The BCG Matrix and its Support of Management Decision Making

Table of Contents

List of Abbreviations

List of Tables

List of Figures

1 Introduction
1.1 Problem definition
1.2 Research question
1.3 Structure and methodology

2 The BCG Matrix
2.1 History
2.2 Objective and application
2.3 Description of the BCG Matrix

3 TopSim General Management II
3.1 Overview about the game
3.2 Game flow
3.3 Introduction of COPYFIX Inc. - Company
3.4 Decisions and simulation
3.5 Application of the BCG model to the simulation

4 Conclusion
4.1 Summary
4.2 Answering the research question

Publication bibliography

List of Abbreviations

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List of Tables

Table 1: Calculation of market growth.

Table 2: Calculation of relative market share

Table 3: Data for the BCG Matrix for company 1.

List of Figures

Figure 1: The BCG Matrix under influence of experience curve and life-cycle curve

Figure 2: The implication for the four quadrants of the BCG-Matrix

Figure 3: Strategy of Company

Figure 4: Price development market

Figure 5: Development of CGM of product 1.

Figure 6: Development of utilization of company

Figure 7: Development of sold units in market 1

Figure 8: Development of revenue in market

Figure 9: Development of market share market 1

Figure 10: Development of net income

Figure 11: Price development in market 2.

Figure 12: Development of revenue in market

Figure 13: BCG Matrix for period five for company 1

1 Introduction

Companies as social systems of our society can only survive if they create something which is in exchange with their environment of value. As the environment changes constantly companies have to adapt their products, processes or even business model to these changes. This is what we call innovation in the broader sense.^[1] If a company does not notice a change in the environment the company will get in trouble. The Finnish company Nokia is on one hand a really good example of a company that correctly early perceived and interpreted developments in their environment and made the right strategic decision. On the other Nokia is a tragic example because the company missed another strategic decision and thus slipped into red numbers. At the beginning of the 20th century Nokia produced successfully rubber boots and bicycle tires. However, the company realized that the future of the market for rubber products will be dominated by Asia and looked around for new high-growth markets. In the 80s, the company introduced the first mobile phone and developed from rubber boots manufacturers over years into a successful technology company. End of the 90s, Nokia was the world leader in the emerging market for mobile phones. But the dominance crumbled after Apple had introduced the iPhone in 2007. The Finnish mobile phone manufacturer reacted too late to the smartphones trend and within a few years Nokia slipped deep into the red numbers. In year 2014 the software manufacturer Microsoft bought the company.^[2]

1.1 Problem definition

The example Nokia impressively demonstrates the importance of strategic decisions for the survival of a company, the safeguarding of jobs and for the survival of capital from shareholders. The management has many different tasks that need to be carried out in order to be successful. But one of the most important tasks of the management is it to make decisions. This is also the most critical task because a decision makes or breaks a manager. Each decision is based on many assumptions for example about future market trends and technological development. Especially strategic decisions are very difficult because they have a sustainable impact on the performance of the company like the example of Nokia has shown. Many corporate crises can be attributed to strategic mistakes. Therefore strategic decisions should be the result of a prepared, planned and controlled analysis.

1.2 Research question

In the literature exist beside porters five forces, the value chain analysis or the competitor analysis many different techniques and models to analyze the macro and micro environment. All the models, techniques and instruments can serve as a basis for decisions. But one of the most renowned instruments in the management for the strategic decisions is the BCG Matrix. Therefore, the question arises: How far can the BCG Matrix contribute to support management decisions?

1.3 Structure and methodology

This work is divided into different parts. The first part demonstrates the theory behind the BCG Matrix. The section starts with a rough overview about the history of the BCG Model followed by the objectives and the application field. The first part ends with a description of the various dimensions, the four quadrants and different standard strategies. The second section represents the case study. This part starts with a compressed overview about the TOPSIM – General Management II simulation itself and the game flow. After a short introduction of the COPYFIX Inc. (Company 1) the decisions and results will be presented. At the end of the second section the BCG Matrix will be applied to the simulation. In the last part a conclusion will complete the entire work and will answer the research question.

For that work no primary data was gathered, the entire work is based on secondary data as the scope of this assignment does not allow for any explorative approaches, interviews or surveys. The necessary information for the work that were previously scattered published or accessible will be arranged, analyzed and interpreted. The sources of secondary data are gathered form books, magazines and sources in the worldwide-web.

