CHAPTER10 Corporate Development: Building and Restructuring the Corporation 349

. Portfolio Planning

One of the most famous portfolio planning matrices is referred to as the growth-

share matrix. This was developed by the Boston Consulting Group (BCG), princi-pally to help senior managers identify the cash flow requirements of differentbusinesses in their portfolio and to help determine whether they need to changethe mix of businesses in the portfolio. We review the growth-share matrix in order

to illustrate both the value and the limitations of portfolio planning tools. Thegrowth-share matrix has three main steps: (1) dividing a company into strategicbusiness units (SBUs); (2) assessing the prospects of each SBU and comparing themagainst each other by means of a matrix; and (3) developing strategic objectives foreach SBD.

Identifying SBUs According to the BCG, a company must create an SBU for eacheconomically distinct business area that it competes in. Normally, a company de-

fmes its SBUs in terms of the product markets they are competing in. For example,Ciba Geigy, Switzerland's largest chemical and pharmaceutical company and an ac-tive user of portfolio planning techniques, has identified thirty-three strategic busi-ness units in areas such as proprietary pharmaceuticals, generic pharmaceuticals,seed treatments, reactive dyes, detergents, resins, paper chemicals, diagnostics, andcomposite materials (see Strategy in Action 10.1).

Assessing and Comparing SBUs Having defined SBUs, top managers then assesseach according to two criteria: (1) the SBU's relative market share and (2) the growthrate of the SBU's industry. Relative market share is the ratio of an SBU's market

share to the market share held by the largest rival company in its industry. If SBU X

has a market share of 10 percent and its largest rival has a market share of 30 percent,SBU X's relative market share is 10/30, or 0.3. Only if an SBU is a market le~der in its

industry will it have a relative market share greater than 1.0. For example, if SBU Y hasa market share of 40 percent and its largest rival has a market share of 10 percent,then SBU Y's relative market share is 40/10, or 4.0. According to the BCG, marketshare gives a company cost advantages from economies of scale and learning effects.An SBU with a relative market share greater than 1.0 is assumed to be farther down

the experience curve and therefore to have a significant cost advantage over its rivals.By similar logic, an SBU with a relative market share smaller than 1.0 is assumed tolack the scale economies and low-cost position of the market leader.

The growth rate of an SBU's industry is assessed according to whether it is fasteror slower than the growth rate of the economy as a whole. BCG's position is thathigh-growth industries offer a more favorable competitive environment and betterlong-term prospects than slow-growth industries.

Given the relative market share and industry growth rate for each SBU, manage-ment compares SBUs against each other by way of a matrix similar to that illus-trated in Figure 10.1. The horizontal dimension of this matrix measures relative

market share; the vertical dimension measures industry growth rate. The center ofeach circle corresponds to the position of an SBU on the two dimensions of the ma-

trix. The size of each circle is proportional to the sales revenue generated by eachbusiness in the company's portfolio. The bigger the circle, the larger is the SBU'srevenue relative to total corporate revenues.

350 PART3 Strategies

10.1

portfolio Planningat Ciba-Geigyiba-GeigyisalargeSwiss-basedcompanywith interestsin chemicalsandpharmaceuti-calsandannualrevenuesin excessof $25billion. Since1984,thecompanyhasbeen

usingportfolio planningtechniquesasa tool to assistcor-poratemanagementin theprocessofstrategicplanning,resourceallocation,andperformanceassessment.Al-thoughthecompanylookedcloselyat thegrowth-sharematrix devisedbytheBostonConsultingGroup,it decidedto developacustomizedportfolio planningtool thatwould bettersuit its needs.

ciba haddividedthe companyinto thirty-threesepa-ratestrategicbusinessunits,suchasproprietarypharma-ceuticals,genericpharmaceuticals,seedtreatments,reactivedyes,detergents,resins,paperchemicals,diag-nostks,andcompositematerials.AtCiba,eachSBUis as-sessedaccordingtotwomaincriteria: thelikely futuregrowthrateof its industry,andthecompetitivepositionoftheSBUrelativeto its rivals.In derivingameasureofcompetitiveposition,Cibalooksat relativemarketshare,but unlike theoriginalBCGgrowth-sharematrix, thecompanyalsoconsidersa rangeof othercompetitivefac-tors, suchascoststructure,productquality,corecompe-tencies,andrelativeprofitability.

