Portfolio Models

Table of Contents

Table of figures

Introduction

1.Portfolio Analysis
1.1 The BCG growth - share matrix
1.2 The GE business screen

2. Comparison
2.1 Review of both models

3. Synergies and the portfolio models

4. Application of the GE business screen

5. Conclusion

Bibliographic Reference

Table of figures

Figure 1: The portfolio models

Figure 2: The GE business screen/ Nestlé

Introduction

The growing and brisk market during the 1950s and 1960s made companies to operate more and more businesses and led not only to larger and complex firms but also to a high number of divisions. The overall corporate strategy was therefore insufficient, especially when divisions led on to diversifications different strategies, business unit strategies, were required.

In order to find out in which business a company should be in and how resources can be allocated amongst them, different portfolio analyses are developed in the 1970s. The idea goes back to the Portfolio Selection Theory from Markowitz (1959) in which a portfolio is described as an ideal mix of different securities.

The portfolio analysis in this context can be described as a framework to analysis the balance of an organization’s strategic business units (Johnson and Scholes, 1999, p.186).

The objective of this piece of work is to explain the two best-known portfolio analysis approaches: The Boston Consulting Group’s growth- share and growth-gain matrix and the General Electric Company business screen in regard to advantages and disadvantages, generated strategies, interdependence of products, opportunities for synergy as well as the problems which can occur when applying those models in practice.

In the first chapter both models and the different strategies will be explained and definitions will be given.

A comparison of both models in relation to their advantages and disadvantages can be found in the second chapter. In the third chapter the relevance of synergy will be discussed. Chapter four contains a GE matrix for Nestlé Waters and the validity of the possible strategies is critically evaluated. The conclusion can be found in chapter five.

1. Portfolio Analysis

The central idea of the portfolio analysis is the realization that strategic planning is influenced by external facts, such as competition or an increase of costs for primary products etc. and by internal facts, like the number of businesses the company operates in or the amount of available assets etc. as well as that the company has strengths and weaknesses and that it has to react on opportunities and threats of the environment.

Another starting point is the assertion that over the long run a firm could not success at a corporate level until it knew how to achieve success at a business level (Hofer, 1975, p.786).

Both aspects can be found in the various portfolio diagrams, which consist of a two-dimensional matrix - one axis shows the company’s or internal dimension, the other shows the environment or the external dimension. The position of the different products or strategic business units is the result of the external and internal influences. The term strategic business unit (SBU) emerged in the 1960s and it stands for a single business or collection of related businesses that offers scope for independent planning and that might feasibly stand alone from the rest of the organization, that has its own set of competitors and it has a manager who has responsibility for strategic planning and profit performance, and control of profit- influencing factors (Gilligan and Wilson, 2003, p.453). Another shorter description is given by Cliff Bowman who defined a strategic business unit as a number of discrete and fairly autonomous units or divisions within a company (1989, p.3).

Afterwards the different strategies were deducted depending on the position of the SBUs within the matrix. Those strategies should be applied in order to achieve the aimed-at cash-flow balance, for example. Balancing cash-generating businesses against cash-absorbing businesses can arouse a cash-flow balance and can be seen as an increase of the overall value of the company.

According to Robert M. Grant (Contemporary Strategy Analysis - concepts, techniques, applications, 4th Edition) it can be summarized that the portfolio models are used to:

- Evaluate business unit performance
- Formulate business unit strategies
- Assess the overall balance of the corporate portfolio.

In the next part the Boston Consulting Group’s growth-share and growthgain matrix (BCG growth-share matrix) is explained.

1.1 The BCG growth-share matrix

This matrix model was developed in the 1970s by the Boston Consulting Group, an international management-consulting firm, which exists over 40 years now.

The portfolio analysis matrix shown in figure 1 consists of two axes:

- The abscissa is the relative market share
- The ordinate the rate of market growth

The relative market share measures the market share of the business relative to the market share of the largest competitor (Goold and Sommer Luchs, 1996, p.95).

The rate of market growth can also be used as an indicator for the market attractiveness. The unit for measurement is (%).

The vertical axis is used to illustrate the largely uncontrollable annual rate of market growth in which the business operates (Gilligan and Wilson, 2003, p.454).

Both dimensions are divided in high and low and this is why there are four quadrants or cells:

- The stars cell
- The cash cow cell
- The question mark cell
- The dog cell

The different SBUs are then positioned with regard to the market growth and their relative market share into the appropriate cell with the appropriate characteristics, which are the following:

Stars:

SBUs in this cell are in an attractive market, high market growth rate, and have a high market share in comparison to their competitor - they are market leaders and profitability is good, but according to Peter Doyle investments to maintain the SBU’s position are likely to be high (1998, p.111). This is why the cash flow in this cell is rather neutral.

Cash cows:

This cell consists of SBU’s, which keep the company alive, i.e. they earn more than they need to maintain the position they have and therefore generate resources that are needed elsewhere in the company, e.g. to support a star.

The cash cow has a high market share in a mature market. Because growth is low and market conditions are more stable, the need for heavy marketing investments is less… The cash cow should then be a cash provider (Johnson and Scholes, 1999, p.188).

Question marks:

A SBU in this cell have a low market share in a high-growth market. There are two ways to change it’s positioning: The company can make high investments in order to increase the market share or, if the company cannot afford such investment or if the company do not expect the SBU to be successful although they have invested a lot of money, they can abandon it.

Peter Doyle describes this as a “double or quit” situation (1998, p.112). In order to avoid a financial burden for the company the latter is the most reasonable decision that is generally suggested.

Dog:

A product in this quadrant is rather uninteresting or even cash absorbing and therefore dangerous for a balanced cash flow in the product portfolio of a company. Their market share is low as well as the market growth rate.

This is why they are not profitable - their cash flow is neutral or negative. The company should phase out the product, except the company expect the market to grow, for example, or the dog do earn cash, which can be used elsewhere again. Products with low shares in low-growth markets, referred to as dogs, have a bleak future. The cash flow associated with such products may be positive or negative depending on circumstances (Bradley, 1995, p.102).

The different characteristics of each cell, shown above, require different strategies, which are the following:

- Invest for growth
- Milk, i.e. maintain
- Growth or divest
- Divest

Invest for growth:

This strategy is used for SBU’s in the star quadrant in order to maintain their position and to make them to cash cows when the market matures.

Milk/ maintain:

This strategy is used for cash cows - The major objectives of this strategy is to maintain the position, to invest in product improvement or modification and to use e.g. milk the generated cash.

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