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The matrix proceeds from the assumption that a company’s business units can be classified into four categories based on combinations of market growth and market share relative to the largest competitor, hence the name «growth-share». Market growth serves as a proxy for industry attractiveness, and relative market share serves as a proxy for competitive advantage. The growth-share matrix maps the business units’ positions within these two important determinants of profitability.

This framework assumes that an increase in relative market share will result in an increase in the generation of cash. This assumption often is true because of the experience curve; increased relative market share implies that the firm is moving forward on the experience curve relative to its competitors, thus developing a cost advantage. A second assumption is that a growing market requires investment in assets to increase capacity and therefore results in the consumption of cash. Thus the position of a business on the growth-share matrix provides an indication of its cash generation and its cash consumption.

The cash required by rapidly growing business units could be obtained from the firm’s other business units that were at a more mature stage and generating significant cash. By investing to become the market share leader in a rapidly growing market, the business unit could move along the experience curve and develop a cost advantage. From this reasoning, the BCG Growth-Share Matrix was born.

The four categories of the matrix are:

Dogs. Dogs have a 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 businesses are candidates for divestiture.

Question Marks. Question Marks are growing rapidly and thus consume large amounts of cash, but because they have low market shares they do not generate much cash. 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 the question mark does not succeed in becoming the market leader, then after 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.

Stars. 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 rates; 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. The portfolio of a diversified company always should have stars that will become the next cash cows and ensure future cash generation.

Cash Cows. As 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. Such business units should be «milked», extracting the profits and investing as little cash as possible. Cash cows provide the cash required to turn question marks into market leaders, to cover the administrative costs of the company, to fund R&D, to service the corporate debt, and to pay dividends to shareholders. Because the cash cow generates a relatively stable cash flow, its value can be accurately determined by calculating the present value of its cash stream using a discounted cash flow analysis.

Under the growth-share matrix model, as an industry matures and its growth rate declines, a business unit will become either a cash cow or a dog, determined solely by whether it had become the market leader during the period of high growth.

While originally developed as a model for resource allocation among the various business units in a corporation, the growth-share matrix also can be used for resource allocation among products within a single business unit.

The BCG matrix can help understand a frequently made strategic mistake: having a one-size-fits-all approach to strategy such as a generic growth target or a generic return on capital for the entire corporation.

In such a scenario:

Cash Cows will beat their profit target easily; their managers have an easy job and are often praised anyhow.

Dogs fight an impossible battle and, even worse, investments are made now and then in hopeless attempts to «turn the business around».

As a result, Question Marks and Stars get mediocre investment funds. In this way they are unable to ever become cash cows and earn money.

Limitations

The BCG matrix once was used widely, but has since faded from popularity as more comprehensive models have been developed. Some of its weaknesses are:

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.

While its importance has diminished, the BCG matrix still can serve as a simple tool for viewing a corporation’s business portfolio at a glance, and may serve as a starting point for discussing resource allocation among strategic business units (SBUs).

Source: www.netmba.com

The GE/McKinsey Matrix

The GE/McKinsey Matrix is a later and more advanced form of the BCG Matrix. It is a model to perform business portfolio analysis on the Strategic Business Units of a corporation. A business portfolio is the collection of SBUs that make up a corporation. The optimal business portfolio is one that fits perfectly to the company’s strengths and helps to exploit the most attractive industries or markets. A SBU can either be a midsize company or a division of a large corporation that formulates its own business level strategy and has separate objectives from the parent company.

The aim of a portfolio analysis is to:

– analyze its current business portfolio and decide which SBUs should be allocated more or less investment;

– develop growth strategies for adding new products and businesses to the portfolio;

– decide which businesses or products should be divested.

The GE/McKinsey Matrix is more sophisticated than the BCG Matrix:

1. Market (industry) attractiveness replaces market growth as the dimension of industry attractiveness. Market attractiveness includes a broader range of factors than just the market growth rate that can determine the attractiveness of an industry/market.

2. Competitive strength replaces market share as the dimension by which the competitive position of each SBU is assessed. Competitive strength likewise includes a broader range of factors than just the market share that can determine the competitiveness of a SBU.

3. The GE/McKinsey Matrix works with a 3*3 grid, while the BCG matrix has only 2*2.

SBUs are portrayed as a circle plotted in the GE/McKinsey Matrix whereby: