9. In the indifferent (also called impoverished) style (1,1), managers have low concern for both people and production. This leads to self-perpetuating culture with low innovation. In the accommodating (also, country club) style (1,9) managers have a high concern for people and a low concern for production. The resulting atmosphere is usually friendly, but not necessarily very productive. The dictatorial (also, produce or perish) style (9,1) has high concern for production, and a low concern for people. Managers using this style find employee needs unimportant and follow Theory X of Douglas McGregor. The sound (also, team) style (9,9) managers have high concern for both people and production. As suggested by the propositions of Theory Y of McGregor, managers choosing to use this style encourage teamwork and commitment among employees. Managers following   status quo (also, middle-of-the-road) style (5,5) try to balance between company’s goals and workers' needs. By giving the same level of concern to both people and production, managers who use this style hope to achieve suitable performance but doing so compromises a bit of each concern so that neither production requirements nor people needs are met.
Other potential models
Despite the limitations (which are discussed later), the 2D matrix models have great relevance in corporate strategy. Given the fact that corporate life is one of challenges, and given also the desirability of leaders needing to take a “black or white” view of decision making, there are many areas of application for the 2D matrix model. Apart from revenue-profit and risk-reward assessment models, the 2D matrix offers significant analytical power in product-market assessments. How to grow the corporation in a competitive business environment through existing and/or new products and through existing and/or new products is a major decision matrix for 2D application. There are several other interesting and non-conventional 2 axis applications in varied domains such as assessing a manufacturing plant decision in terms of economies of scale versus economies of scope, evaluating people in terms of their performance versus potential, understanding a technology in terms of innovation versus obsolescence, examining a software in terms of complexity versus utility appreciating real estate in terms of current cost versus future escalation, appreciating the paradox of market share and profitability, and adopting a managerial style based on relations versus results.
The 2D matrix could also be a viable tool in mapping companies, and industries or benchmarking them. For example, data generated out of financial ratio analysis can be utilized to position firms differentially. Firms can be assessed in terms of capital structure solidity on the two dimensions of debt and equity. Industries, themselves, can be comparatively positioned in terms of debt-equity structures. A firm can be assessed in terms of working capital efficiency vis-a-vis long term capital efficiency by treating current ratio and asset turnover ratio as two dimensions. Misleading conclusions on high level debt levels can be avoided by plotting firms on the twin dimensions of debt and interest cover. Given the importance of supply chain management, net profit margin and inventory turns ratio can relate a company’s operating efficiencies to the nature of the industry environment. Beyond financial ratios, firms can be assessed in terms of a number of performance metrics. For example, field force efficiency can be assessed in terms of per capita sales and profit margin. The 2D matrix could thus be a powerful tool in analyzing corporate performance.
Application to Porter’s framework
Any discussion on strategic analysis cannot be complete without touching upon Michael Porter’s theory of competitive strategy. Porter’s five forces theory lists five competitive forces, namely, bargaining power of suppliers, bargaining power of customers, threat of new entrants, threat of substitute products and intensity of rivalry as the five determinants of the relative attractiveness of an industry.  Porter also speaks of viewing incumbents in an industry in terms of strategic groups formed on select combinations of two dimensions. The author of this blog post carried out pioneering research work in translating Porter’s qualitative strategy into quantitative dimensions of performance. Physical and financial performance of the Indian automobile industry as a whole, and that of the strategic groups in the industry was analyzed through regression on six predictive variables of technology (see C Bhaktavatsala Rao, ”Indian Automobile Industry : A Study of Structure and Performance of the Four-Wheeler Sector”, Ph D Thesis, Indian Institute of Technology Madras, 1991). While the results were compellingly intuitive and elegant, the regression itself was complex and sophisticated. The formation of certain 2 dimensional strategic groups, based on product and manufacturing strategies, provided additional research and explanatory power to the author’s research.
On a different plane, the attractiveness of the industry can be assessed by applying the 2D approach to the five competitive forces. Appropriate combinations are the bargaining power of suppliers and bargaining power of customers on one hand and the threat of new entrants and the threat of substitute products on the other. Utilizing the author’s extension of Porter’s theory to a sixth competitive force, namely economic liquidity (see Beyond Porter’s Darwinism: Sixth Competitive Force, Strategy Musings, August 23, 2009, www.cbrao2008.blogspot.com), the third combination can be in terms of intensity of rivalry and economic liquidity. Clearly, various firms would be differently positioned in terms of the three grids. Firms operating in industries with low bargaining powers of suppliers and customers, low threats of entrants and substitute products, and with low rivalry and high liquidity would obviously be the most attractive. In reality, industries and firms would fall under different sub-groups with mobility being potentially possible across the groups. The 2D strategic grouping adds more analytical power to porter’s and the author’s works on competitive strategy.
Limitations of the 2D
Simple, effective, elegant and universal though the 2D matrix is, the tool has certain inherent drawbacks that arise from simplification. The relative positioning across the dimensions reflects a cross-sectional status accurately but does not explain the underlying strategic causes or implications. For example, taking the above cited case it cannot be concluded that it is best for firms to be locked into a situation of low bargaining powers of suppliers and customers, low threats of entrants and substitute products, and with low rivalry and high liquidity. In fact, the absence of competitive intensity that is implied in such a comfortable grouping may be reflective of complacency, and may lead to inefficiencies. It may still result in usurious profits, but could hardly be a beacon of long term industrial health, also removing any motivation for innovation. The so called favorable strategic grouping thus acts against consumer interests and economic wellbeing in the long term. None of this is explained in the 2D model.
The other limitation is that when more than 6 or 8 dimensions (that is, more than 3 or 4 pairs are involved), it becomes difficult to form a coherent and seamless strategic canvas. For example, it does become difficult to explain the performance and potential of a high debt-equity firm with good current and poor asset turnover positioning, high interest cover and medium operating margin and a portfolio of products with low risk and high reward, unless the industry environment is also defined in perspective. That would add more dimensions with more than proportionate increase in complexity. Similarly, the product-market grid has to be read in conjunction with the risk-reward grid as well as the financial ratio grids. The 2D approach also does not establish the core competitive dimensions of a firm or relate performance with core dimensions. On the other hand, without an understanding of the longitudinal evolution on the strategic dimensions, the 2D analysis could result in erroneous interpretations on core competencies.
First class tool for first cut analysis
Though there could exist valid limitations of 2D matrix as above, none of the limitations as above militate against the relevance of the 2D matrix. In fact, the 2D matrix is a best-in-class tool for a first cut analysis of strategic positioning of firms and industries. It is important to realize that 2D matrix analysis when conducted longitudinally overcomes many of the limitations above cited. If, in addition, it is combined with qualitative industry information, it would be a very effective tool of strategic analysis. If BCG Matrix and Leadership Grid are the pioneering 2D approaches of the 1960s and are still enduring as relevant strategic frameworks, there is every reason to develop and institutionalize additional 2D matrix approaches for product-market analysis, risk-reward analysis, financial ratio analysis and competitive force analysis as discussed herein. There can be no doubt that the 2D matrix approach meets the three faceted essence of management (in terms of simplicity, prioritization and universality of analysis) as identified in the beginning of this blog post.
Posted by Dr CB Rao on July 3, 2011


2 comments:

padhalam prasad said...

it will be interesting to verify interplay of macro-economic factors as a single entity to the industry specific organization using teh same framework

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