BCG Matrix
The BCG Matrix is a portfolio planning model that had been developed by Bruce Henderson of the Boston Consulting Group in the early 1970 to help corporations with analyzing their business units.This most well-known portfolio management tool.
The business units can be classified into four categories based on combinations of market growth and market share. The market growth serves as a proxy for attractiveness and relative market share serves as a proxy for competitive advantage. BCG Matrix thus maps the business unit positions with these two important determinants of profitability.

1.jpg


The 4 categories are:Stars (=high growth, high market share)Cash Cows (=low growth, high market share)Question Mark (=high growth, low market share)Dogs (=low growth, low market share)
StarsStars are units with a high market share in a fast-growing industry. Stars generate large amounts of cash because of their strong relative market share but also consume large amounts of cash because of their high growth rate, therefore the cash in each direction approximately nets out. If a star can maintain its large market share, it will become a cash cow when the market growth rate declines.
Cash CowsAs leaders in a mature market, cash cows exhibit a return on assets that is greater than the market growth rate and thus generate more cash than they consume. Cash cows provide the cash required to turn question marks into market leaders, to cover the administrative costs of the company, to fund research and development, to service the corporate a relatively stable cash flow, its value can be determined with reasonable accuracy by calculating the present value of its cash stream using a discounted cash flow analysis.
Question MarkQuestion marks are growing rapidly and thus consume large amounts of cash but because they have low market shares they do not generate much cash. The result is large net cash consumption. A question mark (also known as a "problem child") has the potential to gain market share and become a star and eventually a cash cow when the market growth slows. If the question mark does not succeed in becoming the market leader then after perhaps years of cash consumption it will degenerate into a dog when the market growth declines. Question marks must be analyzed carefully in order to determine whether they are worth the investment required to grow market share.
DogsDogs have low market share and a low growth rate and thus neither generate nor consume a large amount of cash. However, dogs are cash traps because of the money tied up in a business that has little potential. Such business are candidates for divestiture.

WHEN TO USE BCG MATRIX
For each product or service, the 'area' of the circle represents the value of its sales. The BCG Matrix thus offers a very useful 'map' of the organization's product (or service) strengths and weaknesses, at least in terms of current profitability, as well as the likely cashflows.


The need which prompted this idea was, indeed, that of managing cash-flow. It was reasoned that one of the main indicators of cash generation was relative market share, and one which pointed to cash usage was that of market growth rate.
Derivatives can also be used to create a 'product portfolio' analysis of services. So Information System services can be treated accordingly

The matrix does not consider the place of traditional/generic products that companies maintain in their product lines that may have had high market share and market growth in time past, but currently do not. Sometimes, companies just can keep the dogs (low growth, low market share) due to some intangible factors.What needs to be done may not necessarily be to let go but to invest more in such products in repackaging (innovation). This is because market expansion is a dynamic process that responds to identified opportunities and there are other basic factors that influence investment decisions and market expansion. The cost element is for instance an essential determinant


Each product has its product life cycle, and each stage in product's life-cycle represents a different profile of risk and return. In general, a company should maintain a balanced portfolio of products. Having a balanced product portfolio includes both high-growth products as well as low-growth products. A high-growth product is for example a new one that we are trying to get to some market. It takes some effort and resources to market it, to build distribution channels, and to build sales infrastructure, but it is a product that is expected to bring the gold in the future. An example of this product would be an iPod. A low-growth product is for example an established product known by the market. Characteristics of this product do not change much, customers know what they are getting, and the price does not change much either. This product has only limited budget for marketing. The is the milking cow that brings in the constant flow of cash. An example of this product would be a regular Colgate toothpaste. But the question is, how do we exactly find out what phase our product is in, and how do we classify what we sell? Furthermore, we also ask, where does each of our products fit into our product mix? Should we promote one product more than the other one? The BCG matrix can help with this. The BCG matrix reaches further behind product mix. Knowing what we are selling helps managers to make decisions about what priorities to assign to not only products but also company departments and business units.

Practical use of the BCG Matrix
For each product or service, the 'area' of the circle represents the value of its sales. The BCG Matrix thus offers a very useful 'map' of the organization's product (or service) strengths and weaknesses, at least in terms of current profitability, as well as the likely cashflows.
The need which prompted this idea was, indeed, that of managing cash-flow. It was reasoned that one of the main indicators of cash generation was relative market share, and one which pointed to cash usage was that of market growth rate.
Derivatives can also be used to create a 'product portfolio' analysis of services. So Information System services can be treated accordingly

