ACCA - P5 Study text - Emile Woolf INT - 2010
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Chapter 14: Strategic models and performance measurement
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Boston Consulting Group (BCG) model
The BCG matrix: market growth (potential) and market share (profitability)
Categories of product in the BCG matrix
Structure of the BCG matrix
Using the BCG matrix for planning and performance measurement
Weaknesses in BCG model analysis
2 Boston Consulting Group (BCG) model
2.1 The BCG matrix: market growth (potential) and market share
(profitability)
In competitive markets, management need information to evaluate their products
(or services) in terms of their:
market potential, and
ability to generate profits and cash flows for the business.
TheBostonConsultingGroupmatrix(orBCGmatrix)isa modelthatcanbeusedto
assess which products should be developed for future growth, and whether a
business entity has an appropriate mix of products for achieving future growth. It
incorporates the concept of the product life cycle. It is useful for companies tha
t
provideanumberofdifferentproducts(orservices)fordifferentmarkets.
The BCG matrix can be drawn as a 2 × 2 matrix, which ‘maps’ each product that a
company sells, in terms of:
the expected growth in the market as a whole, and
the share of the total market that is currently held by the company’s product.
2.2 Categories of product in the BCG matrix
Products are categorised into four types:
stars
cash cows
dogs
question marks.
Stars
Stars are products where the market is growing at a fast rate, and the product enjoys
a large share of the total market. They are normally new products. Stars might not
yet be profitable, but new investment in the product should provide high financial
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returns in the future. Entities need ‘stars’ in order to succeed in the future, and so
should invest in them.
Because the market is strong and growing, there are no problems with over-capacity
in production and over-supply to the market. This means that the company has
some control over prices that it can charge. (It may choose between a pricing
strategy of ‘market penetration’ or ‘market skimming’. These pricing strategies are
explained in another chapter.)
A ‘star’ product has more potential for profits, and it is worthwhile to invest more
money in the product, to increase sales.
Eventually when the growth in sales slows down, a star will become a cash cow. In
other words, a product that is a star early in its life cycle will become a cash cow
during the mature stage of the product’s life.
Cash cows
Cash cows are products where the market is growing slowly, or is not growing at
all, and the product enjoys a large share of the total market. These products are very
profitable and provide large cash inflows for the entity. Every company needs cash
cows to survive in the long-term. The cash from cash cows helps to finance
investment in stars. Eventually, cash cows must be replaced when the product
reaches the end of its economic life.
The strategy for a cash cow should be maintaining and protecting the position of the
product in its market, and to keep costs under control (or reduce costs). The strategy
should not be to seek more sales growth, because the product has no further growth
potential (or very little further growth potential).
Dogs
Dogs are products where the market is growing slowly, or is not growing at all, and
the product has only a small share of the total market. These products are often (but
not always) losing money. The correct strategic decision is usually to withdraw the
product from the market.
Question marks
Question marks (also called ‘problem children’) are products where the market is
growingatafastrate,butthecompany’sproducthasonlyasmall
sh
areofthetotal
market. These products are currently losing money. New investment in ‘dogs’ (for
example,moreinvestmentinresearchanddevelopmentormarketing)mightturna
‘questionmark’intoa‘star’,butthereisalsoariskthatitwillbecomea‘dog’when
thegrowthinthemarketslowsdown.Investingintheseproductswillbeastrategic
gamble.
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2.3 Structure of the BCG matrix
A BCG matrix is shown below. The individual products (or business units) can be
plottedinthematrixasacircle.Thesizeofthecircleshowstherelativemoneyvalue
ofsalesfortheproduct.Alargecirclerepresentsaproductwithlargeannualsales.
Thepositionoftheproductsineachq
uadrantalsoshowstherelativerateofgrowth
in the total market, and the relative share that the company’s product has in the
totalmarket.
BCG matrix
2.4 Using the BCG matrix for planning and performance measurement
CompaniescanusetheBCGmatrixtoanalysetherangeofproductsthatitsells,and
toplanitsfutureinvestmentinproducts.Theaimshouldbetoensurethatthereisa
sufficientinvestmentin‘stars’,andthatcashcowswillgenerateenough cashflowto
financemostorallofthisinvestmen
t.
To carry out an analysis, information is needed for each product about:
Total market size
Rate of growth in the total market
The company’s share of the total market
Changes in the company’s share of the total market.