Usingthesedata,CibaclassifiesitsSBUsinto oneoffivecategories:development,growth,pillar,niche,andcore.Developmentbusinessesarein the earlystageoftheir life cycleandusuallyrequiresubstantialR&Dinvest-ments.GrowthbusinessesarecompetitiveSBUsbasedinlargeand/orgrowingmarkets.Cibawillcommitsubstan-tial funds in order to build thecompetitiveposition of sucha business. Pillar businesses are market leaders that are

basedin attractiveindustries,suchas Ciba'spharmaceuti-cal businesses. Theytypicallyreceiveahighpriorityin

R&Dfundingand resource allocation in order to maintain

their pillar status. Niche businesses are market leaders

that are constrained becausethey servea relativelysmallmarket (Ciba'sanimal health business, for example, was

defined as a niche business). Core businesses are large

SBUs that compete in mature industries (Ciba's dyes, poly-

mers, and pigments SBUs are all classified as core). Core

businesses are seen as generating excess cash that can beused to fund investments elsewhere within the company.

What is interesting about Ciba'sapproach is that theseclassifications arenot takenas gospel.The company isquite willing to violate the investment rules associatedwith the different categories if that seems appropriate. For

example, in 1994Ciba committed itself to major new in-

vestments in its pigments SBUto upgrade its U.S. produc-

tion facilities, eventhoughits portfolio planningcategories suggest that this was a mature low-growth corebusiness that should be used to generate fundsfor invest-

ment elsewhere within the company.Ciba's viewappearsto be that the utility of portfolio planning lies not so much

in its role as a guide to resource allocation, as it does inhelping top managers set reasonable strategic expecta-

tions andobjectivesfor thedifferent SBUswithinthe com-

pany. Thus, Ciba's corporate managers will assign verydifferent strategic and financial objectives to SBUs classi-

fied as growth businesses compared with those classified

as pillars. Pillars would be expected to earu a higher re-

turn on assets, generate greater cash flow, and contribute

more of their earnings to the corporate bottom line than

a growth business. By the same token, however, growth

businesses would be expected to grow their revenues and

earnings at a faster rate than pillars. The performance of

managers running these SBUs is then compared against

these different expectations.4

~ ~' "._-~~ ~-,

The matrix is divided into four cells. SBUsin cell 1 are defined as stars, in cell 2as question marks, in cell 3 as cash cows, and in cell 4 as dogs. BCG argues thatthese different types of SBUshave different long-term prospects and different impli-cations for cash flows.

. Stars. The leading SBUsin a company's portfolio are the stars. Stars have a highrelative market share and are based in high-growth industries. Accordingly, theyoffer attractive long-term profit and growth opportunities.

FIGURE 10.1

The BCG Matrix

CHAPTER10 Corporate Development: Building and Restructuring the Corporation 351

High Celli:Stars

Cell 2:

Question Marks

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Low

Cell]:Cash Cows

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Dogs

High ~ Low

Relative Market Share

Source:Perspectives,No. 66,"The Product Portfolio."Adapted by permission from The Boston ConsultingGroup, Inc., 1970.

. Question marks. Question marks are SBUs that are relatively weak in competi-tive terms (they have low relative market shares) but are based in high-growthindustries and thus may offer opportunities for long-term profit and growth. Aquestion mark can become a star if nurtured properly. To become a marketleader, a question mark requires substantial net injections of cash; it is cash hun-gry.The corporate head office has to decide whether a particular question markhas the potential to become a star and is therefore worth the capital investmentnecessary to achieve stardom.

. Cash cows. SBUsthat have a high market share in low-growth industries and astrong competitive position in mature industries are cash cows. Their competi-tive strength comes from being farthest down the experience curve. They arethe cost leaders in their industries. BCG argues that this position enables suchSBUsto remain very profitable. However, low growth implies a lack of opportu-nities for future expansion. As a consequence, BCG argues that the capital in-vestment requirements of cash cows are not substantial, and thus they aredepicted as generating a strong positive cash flow.

. Dogs. SBUsthat are in low-growth industries but have a low market share are dogs.They have a weak competitive position in unattractive industries and thus areviewed as offering few benefits to a company. BCGsuggests that such SBUsare un-likely to generate much in the way of a positive cash flow and indeed may becomecash hogs. Though offering few prospects for future growth in returns, dogs mayrequire substantial capital investments just to maintain their low market share.