2 The BCG Matrix

2.1 History

The portfolio analysis is based on the model of financial portfolio theory which was developed in 1952 by the Nobel Prize winner Markowitz. The goal is an optimal set of securities in terms of return and risk.^[3] In the 60 years this idea was transferred by Bruce Henderson of the Boston Consulting Group (BCG) from the financial model to the strategic management. Analogous to the securities portfolio, the company is interpreted as a set of investment decisions. Instead of securities paper the BCG considers the various business units or product lines as these are responsible for the company's success.^[4]

2.2 Objective andapplication

The portfolio approach is perhaps the most widely used method in strategic management and the growth-share portfolio analysis better known as the BCG matrix (a.k.a B.C.G. analysis, Boston Box, Boston Matrix, Boston Consulting Group analysis, portfolio diagram), represents the most known embodiment. The core task of the BCG matrix is to support the strategic management to control diversified businesses. Using the Boston Box the different product-market positions of the independent business units can be analyzed, compared and visualized in order to make a selection, prioritization and alignment of the various business segments. Goal is always to generate a balanced portfolio of capital needy and capital-generating business lines. Therefore, the BCG matrix is not only an analysis tool but also a tool for strategic planning and the formulation of strategies of individual business units.^[5]

2.3 Description of the BCG Matrix

The starting point for the Boston box is the simplification of the market key success factors to a from the company impressionable factor (relative market share – internal factor) and to a from the market given not essential controllable factor (market growth – external factor). The basic idea is that the individual business segments are always evaluated from these two dimensions. These strategic success factors which are based on strategic planning models are matched together in the form of a two-dimensional 4-field matrix.^[6] In figure 1 the BCG Matrix is visualized under influence of experience curve and life-cycle curve.

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Figure 1: The BCG Matrix under influence of experience curve and life-cycle curve.^[7]

The environmental axis (y-axis) represents the external not essential controllable factors over the market growth. All environmental-relevant success factors are shown in this single dimension. The market growth is based on the strategic planning model of the Business-Life-Cycle, which demonstrates the sales performance of an industry or a product in a time period. The market growth is expressed in percentage as market growth rate in which operates a specific strategic business unit. It is calculated by the market volume of the current year and the previous year. The simple formula is shown in table 1 “Calculation of market growth”. The market growth is used as indicator for the market attractiveness, as it is easier to gain market share in a growing market as in a shrinking market.^[8]

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Table 1: Calculation of market growth.

Beside the calculation of the market growth rate it is necessary to define an adequate separation line to categorize low and high growing SBUs. This is quite easy as long all SBUs are operating in the same industry. In such a case it makes sense to simply use the median of the industry. In the other case of highly diversified companies an individual scheme must be found. In practice the dividing line is presented by e.g. the defined overall enterprise growth rate or to cross industry average rate.^[9]

The internal situation of a company is compacted in the single dimension relative market share and is often shown on the x-axis (company-axis). This is the controllable factor which serves as a scale for the internal strength or weakness of a business unit. Background of the dimension relative market share is the strategic planning model of the experience curve or also known as economic of scale effect. This model says that an increasing cumulative production and sales volume tends to lower the costs per unit of a company. A rule of thumb says that the unit costs fall by 20-30% with each doubling of the cumulative volume. Thus, a company can build up cost advantages when its cumulative volume increases faster than its competitors - so it gains market share. The company that has in its industry the largest market share has compared to the company with less market share and less experience an advantage in the competition. The relative market share (based on the strongest competitors) has established itself as a dimension because the absolute market share would not allow sufficient comparability.^[10] The relative market share is calculated by the sales of the SBU dividing by the sales of the strongest competitors (alternatively, the three strongest competitors), as shown in table 2 “Calculation of relative market share”.

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Table 2: Calculation of relative market share

The dividing line for the relative market share is a natural dividing line because according to the formula the market leader has a market share bigger one. Some authors define the dividing line at 1.5 with the justification that a significant competitive advantages arise only from a serious relative market share advantage of at least 50%.^[11]

In addition to the two already mentioned dimensions of market growth and relative market share there is a third dimension, the revenue, which takes into account the performance of the individual business units and thus their contribution to the overall success of the company. The revenue is shown in the Boston Matrix on the different sized circles. The diameter of the circles - of which each represents a SBU - symbolizes the revenue of each SBU. With the help of different dimensions, the SBUs can be mapped into the four fields of the matrix. Out of the four quadrants, certain implications can be derived. Figure 4: “The implication for the four quadrants of the BCG-Matrix” shows a summary of all implications.

