Corporate Strategy Formulation with BCG Matrix

 

By Omodiaogbe Samuel

Last Updated: December 15, 2023 

Introduction

Boston Consulting Group (BCG) Matrix is a strategic management tool used for analysis and formulation of corporate strategy for a multidivisional organization. Such organizations could be small businesses with different business units, a non-profit, or a large conglomerate. The matrix is used to formulate strategy for a business units or product lines based on two variables: relative market share and the market growth rate. The BCG matrix is designed to help with long-term strategic planning, by helping a business to consider growth opportunities or by reviewing its portfolio of products to decide where to invest, or discontinue investment. The matrix helps in resource allocation among different cost centers or cost objects by categorizing or ranking them based on their ability to generate cash inflows against cash consumption. The major benefit of the BCG Matrix is that it draws attention to the cash flow, investment characteristics, and needs of an organization’s various divisions. In the BCG matrix, Strategic Business Unit (SBU) or Independent Brands, or Product Lines is a unit of the company that has a separate mission and objectives that can be planned independently from the other company businesses.

Specifically, the characteristics that define a Strategic Business Units (SBUs) are:

  • A unique business missions
  • An identifiable set of competitors
  • The SBU strategic manager can make or implement a strategic decision relatively independent of other SBUs
  • Crucial operating decisions can be made within the SBU.

Essentially, the BCG is one of the most accepted methods of portfolio analysis tool, and it segregates a firm’s product and services into a 2X2 Matrix or, into four quadrants. Each quadrant is labeled as low or high according to their performance which is again further based on the Relative Market Share and Growth Rate of The Market.

Relative market share: Relative market share is a variable used for measuring a company’s competitiveness. And that is based on the assumption that higher corporate’s market share results in higher cash returns. This is because a firm that produces more, benefits from higher economies of scale and experience curve, which results in higher profits. To get the Relative Market Share, you estimate your market share by comparing your brand’s revenue with that of your largest competitor in the industry to get a ratio. If you are stronger, your share is greater than 1, but if they are stronger, then the number is less than 1.

Market growth rate: Market growth rate is used to measure the market attractiveness. High market growth rate means higher earnings and sometimes profits but it also consumes lots of cash, which is used as investment to stimulate further growth.  The market growth rate provides more information about the brand position than just the cash flow. It’s a good indicator of the strength of the market and its future potential as well as attractiveness to more competitors. Market growth rate is expressed in percentage

Strategic Options of BCG Application:

The portfolio matrix gives the company an idea about the health of its businesses. After getting the portfolio’s picture, the company should then decide on each SBU’s objective, strategy, and budget. Essentially the 2X2 matrix is structured on the quadrant based on where the SBU fall on the following:

  • Star
  • Cash cow
  • Question mark
  • Dog

By identifying the business units on the quadrants, the company would be able to formulate the corporate strategy that centers on the following:

Build: Increase market share by making further investments. For example, to maintain star status, or to turn a question mark into a star. The building strategy is designed to improve market positions in spite of possible short-run damage to profitability. Building strategies are most appropriate when a firm wants to move question marks into the star category. A building approach can also be used to convert small stars into bigger stars. To ensure success, both of these building strategies require significant commitments of company resources.

Hold: A holding strategy, on the other hand, is a defensive strategy designed to preserve market positions. Holding is most commonly used to keep cash cows productive. Cash cows are often vulnerable to newer competitors, and marketing programs need to promote new versions and applications to maintain customer interest.

Harvest: Harvesting strategies are aimed at making as much money off a product as possible. The idea is to cut promotion and production costs to the bone and mine the product for its cash flow. This approach focuses on extracting cash from a project at the expense of the business’s long-run survival. Harvesting is a ruthless strategy that is best suited to weakening cash cows, dogs, and some question marks.

Divestment: A strategy of divestment attempts to sell or liquidate businesses to generate cash so it can be better used in other areas. Divestment is employed on question marks and dogs that the firm cannot finance into better growth positions. Candidates for divestment include businesses that have little room for cost savings and those that just break-even or operate at a loss. Sometimes divestment can work to the advantage of both the seller and the buyer.

Step-by-Step Approach to Developing the BCG Matrix

Step 1 – Choose the Unit: strategic business units, individual brands, product lines or the firm as a whole are all areas that can be analyzed using the BCG matrix. The unit you chose will have an impact on the whole analysis. The market, industry, competitors and position will all be based on the chosen unit. Therefore, it is essential to define the unit for which you’ll do the analysis.

Step 2 – Define the Market: Defining the market is one of the most important things to do in this analysis. An erroneously defined market will make way for an erroneous classification of the unit. Therefore, it’s a major task to transparently explain the market in order to get a solid grip on a firm’s portfolio position

Step 3 – Calculate Relative Market Share: Relative Market Share is expressed in terms of revenues or, market share. The formula used for computing this is division of your brand’s market share or revenues by the market share or revenues of the biggest competitor in the industry. The result is then plotted on the x-axis.

