Sunday, April 8, 2012

From Business Matrix to Technology Matrix: The re-crafting of the BCG Model

The BCG Growth-Share matrix is a portfolio planning model developed by Bruce Henderson of the Boston Consulting Group in the early 1970s. It is based on the premise that a corporation's business units can be classified into four categories (shown as four quadrants of a business grid) based on combinations of market growth and market share relative to the largest competitor. Market growth serves as a proxy for competitive advantage and relative market share serves as a proxy for competitive advantage. These two variables of market performance are considered in the BCG model to be the critical determinants of profitability of a company.

The BCG matrix has lost much of its sheen over the years mainly because of three reasons. Firstly, business performance is influenced by a greater number of strategic factors than just market variables. Secondly, the four types of businesses are not independent of each other; some could be actually supporting the other while some could be in the kind of position they are in due to the others. Thirdly, the matrix is applicable more for broad and large markets rather than to small and niche markets. The concepts, unfortunately however, still get to be utilized extensively in academic and business settings mainly to determine the investment philosophy of a firm towards business units in each of the four segments. This is a worrisome factor.

Investment logic and fallacy

The BCG investment logic is that based on the future business and profit potential, businesses or products must be divested, analyzed, invested or milked, each of this being a mutually exclusive option, in the proponents’ view.

Businesses which have low market share and low growth rate tend to be marginal businesses which could consume disproportionately higher management time and organizational human resources. These businesses called Dogs must be divested, according to the BCG theory. Some consider these as cash traps which have little potential as a result of which the company would be better off without them than with them.

Question marks are products or businesses that grow rapidly, and as a result consume large amounts of cash. However, because they have low market shares they do not generate much cash. The result is a large net cash consumption. A question mark has the potential to gain market share and become a star, and eventually, a cash cow when the market growth slows. If it does not become a market leader it will become a dog when market growth declines. Question marks need to be analyzed carefully to determine if they are worth the investment required to grow market share.

Stars are products or businesses that generate large sums of cash because of their strong relative market share that too in a fast growing industry, but also consume large amounts of cash because of their high growth rate. So the cash being spent and brought in approximately nets out, unless managed well. If a star can maintain its large market share it will become a cash cow when the market growth rate declines. On the other hand, if stars cannot maintain their market dominance with reasonable investment logic, they could become dogs.

As market leaders in a mature market, cash cows are businesses or products that exhibit a return on assets that is greater than the market growth rate – so they generate more cash than they consume. These units should be ‘milked’ extracting the profits and investing as little as possible. They provide the cash required to turn question marks into market leaders. A corporation that has more cash cows in its portfolio tends to soar high on market capitalization. The concept of milking without investments does not appear to be progressive management thought, however.

Distorted logic

The BCG Matrix has always been deficient due to its preoccupation with visible variables of market performance, ignoring the underlying drivers of either firm competencies or market requirements. In fact, the way the investment logic is built up there is a clear absence of customer or market centricity and a dominant preoccupation with the firm’s business or growth. More importantly, the corporate responsibility to serve the markets with appropriate products and businesses is made subservient to return on investment as the only criterion. Fundamentally, products and businesses are built on investments in R&D and manufacturing assets which have a useful life. The corporate leadership has a responsibility to ensure that the assets run their useful life, and if the product life cycle outlives the asset life cycle, the assets are either modernized or substituted.

The BCG Matrix also ignores the logic that product technology has the capability to make the quadrants relive their utility or lose their utility much earlier than the asset life. Automobiles, for example, are a classic group of products which can be produced to newer capabilities on apparently dated machinery. Smart phones, on the other hand, can be rendered obsolete in a year due to changes in operating systems rather than the declines in the manufacturing assets. Technology well harnessed can help channel additional investments to enhance the returns on the total investments, past and the new ones together. The computer chip is a striking example of technology beefing that can rewrite the rules of the BCG Matrix.

The essential logic of the BCG Matrix is that all products and businesses outlive their utility, and firms must therefore be opportunistic in utilization of the assets. While the Matrix explicitly considers market based variables, it does not exhort firms to first understand the key drivers of the markets prior to matching the available or future assets to the market needs. The Matrix does not take into consideration either the consumer or the competition. While it may be argued that the BCG Matrix is not intended to address the issues of competitive strategy, an important management tool cannot be allowed to be grossly deficient, leading to errors in how corporate leaders use it while trying to serve their stakeholders, including customers and investors.

Quadrants astray

The BCG Matrix is essentially a 2X2 matrix. The author of this post has been a votary of the simple, but exceptional, usefulness of a 2X2 segmentation in the strategic classification of issues, products, assets or markets (please refer to the author’s earlier post, “The 2 Dimensional Matrix: A Universal Analytical Tool” in Strategy Musings, July 3, 2011). The 2X2 product-market matrix is a fine example of connecting existing products and new products with existing markets and new markets to define four unique strategies of market penetration, product expansion, market expansion and product-market diversification. However, the product-market matrix is just a lens to clarify strategic approaches to product-market options; and no less or no more. On the other hand, the BCG Matrix is erroneously used to drive the investment strategies of a firm that could actually injure the firm and its markets.

The concept of cash cows, for example, is deleterious to the long term health of a corporation. The approach that market leading products and businesses in mature industries must be milked to earn high returns with the least investments is deficient in that it could compromise key parameters of safety, quality and productivity, if indiscriminately deployed. The temptation to earn super-profits on the basis of lean investments needs to be resisted, and instead cash cows must merit reasonable reinvestments to ensure that the products and businesses, which are favored by mature markets, meet the high standards.

Stars are considered cash guzzlers as well as cash generators. The BCG Matrix suggests good management as the requirement to ensure the net cash surplus of stars. Management could, however, just be one factor. Luxury products in any space, for example, require significant investments. The ability of the stars to be net cash generators often is a function of economic strength of the nations as much as the managerial strength of the firms. JLR, for example, became sick as part of global meltdown but became a star in the hands of Tata Motors not merely because of the Indian management (or component supplies) but also due to the global economic recovery.

Question Marks need to be analyzed, according to the BCG proponents. Question marks actually require risk taking ability on the part of the managements as the products and businesses represent bets on the future. Focus needs to be on securing the right blend of technology and management to ensure that the question marks fulfill their potential. Manufacture of fire resistant glass could be a question mark given the high costs but with appropriate technology and scale it could be the most preferred glass option at least for commercial and industrial spaces.

Dogs is an uncharitable sobriquet given to a quadrant of products and businesses which the BCG Matrix recommends to be divested. Dogs, if at all, are the most faithful, loving and adorable creatures. It is rather paradoxical to suggest that businesses that served well once upon a time should be divested once they become frail. The inability of the leadership to read market signals and technological trends should not lead to divestitures. More appropriately, resetting of business priorities or the possibility of generating greater value for a business or a product line in someone else’s hands should be the real driver. The success of IBM’s computer business under Lenovo after the acquisition is an example of win-win divestiture.

Technology matrix

Management of the product-market portfolio is one of the greatest challenges of corporate leadership. As companies become multi-product and multi-business, the challenges of portfolio management become more complex. The strategic issue for the leadership is not as simple as finding an easy solution through simplistic analytical tools such as the BCG Matrix, which has several limitations in itself. The challenge for the leadership is to have a portfolio of projects with not only with the right growth and earning parameters but also with the needed customer centricity and technological profiles. For those who visit the established automobile plants of Japan and Korea it is a surprise how the relatively older plants produce the most gleaming automobiles. The answer lies in the prudent investments that are made in product and process technologies to keep the standards high. Once the leadership starts viewing its portfolio of products and services or businesses from a true market serving perspective rather than from the firm performance perspective, the BCG Matrix loses its glamour as well as the relevance.

The more appropriate dimensions to assess the portfolio of products and businesses of a company are the product technologies and process technologies. A technology matrix drawn on product and process technologies provides sharper insights into the management of the future. A quadrant with dated product and dated process technologies has no justification to stay in economic life; divestiture is not an option. Companies which have quadrants of products and businesses with dated product and contemporary process technologies, but with contemporary product and dated process technologies would be able to grow these question marks into viable options by making relevant investments in product and process technologies respectively. Companies which secure a quadrant of businesses and products that have contemporary product and contemporary process technologies are destined to win in the current competitive world. Responsible and proactive leaderships will need to consider Technology Matrix rather than Business Matrix as the tool to achieve sustainable growth with profits.

Posted by Dr CB Rao on April 8, 2012

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