Example
A company produces five different products, and sells each product in a different
market.
The managementaccountant has obtained the following information about market
sizeandmarketshareforeachproduct.Itconsistsofactualdataforeachofthelast
threeyearsandforecastsforthenexttwoyears.
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Year - 2 Last year
Year -1
Current
year
Next year
Year + 1
Year + 2
Actual Actual Actual Forecast Forecast
Product 1
Total market size ($ million) 50
58
65
75 84
Product 1 sales
2
2
2.5
3 3.5
Product 2
Total market size ($ million) 150
152
149
153 154
Product 2 sales
78
77
80
82 82
Product 3
Total market size ($ million) 40
50
60
70 80
Product 3 sales
3
5
8
10 12
Product 4
Total market size ($ million) 60
61
61
61 60
Product 4 sales
2
2
2
2 2
Product 5
Total market size ($ million) 100
112
125
140 150
Product 5 sales
4
5
5.5
6 6.5
Inthecurrentyear,themarketshareofthemarketleader,orthenearestcompetitor
tothecompany,hasbeenestimatedasfollows:
Market share of market leader or the company’s
nearest competitor
Market for:
%
Product 1
37
Product 2
26
Product 3
12
Product 4
29
Product 5
20
Required
(a) Using the Boston Consulting Group model, how should each of these
productsbeclassified?
(b) How might this analysis help the management of the company to make
strategic decisions about its future products and markets (‘product‐market
strategy’)?
Answer
A star is a product in a market that is growing quickly, where the company’s
producthasalargemarketshareorwherethemarketshareisincreasing.Product3
appearstobeastar.ThetotalmarketisexpectedtodoubleinsizebetweenYear–2
andYear+2.Theexpectedmarkets
hareintwoyears’timeis15%,comparedwith
7.5%in Year – 2. Its market share in the current year is over 13%, which makes it
thecurrentmarketleader.
Acashcowisa productinamarketthathaslittleornogrowth.Thema
rketshare,
however, is normally quite high, and the product is therefore able to contribute
substantially to operational cash flows.Product 2 appears to be a cash cow. In the
currentyearitsmarketsharewasover53%,anditisthemarketleader.
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A dog isa product in a market with no growth, and where the product has a low
share of the market. Dogs are likely to be loss‐making and its cash flows are
probably negative. Product 4 appears to be a dog. The total market size is not
changing, and the ma
rket share for product 4 is only about 3%. This is much less
thanthe29%marketshareofthemarketleader.
A question mark is a product with a fairly low market share in a market that is
growingfairlyquickly.Product1appearstobeaquestionmark.Thetot
almarketis
growingquitequickly,butthemarketshareofProduct1isabout4%andthisisnot
expected to change. Product 5 also appears to be a question mark, for the same
reason.
The company should decide on its strategy for the products it will sell.
It should benefit from the cash flows generated by its only cash cow, Product 2.
It should invest in its star, Product 3, with the objective that this will eventually
become a cash cow.
It should give serious consideration to abandoning its dog, Product 4, and
withdrawing from the market.
It has to make a decision about its two question marks, Product 1 and Product 5.
The main question is whether either of these products can become a star and
cash cow. Additional investment and a change of strategy for these products
might be necessary, in order to increase market share.
For all the products (with the exception of Product 4, if this is abandoned) the
company should also consider ways of making the products more profitable.
Techniquessuchasvaluechainanalysismighthelptoidentifycostsavings.
2.5 Weaknesses in BCG model analysis
There are several criticisms of the BCG model.
The BCG model assumes that the competitive strength of a product in its market
depends on its market share, and the attractiveness of a market for new
investment depends only on the rate of sales growth in the market. Unless a
product can achieve a large share of the market, it is not sufficiently competitive.
Unless a market is growing quickly enough, it is not worthwhile to invest more
money in it. It can be argued that these assumptions are incorrect.
‐ Aproductcanhaveastrongcompetitivepositioninitsmarket,evenwith
alowmarketshare.Competitivestrengthcanbeprovidedbyfactorssuch
asproductquality,brandnameorbrandreputation,orlowcosts.
‐ A company might benefit frominvesting in an industry or market whe
re
salesgrowthislow.
It might be difficult to define the market.
‐ There might be problems with defining the geographical area of the
market.Amarketmightbedefinedintermsofasinglecountry,aregionof
acountryorasaninternationalorglobalmarket.
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‐ It might also be difficult to identify which products are competing with
each other. For example, the total market for cars may be divided into
different categories of car, but there may be problems in deciding which
modelsofcarbelongtoeachcategory.
It might be that the BCG matrix is better for analysing the performance of
strategic business units (SBUs) and market segments. It is not so useful for
analysing entire markets, which might consist of many different market
segments.
It might be difficult to define what is meant by ‘high rate’ and ‘low rate’ of
growth in the market. Similarly, it might be difficult to define what is meant by
‘high’ market share and ‘low’ market share.
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Ansoff’s growth vector analysis
Four product market strategies for growth
Market penetration strategy
Product development strategy (innovation strategy)
Market development strategy
Diversification strategy
The growth vector
Ansoff’s growth vector and gap analysis
3 Ansoff’s growth vector analysis
3.1 Four product market strategies for growth
Ansoff’s growth vector analysis is another model for strategic development and
growth.Themodelidentifiesfourstrategiesfordevelopingproductsandmarketsin
ordertogrowthebusiness.
The four strategies are as follows:
Market penetration
Product development (innovation)
Market development
Diversification
3.2 Market penetration strategy
This is a strategy of trying to gain higher sales in the entity’s current markets with
its existing products. Market penetration is achievable:
when the total market is growing, or
by increasing market share.
For example, a company providing mobile telephone services might pursue a
market penetration strategy, by trying to sell to more customers. This is possible if
the total demand for mobile telephone services is increasing, or by taking market
share from competitors.
A market penetration strategy is a low-risk strategy, and is unlikely to result in a
high rate of sales growth. The product is not altered and there is no attempt to find
new markets for the product.
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3.3 Product development strategy (innovation strategy)
This is a strategy for growth that involves developing new products for existing
markets and customers. For example, a software company might develop a new
product or enhanced product that it tries to sell to its existing customers. Similarly, a
car manufacturer might develop a new model of car, which it then tries to sell to its
existing customers.
3.4 Market development strategy
This is a strategy of trying to enter new markets for the entity’s existing products. In
other words, it is a strategy of selling current products to new customers by finding
a new market, or a new market segment. For example:
a supermarkets company might try to increase its sales by entering the market
for Internet shopping and home delivery
a company might grow by trying to enter markets in other countries.
3.5 Diversification strategy
This is a strategy of developing new products for new markets. A diversification
strategy is a high‐risk strategy, because the company needs to develop a new
product that will meet customer needs successfully, butitdoes not yethave much
knowledge or understanding of customers in the market and what th
eir needs
mightbe.
There are two types of diversification:
Related diversification, where the business entity develops new products and
markets that are in a related industry. For example, a manufacturer of ice cream
might diversify into producing soft drinks.
Unrelated diversification, where the business entity develops new products and
markets that are in an industry where it has no previous experience. For
example, a manufacturer of ice cream might diversify into making and selling
shoes.
Unrelated diversification is usually a much higher‐risk strategy than related
diversification. However, even a strategy of related diversification can be a high
risk.
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3.6 The growth vector
TheAnsoffgrowthvectormightbepresentedasfollows:
Product
Current New
Market
Current
Market penetration
Product development
New
Market development
Diversification
Management should be provided with information that helps them to monitor the
success of their growth strategy. The items of information that might be provided
include:
Potential market demand
Market size
Market share
Information about competitors and their products
Pricing information
Information about costs
Information about required investment and financing
Estimated returns from a chosen strategy
The risks in the chosen strategy.
3.7 Ansoff’s growth vector and gap analysis
Ansoff’s growth vector can be used together with gap analysis. Gap analysis is the
analysis of the difference between a strategic target and the expected performance
that will be achieved without any new strategies.
For example, a company might measure the gap between the profits it would like to
make in five years’ time and the profits it would expect to make if it did not
undertake any new growth strategy.
Having estimated the size of the profit gap, the company can then consider growth
strategies to increase profitability. The contribution of each growth strategy to
profits can be estimated. Together, a combination of growth strategies might enable
a company to close the profit gap and pursue strategies that will enable it to meet its
targets.
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Strategies to fill the profit gap
Profit
Time
Target profit
Profit gap
Expected profit