This article provides a brief overview of the second of two models, which can assist accountants, not only in the determination of business strategy, but also in the appraisal of business performance. It also looks at how to approach a particular style of question that may appear in the APM exam.
In this part the Boston Consulting Group matrix will be reviewed, you may also wish to read part 1, which covers Porters Five Forces.
There is a fundamental need for management to evaluate existing products and services in terms of their market development potential, and their potential to generate profit. The Boston Consulting Group matrix, which incorporates the concept of the product life cycle, is a useful tool which helps management teams to assess existing and developing products and services in terms of their market potential. More importantly, the model can also be used to assess the strategic position of strategic business units (SBUs), and in this respect it is particularly useful to those organisations which operate in a number of different markets and offer a number of different products or services.
The matrix offers an approach to product portfolio planning. It has two axes, namely relative market share (meaning relative to the competition) and market growth. Management must consider each product or service marketed, and then position it on the matrix. This is done by considering the relative market share, which for the company with the largest share (market leader) means comparing to the next biggest player and for smaller players (market followers) it means comparing their share to the leader. The other axis on the matrix is the market growth rate – which is either growing quickly or the market is mature where it will grow slowly or may even have stopped growing altogether.
Problem children have a relatively low market share in a market that is growing quickly, often due to the fact that these are new products/services, or that they are yet to receive recognition by prospective purchasers. In order to realise the full potential of problem children, management needs to develop new business prudently, and apply sound project management principles if it is to avoid costly disasters. Gross profit margins are likely to be high, but overheads are also high, covering the costs of research, development, advertising, market education, and low economies of scale. As a result, the development of problem children can be loss-making until the product moves into the rising star category, which is by no means assured. This is evidenced by the fact that many problem children products remain as such, while others become tomorrow’s dogs.
Note: Problem children are also known as question marks.
Stars are products which are in the high market share and growing market quadrant. As a product moves into this category it is commonly known as a rising star. While a market is strong and still growing, competition is not yet fully established. Since demand is strong, and market saturation and over-supply is not an issue, the pricing of such products is relatively unhindered, and therefore these products generate very good margins. At the same time, costs per unit are minimised due to high volumes and good economies of scale. These are great products, and worthy of continuing investment for as long as they have the potential to achieve good rates of growth. In circumstances where this potential no longer exists, these products are likely to fall vertically in the matrix into the cash cow quadrant (fallen stars), and their cash generating characteristics will change. It is therefore vital that a company has rising stars developing from its problem children in order to fill the void left by the fallen stars.
A cash cow has a relatively high market share in a mature/low growth market and should generate significant cash flows. This somewhat crude metaphor is based on the idea of ‘milking’ the returns from a previous investment that established good distribution and market share for the product. Activities to support products in this quadrant should be aimed at maintaining and protecting their existing position, together with good cost management, rather than aimed at investment for growth. This is because there is little likelihood of additional growth being achieved.
A dog has a relatively low market share in a mature/low growth market, might well be loss making, and therefore have negative cash flow. A common belief is that there is no point in developing products or services in this quadrant. Many organisations discontinue dogs, but businesses which have been denied adequate funding for development may find themselves with a high proportion of their products or services in this quadrant. A dog product that forms an integral part of a portfolio may also be retained to ensure complete coverage – eg a furniture reseller may have some dog products but does so in order to remain a ‘one-stop-shop’ for all customer furniture needs and not lose customers.
The popularity of the matrix has diminished a little as the criteria it is based on – market share and market growth are no longer reliable predictors of long-term success. Other models have been developed from it – with further criteria added (these are outside the scope of APM, however). It was also very useful when conglomerates were much more common, and these companies needed to review their portfolios of SBUs to ensure that effort/funds are focused on the correct markets. Management should therefore exercise a degree of caution when using the matrix. Some of its limitations are detailed below:
Notwithstanding these limitations, the Boston Consulting Group matrix provides a useful starting point in the assessment of the performance of products and services and, more importantly, of SBUs. Although when conducting a BCG assessment an organisation will need to consider:
Now that the model has been explained and demonstrated we will move on to look at how it can be examined in APM. An analysis using the model may be asked for, however often this will be done for you in the question and the requirements will focus on how these SBUs can be managed and what performance measures may be required. You may also be expected to evaluate the use of BCG matrix as a performance management system. This section of the article will provide advice about answering several types of requirements. In the examples, only extracts from the requirements and answers are provided, to keep the article to a sensible length.
EXAMPLE 1 – Using the model to perform the analysis
FNI is a large, diversified entertainment business based in Zeeland. It has a main objective of maximising shareholder wealth and is made up of four divisions:
|Position in the matrix
|Online, live-streamed events
A consultant has performed the BCG analysis of the four divisions and you are required to evaluate their positions in the model and discuss the measures necessary to monitor performance.
An extract from a very good answer is reproduced below to show the approach which will score the well, focused on the bar division which has been identified as a cash cow:
The bar division is a cash cow as it has a very strong share of a low growth market. The focus for this division will be on generating as much cash flow as possible in order to continue to invest elsewhere in the business. It will also have a focus on cost control to ensure that it continues to be as profitable as possible. As a result, measures which would be suitable for the bar division would be profit margins and cash generation.
Comment: This answer begins by justifying the bar division’s placement in the matrix. It then goes on to explain what this division’s focus will be and why. It then concludes with measures that relate to its situation.
You could also be asked to evaluate the BCG analysis as a performance management system at the company.
The BCG matrix can be beneficial as it allows the company to view the prospects of its different divisions. A different style of management should be applied to each division based on this analysis. Those businesses which are in faster growing sectors will require more capital to be invested and may not generate cash as efficiently from profits. However, those businesses in slower growing mature markets should have a focus on cost control and cash generation. Business units identified as cash cows and, particularly, dogs should not be dismissed since if they are properly managed, they can provide a rich source of cash as they are run down.
The performance management systems and metrics used by the divisions should therefore be adjusted to reflect this analysis. The metrics for high growth prospects of dance clubs and live-streamed events will be based on profit and return on investment.
However, the BCG matrix is a very simple method of analysis. For example, using relative market share measured against the largest competitor, where a value of 1·0 is used as cut off between large and small, means there is only one star or cow per market. It was designed as a tool for product portfolio analysis rather than performance measurement. As a performance system, it seems to downgrade traditional measures of performance such as profit and shareholder wealth and therefore may not be well aligned with all of the key stakeholders’ objectives. It should be seen as a starting point for considering the appropriate performance management for a business unit but not the final result for the overall company.
Additionally, it may be that different products with each business unit may not fit the unit’s classification. For example, a newly launched street food format would be under the restaurant division but may be in a higher growth sub-sector and so applying the performance systems and management style of a dog business would not be appropriate. It may also be difficult to distinguish the sectors from each other as, for example, it may be difficult to define the difference between a bar and a restaurant where both sell much of the same services. The model also fails to consider the links between the business units, for example, where the bars may serve the dance clubs.
Comment: An evaluation needs to look at the good and bad points of any model being discussed in the context of the question. This answer builds up a picture via looking at how the model works, then considering if it is appropriate when looking at the objectives of the company. It finishes with some clear negatives and limitations of the model for managing performance. This is a very good answer which focuses on the exact requirement – it is not simply looking at limitations of the model in itself but as a tool for performance management.
These two articles have covered two common models used in the APM exam. As well as explaining the models they have given advice and examples of how to answer questions set on them. It will be a good idea to now review questions in past APM exams which have been set using them. This will help you to see more examples of how they are examined and that it is not enough to simple quote theory to score well in APM.