Step 4 – Calculate Market Growth Rate:  The y-axis represents the industry growth rate (IGR) in sales, measured in percentage terms—that is, the average annual increase in revenue for all firms in an industry. The growth rate percentages on the y-axis could range from −20 to +20 percent (although, this could vary), with 0.0 being the midpoint.

Step 5 – Draw Circles on the Matrix: Once all the measures are calculated, they can be put onto the matrix. This can be done by drawing a circle for each brand within a unit, or all the brands in a company. The size of each circle should correspond to business revenue generated by the brand.

Step 6― Make strategic decisions: The purpose of the analysis is at the end of the day to set the right strategy for the corporation. The managers should therefore use the results to determine which brands the firm should invest in and which ones should be divested.

Case Study

Okoroh Energy Services

Okoroh Energy Services is an energy services company that provide solutions to oil & gas, power plants, petrochemical, and other construction companies in Nigeria. The company has five strategic business units (SBUs) comprising of maintenance, fabrication, electrical & Instrumentation (E&I), drilling, and installation services. Each division of the company is competing for resources but the company wants to conduct analysis on each to determine their performance, as that would inform the most effective way to allocate resources.  Without understanding what each of the division contribute to the company, it would be very difficult for the company to make corporate planning for the entire company. The analysis would help the company to determine the strategy to pursue on each of the division

For Okoroh Energy Service to understand the type of strategy to pursue or effectively allocate resources to each of the strategic business units, it has decided to use the Boston Consulting Group (BCG) matrix to conduct the analysis and formulate the corporate strategy. The matrix will provide Okoroh Energy Services with a simple tool for maximizing its competitiveness by striking the right balance between exploitation of mature businesses and the exploration of new businesses to secure its future growth. With the BCG Matrix, Okoroh Energy Services would be able to formulate its corporate strategy that centers on “milking” the cows; not wasting its money on the dogs; investing in the stars; and applying some resources to the question marks to identify if they can become stars. However, it should be recognized that SBUs can evolve over time: dogs can become question marks, question marks can become stars, stars can become cash cows, and cash cows can become dogs in an ongoing counterclockwise motion. Therefore, the right strategy will be based on knowing how to seize opportunities, and knowing when to mitigate risks. Essentially, the results from the BCG Matrix analysis, would help Okoroh Energy Services to improve on its corporate strategic planning, enhances decision-making, and help in coordination of its corporate operations

Analysis of the five divisions of Okoroh Energy Services

The Four Quadrants

The Four Quadrants Strategic Analysis

High Growth, High Share

Stars are business units with a high market share (potentially market leaders) in a fast-growing industry. Stars generate large amounts of cash due to their high relative market share but also require large investments. They are the primary units in which the company should invest its money, because stars are expected to become cash cows and generate positive cash flows. Although, not all stars become cash flows. Possible strategic actions to consider here are vertical or horizontal integration, invest for market penetration, market development, or product development.

For Okoroh Energy Services, the fabrication unit falls on the Star. Therefore, the company should deploy more resources to the unit to maximize the potentials of the unit. The strategic options of market penetration and market development would help to company to take the full advantage of the potentials of the market

High Growth, Low Share

These are the units that have high growth prospects but a low market share.  They consume a lot of cash but bring little in return. However, since these business units are growing rapidly, they have the potential to turn into stars in a high growth market. Companies are advised to invest in question marks if the product has the potential for growth.  The suggested strategic actions center on careful analysis to see if they’re worth investing in to increase market share. Therefore, you need to consider investing for market penetration, market development, or product development; or divesting

For Okoroh Energy Services, the E&I units falls on the Question Mark. We foresee a high potential for the E&I unit, given the expansion of investment in the gas exploration and development in the country. Therefore, market development by investing in new technologies and human capital development would be the right option here

Low Growth, High Share

Cash cows are termed as the most prosperous brands and should be “milked” to generate consistent cash flow as much as possible. These Cash flows are generally utilized to finance Stars and Question Marks to nurture their future growth. Products in the cash cow’s quadrant are looked up to as products that are the leadmen in the market. These products already have an important chunk of investments and do not demand more investments to withhold their position. Suggested strategic actions is to consider investing in product development, diversifying, divesting or retrenching

For Okoroh Energy Services, the two strategic business units that falls on the Cash Cow are Installation and Drilling. Because we foresee that the market of drilling is getting to its peak, and the potential for growth is low, therefore, we should consider divesting in that unit. While on the other hand, we foresee some potentials in installation, and therefore diversifying to gas facility installation would help us to take advantage of the untapped market.