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Figure 2: The implication for the four quadrants of the BCG-Matrix.^[12]

Question Marks (low relative market share, high market growth):

SBUs this category have a low relative market share but operating in attractive markets with a high growth rate. This means in this sector the company has potentials that have not been used so far. A low cash flow due to the weak market position meets a high financial need to boost the SBU form a Question Mark to a star. In general it can be assumed for Question Marks a low to negative contribution margins, so losses can be expected. With Question Marks, it is unclear whether these develop to Stars or Poor Dogs therefore the company should take every opportunity to make the concerned SBUs to develop into a star. However, if the market growth rate decreases significantly the company should try to sell or divest the business unit. Here a selective strategy has to be applied.^[13]

Stars (high relative market share, high market growth):

Compared to the Question Marks Stars generate already a positive contribution margins and profit. The win is generally still below the required investment that is needed to save or to the further expansion of its own market position. The company can boast a strong competitive position in attractive markets. The here positioned SBUs are market leader in a high growth market. Therefore the company should try thru investments to keep the position. When the market growth slows down and the company manages to keep the market share, the star will developed into a Cash Cow, otherwise a Poor Dog.^[14]

Cash Cows (high relative market share, low market growth):

The SBUs in this sector operating in markets those are already in the mature or saturation phase. That means the market growth is below the average. Due to their high market share these SBUs have regular high profit and cash flow. As the market grows only slightly there are none or even only small investments necessary. The strategy has to be hold the position and harvest the profit and cash flow to use it for Stars.^[15]

Poor Dogs (low relative market share, low market growth):

Poor Dogs are also in the saturation phase of a market. However, the company could not manage to generate significant market share. Therefore the SBU cannot benefit from economies of scale effects and makes little or no profit. It is recommended to clean out all the concerned SBUs.^[16]

3 TopSim General Management II

3.1 Overview about the game

TopSim General Management II is a sophisticated and up to date simulation program that helps students to learn how to deal with complex situations and to make decision. It covers all areas of a company from manufacturing, purchasing, human resources planning, research and development to marketing and sales. The simulation gives students the possibility to gather practical experience. The big advantages of simulation based learning are obvious. It is repeatable, risk free, time efficient, cost efficient and realistic. It is more or less learning by doing.

3.2 Game flow

To the beginning of the simulation participants got an introduction to the cover story including of all the detail of the company that the students had to manage. The next step was it to form three different teams. After the teams were formed the game started with a forecast for the next period. The three teams tried to be successful by defining a strategy, analyzing and interpreting the own company and watching the competitors. Furthermore the teams had to make educated guesses about market development and customer behavior based on forecast. The participants submitted various kinds of management decisions to the course instructor. The facilitator calculated the current period by consideration the decisions of all teams. A detailed presentation by the instructor guaranteed the understanding of cause and effects of group decisions. After the presentation the facilitator started the next decision cycle. The game ended with the period five.

3.3 Introduction of COPYFIX Inc. - Company 1

COPYFIX Inc. is a company that sells a high-quality black and white copier. To the beginning of the game a new executive board was introduced. In order to guide COPYFIX to former success and to separate important from what is not the new management declared the following mission statement. “The company wants to be a leading global manufacturer of copier for price-conscious customers and creating exceptional value for our shareholders and employees.”

Beside the mission statement a new strategy was defined. The systematic analysis of the factors associated with customers, competitors and the organization itself led to the definition of the following strategy statement. The strategy was aligned to the mission statement and is divided into three different fields as illustrated in figure 5. It was aimed to implement the strategy within 5 periods.

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Figure 3: Strategy of Company 1.