1. Relative market share

This indicates likely cash generation, because the higher the share the more cash will be generated. As a result of 'economies of scale' (a basic assumption of the BCG Matrix), it is assumed that these earnings will grow faster the higher the share. The exact measure is the brand's share relative to its largest competitor. Thus, if the brand had a share of 20 percent, and the largest competitor had the same, the ratio would be 1:1. If the largest competitor had a share of 60 percent; however, the ratio would be 1:3, implying that the organization's brand was in a relatively weak position. If the largest competitor only had a share of 5 percent, the ratio would be 4:1, implying that the brand owned was in a relatively strong position, which might be reflected in profits and cash flows. If this technique is used in practice, this scale is logarithmic, not linear.
On the other hand, exactly what is a high relative share is a matter of some debate. The best evidence is that the most stable position (at least in Fast Moving Consumer Goods FMCG markets) is for the brand leader to have a share double that of the second brand, and triple that of the third. Brand leaders in this position tend to be very stable—and profitable; the
The reason for choosing relative market share, rather than just profits, is that it carries more information than just cash flow. It shows where the brand is positioned against its main competitors, and indicates where it might be likely to go in the future. It can also show what type of marketing activities might be expected to be effective.

2. Market growth rate

Rapidly growing in rapidly growing markets, are what organizations strive for; but, as we have seen, the penalty is that they are usually net cash users - they require investment. The reason for this is often because the growth is being 'bought' by the high investment, in the reasonable expectation that a high market share will eventually turn into a sound investment in future profits. The theory behind the matrix assumes, therefore, that a higher growth rate is indicative of accompanying demands on investment. The cut-off point is usually chosen as 10 per cent per annum. Determining this cut-off point, the rate above which the growth is deemed to be significant (and likely to lead to extra demands on cash) is a critical requirement of the technique; and one that, again, makes the use of the BCG Matrix problematical in some product areas. What is more, the evidence, from FMCG markets at least, is that the most typical pattern is of very low growth, less than 1 per cent per annum. This is outside the range normally considered in BCG Matrix work, which may make application of this form of analysis unworkable in many markets.
Where it can be applied, however, the market growth rate says more about the brand position than just its cash flow. It is a good indicator of that market's strength, of its future potential (of its 'maturity' in terms of the market life-cycle), and also of its attractiveness to future competitors. It can also be used in growth analysis.

OTHER USES AND BENEFITS OF THE BCG MATRIX
  • If a company is able to use the experience curve to its advantage, it should be able to manufacture and sell new products at a price that is low enough to get early market share leadership. Once it becomes a star, it is destined to be profitable.
  • BCG model is helpful for managers to evaluate balance in the firm’s current portfolio of Stars, Cash Cows, Question Marks and Dogs.
  • BCG method is applicable to large companies that seek volume and experience effects.
  • The model is simple and easy to understand.
  • It provides a base for management to decide and prepare for future actions.

LIMITATIONS OF THE BCG MATRIX


Some limitations of the Boston Consulting Group Matrix include:

  • It neglects the effects of synergy between business units
  • Market growth rate is only one factor in industry attractiveness, and relative market share is only one factor in competitive advantage. The growth-share matrix overlooks many other factors in these two important determinants of profitability.
  • The framework assumes that each business unit is independent of the others. In some cases, a business unit that is a "dog" may be helping other business units gain a competitive advantage.
  • The matrix depends heavily upon the breadth of the definition of the market. A business unit may dominate its small niche, but have very low market share in the overall industry. In such a case, the definition of the market can make the difference between a dog and a cash cow.
  • High market share is not the only success factor.
  • Market growth is not the only indicator for attractiveness of a market.
  • Sometimes Dogs can earn even more cash as Cash Cows.
  • The problems of getting data on the market share and market growth.
  • There is no clear definition of what constitutes a "market".
  • A high market share does not necessarily lead to profitability all the time.
The model uses only two dimensions – market share and growth rate. This may tempt management to emphasize a particular product, or to divest prematurely.
  • A business with a low market share can be profitable too.
  • The model neglects small competitors that have fast growing market shares.


Critical evaluation

The matrix ranks only market share and industry growth rate, and only implies actual profitability, the purpose of any business. (It is certainly possible that a particular dog can be profitable without cash infusions required, and therefore should be retained and not sold.) The matrix also overlooks other elements of industry. With this or any other such analytical tool, ranking business units has a subjective element involving guesswork about the future, particularly with respect to growth rates. Unless the rankings are approached with strictness and doubt, optimistic evaluations can lead to a mentality which even the most dubious businesses are classified as "question marks" with good prospects; enthusiastic managers may claim that cash must be thrown at these businesses immediately in order to turn them into stars, before growth rates slow and it's too late. Poor definition of a business's market will lead to some dogs being misclassified as cash cows.

Reference



About BCG: http://www.bcg.com/about_bcg/history/history_1968.aspx
NetMBA-Business Knowledge Center, 2011, The BCG Growth-Share Matrix, [Online] Available at: http://www.netmba.com [Accessed 19 May 2011].