Low Growth, Low Share

Dogs are those business entities that have a scanty market share in a ripened and slow-growing market. Dogs are generally considered cash traps because businesses have money tied up in them, even though they are bringing back basically nothing in return. The suggested strategic actions to consider here are retrenching, divesting, or liquidating

The strategic business unit of Okoroh Energy Services that falls on the Dog quadrant is the Maintenance. Because of the low attractiveness, and low competitiveness of the unit, we should consider liquidation or retrenchment strategic options

Strategic Implications

The general strategy of a company with diverse portfolio is to maintain its competitive position in the Cash Cows, but avoid over-investing. The surplus cash generated by Cash Cows should be invested first in Star businesses, if they are not self-sufficient, to maintain their relative competitive position. Any surplus cash left with the company may be used for selected Question Mark businesses to gain market share for them. Those businesses with low market share, and which cannot adequately be funded, may be considered for divestment. The Dogs are generally considered as the weak segments of the company with limited or low new investments allocated to them.

The BCG Growth-share matrix links the industry growth characteristic with the company’s competitive strength (market share), and develops a visual display of the company’s market involvement, thereby indirectly indicating current resource deployment. The underlying logic is that investment is required for growth while maintaining or building market share. But, while doing so, a strong competitive business in an industry with low growth rate will provide surplus cash for deployment elsewhere in the corporation. Thus, growth uses cash whereas market competitive strength is a potential source of cash

Purpose of the BCG Matrix

Essentially, the BCG matrix in practice has utility in twofold:

  • The model provides multidivisional companies with a logic to redeploy cash from cash cow to business units with higher growth potential. This came at a time when units often kept and reinvested their own cash―which in some cases had the effect of continuously decreasing returns on investment. Organizations that allocated cash smartly gained an advantage
  • It also provided companies with a simple but powerful tool for maximizing the competitiveness, value, and sustainability of their business by allowing them to strike the right balance between the exploitation of mature businesses and the exploration of new businesses to secure future growth

Advantages and Disadvantages of BCG Matrix

Advantages

The advantages of the BCG Matrix include:

  • The tool is very simple to use and understand
  • It provides a high-level way to see the opportunities for each product in your portfolio.
  • It enables you to think about how to allocate your limited resources to the portfolio so that profit is maximized over the long-term.
  • Helpful for managers to evaluate balance in the firm’s current portfolio of Stars, Cash Cows, Question Marks, and Dogs
  • The matrix indicates that the profit of the company is directly related to its market share. Therefore, a company can increase market share if it seems profitable.

Disadvantages

The limitations of the BCG Matrix include

  • This four-celled approach is considered as to be too simplistic
  • High market share does not always lead to high profits. There are high costs also involved with high market share.
  • Growth rate and relative market share are not the only indicators of profitability. This model ignores and overlooks other indicators of profitability.
  • The matrix does not take into consideration any other factors that may have an effect on both competitive advantage & industry attractiveness.
  • It denies the correlation between different existing units. In reality, products under Dogs may be assisting another unit to gain a competitive advantage
  • It does not account for external factors, known as environmental factors. These factors include such things as the emergence of new technologies or potential changes in tax laws
  • It is only a snapshot of the current situation. It doesn’t look to see what is likely to happen to a market in the future.

Summary

BCG matrix is a strategic decision-making framework that helps in resource allocation among different strategic business units (SBUs) by categorizing them based on their ability to generate cash inflows against cash outflows. The matrix classifies business portfolio into four categories based on industry attractiveness (growth rate of that industry), and competitive position (relative market share). The growth vs share model provides an indication of which products an organization should invest in, those they should develop, and the ones they should get rid of. The framework is a simple but powerful tool for maximizing corporate competitiveness, and sustainability by allowing them to strike the right balance between exploitation and exploration.

Key Takeaways

  • The BCG Matrix is a method of examining a portfolio of products by relative market share and relative market growth.
  • This results in the portfolio broken down into stars, cash cows, dogs, and question marks.
  • The information within the matrix can then be used to create a balanced portfolio
  • Strategically, the portfolio should have enough stars to secure the future high-growth of the organization. It should have enough cash-cows to supply the funding for this future growth, and it should have enough question marks in the portfolio with the potential to be turned into future stars.
  • Despite the benefits of the BCG Matrix, it still has some limitations, and therefore should be used along with other strategic management tools for deeper analysis and effective corporate strategy formulation

 

Omodiaogbe Samuel, MSc. CMC, ChMC, FIMC

Omodiaogbe is a Strategic Management Consultant, and he the Principal Consultant/CEO at Vast Thinking Consults Ltd where he help organizations and business leaders to create superior value. Omodiaogbe holds BSc. and MSc. in Economics. Also, he is a Certified Management Consultant (CMC), a Chartered Management Consultant (ChMC), and a Fellow, Institute of Management Consultants, Nigeria. He is an Instructor on Coursera, where he teaches 25 courses in Strategic Management. Omodiaogbe is one of the world’s leading  learners on Coursera and Edx with over 500 Certificates from top-ranked Universities, Business Schools, and Organizations 

Contact him:
Email; somodiaogbe@vastthinking.com.ng
Visit: www.vastthinking.com.ng

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