Strategic Implications The objective of the BCG portfolio matrix is to identify

how corporate cash resources can best be used to maximize a company's futuregrowth and profitability. BCG recommendations include the following:

PART3 Strategies

. The cash surplus from any cash cows should be used to support the develop-ment of selected question marks and to nurture stars. The long-term objective isto consolidate the position of stars and to turn favored question marks intostars, thus making the company's portfolio more attractive.

. Question marks with the weakest or most uncertain long-term prospects shouldbe divested to reduce demands on a company's cash resources.

. The company should exit from any industry where the SBUis a dog.

. If a company lacks sufficient cash cows, stars, or question marks, it should con-sider acquisitions and divestments to build a more balanced portfolio. A portfo-lio should contain enough stars and question marks to ensure a healthy growthand profit outlook for the company and enough cash cows to support the in-vestment requirements of the stars and question marks.

. Limitations of Portfolio Planning

Though portfolio planning techniques may sound reasonable, if we take the BCGmatrix as an example, there at least four main flaws. First, the model is simplistic. Anassessment of an SBUin terms of just two dimensions, market share and industrygrowth, is bound to be misleading, for a host of other relevant factors should betaken into account. Although market share is undoubtedly an important determi-nant of an SBU's competitive position, companies can also establish a strong com-petitive position by differentiating their product to serve the needs of a particularsegment of the market. A business having a low market share can be very profitableand have a strong competitive position in certain segments of a market. The automanufacturer BMW is in this position, yet the BCG matrix would classify BMWas adog because it is a low-market-share business in a low-growth industry. Similarly,in-dustry growth is not the only factor determining industry attractiveness. Manyfac-tors besides growth determine competitive intensity in an industry and thus itsattractiveness.

Second, the connection between relative market share and cost savings is not asstraightforward as BCG suggests. High market share does not always give a companya cost advantage. In some industries-for example, the U.S. steel industry-Iow-market-share companies using a low-share technology (minimills) can have lowerproduction costs than high-market-share companies using high-share technologies(integrated mills). The BCGmatrix would classify minimill operations as the dogs ofthe U.S. steel industry, whereas in fact their performance over the last decade hascharacterized them as star businesses.

Third, a high market share in a low-growth industry does not necessarily resultin the large positive cash flow characteristic of cash cow businesses. The BCGma-trix would classify General Motors' auto operations as a cash cow. However,the cap-ital investments needed to remain competitive are so substantial in the autoindustry that the reverse is more likely to be true. Low-growth industries can bevery competitive, and staying ahead in such an environment can require substantialcash investments.

To be fair, several companies and management consulting enterprises have rec-ognized the limitations of the BCG approach and developed alternative approachesthat address the weaknesses noted above. For example, Ciba-Geigy,whose use ofportfolio planning techniques is reviewed in Strategy in Action 10.1, has devised a

GURE 10.2

e McKinsey Matrix

CHAPTER10 CorporateDevelopment:Building andRestructuringtheCorporation 353

planning approach that recognizes a wider range of competitive factors needed tobe taken into consideration when assessing an SBD'sposition. Similarly,the manage-ment consultants McKinsey and Company developed a portfolio matrix that uses amuch wider range of factors to assess the attractiveness of an industry in which anSBDcompetes, as well as the competitive position of an SBD(see FigurelO.2). In-cluded in the assessment of industry attractiveness are factors such as industry size,growth, cyclicality, competitive intensity, and technological dynamism. The assess-ment of competitive position relies on factors such as market share and an SBD'srelative position with regard to production costs, product quality,price competitive-ness, distribution, and innovation.

Although there is no doubt that the approaches adopted by Ciba and McKinseyrepresent a distinct improvement over the original BCGmodel, in general all portfo-lio planning techniques suffer from significant flaws. Most important, they fail topay attention to the source of value creation from diversification. They treat busi-ness units as independent, whereas in fact they may be linked by the need to trans-fer skills and competencies or to realize economies of scope. Moreover, portfolioplanning approaches tend to trivialize the process of managing a large diversifiedcompany. They suggest that success is simply a matter of putting together the rightportfolio of businesses, whereas in reality it comes from managing a diversifiedportfolio to create value, whether by leveraging distinctive competencies acrossbusiness units, by sharing resources to realize economies of scope, or by achieving

High Winner Questionmark

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Competitive Position