On basis of the strategy different goals for the company were elaborated. The main goal was to double the sales while reducing the cost. Cost leadership and growth should be achieved by very low production costs and thereby a low price. Thus the market share should grow relatively fast. The production costs should be decreased using economies of scale (e.g. fixed cost degression), experience curve effects (high production volume) and a high utilization of machinery and staff. Furthermore, the cost leadership required investments in modern manufacturing equipment, training of the staff, process optimization, elimination of cost drivers (e.g. low storage costs) and constant attention to technological developments. In order to raise the market awareness of our company and our product, the advertising expenditure and corporate identity expenditure should be raised. In order to spread the risk by diversification another goal of the management was it to develop more products and serve other markets.

3.4 Decisions and simulation

In the interest to become the global manufacture of copier and to gain quick and constantly market share the important marketing instrument the price was used. To the beginning the management made the decision to consequently decrease the price over all periods. In the first period the price dropped from 3.000 EUR by 250 EUR to 2.750 EUR. It turned out that the price was too low in order to cover all cost. Therefore in the second period the price was increased by 50 EUR to 2.800 EUR and hold in period 3. In period 4 the price could decrease from 2.800 EUR to 2.650 EUR because of the low CGM. One more time the price could be reduced in the period 5 from 2.650 EUR to 2.600 EUR. Figure 4 demonstrates the development of the price for product 1 and for all three companies over the five periods.

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Figure 4: Price development market 1.

In the first period by watching the competitors it turned out that only company 2 was a direct competitor because company 2 had a similar aggressive price strategy and penetrated the same market as company 1. Company 3 was a premium provider of printers and had its own market.

In order to offer a low price on the market and to be a cost leader the focus of the company was to reduce the CGM and to keep the utilization as high as possible. As shown in figure 5 the CGM could be decreased over all periods expect in period 1. In period 1 the capacity for the growth had to be created (especially staff was hired) and thereby the CGM increased. From the third period, the manufacturing costs were in company 1 about 100 EUR less than at the competitors what resulted in a competitive advantage in the price.

Under the authority of keeping the manufacturing costs low high machinery and personnel utilization was aimed. The average machine utilization was over 5 periods at 97%. The average of staff utilization was even at 98%. Figure 6 shows the development of the utilization over the five periods. In addition to the standard sales the distribution channel bulk buyers was chosen to ensure a high level of utilization.

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Figure 5: Development of CGM of product 1.

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Figure 6: Development of utilization of company 1.

To further reduce manufacturing costs and to further optimize the utilization the expenditure for process optimization were increased in period 1 to one million and held up to period 5 on this level. At the same time the training cost were doubled from 0.5 million to one million.

A high customer satisfaction and above average technology and ecological indices should ensure sales. Therefore the spending on corporate identity were increased in order to create a good cooperate image. Also the expenditures on advertising were raised from 6.0 million EUR in period 1 to 7.0 million EUR in period 2 and to 10 million EUR in the periods 3 to 5. The total expenditures on advertising in market 1 were 23.0 million EUR.

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Figure 7: Development of sold units in market 1.

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Figure 8: Development of revenue in market 1.

The by the management to the beginning of the simulation defined strategy and goals showed quite early results. Thus the number of sold units could be raised from 43.000 to over 82.195 in period 4 as represented in figure 7. At the same time the revenue could be raised in average by 15%. The goal to double the revenue was reached in period 4 as illustrated in figure 8. Also the market share could be elevated by an average of 7%. Over all periods company 1 had the highest market share followed by company 2 as represented in figure 9. Company 3 with the premium strategy lost in every period market share to the other two companies even the overall market grew in average by 6% per period.

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Figure 9: Development of market share market 1.

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Figure 10: Development of net income.

[...]

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^[1] cf. Williamson (1975).

^[2] cf. Handelsblatt (2011).

^[3] Markowitz 1952, page 77-91

^[4] Kerth et al. 2011, page 85

^[5] Kerth et al. 2011, page 85

^[6] Weber et al. 2008, page 388

^[7] Own grafic based, translated and modified form Kerth et al. 2011, page 86

^[8] Matzler et al. 2011, page 106

^[9] Kerth et al. 2011, page 90

^[10] Hungenberg 2012, page 461, 462

^[11] Kerth et al. 2011, page 90

^[12] Own grafic based, translated and modified form Kerth et al. 2011, page 88

^[13] Kerth et al. 2011, page 86, 87

^[14] Weber et al. 2008, page 389

^[15] Hungenberg 2012, page 463

^[16] Hungenberg 2012, page 463, 464