A good planning system must guide the development of strategic alternatives for each of the company's current businesses and new business possibilities. It must also provide for management's review of these strategic alternatives and for corresponding resource allocation decisions. The result is a set of approved business plans that, taken as a whole, represent the direction of the firm. This process starts with, and its success is largely determined by, the creation of sound strategic alternatives.
The top management of a multibusiness firm cannot generate these strategic alternatives. It must rely on the managers of its business ventures and on its corporate development personnel. However, top management can and should establish a conceptual framework within which these alternatives can be developed. One such framework is the portfolio matrix associated with the Boston Consulting Group (BCG). Briefly, the portfolio matrix is used to establish the best mix of businesses in order to maximize the long-term earnings growth of the firm. The portfolio matrix represents a real advance in strategic planning in several ways:
• It encourages top management to evaluate the prospects of each of the company's businesses individually and to set tailored objectives for each business based on the contribution it can realistically make to corporate goals.
• It stimulates the use of externally focused empirical data to supplement managerial judgment in evaluating the potential of a particular business.
• It explicitly raises the issue of cash flow balancing as management plans for expansion and growth.
• It gives managers a potent new tool for analyzing competitors and for predicting competitive responses to strategic moves.
• It provides not just a financial but a strategic context for evaluating acquisitions and divestitures.6
As a consequence of these benefits, the widespread application of the portfolio matrix approach to corporate planning has sounded the death knell for planning by exhortation, the kind of strategic planning that sets uniform financial performance goals across an entire company—15 percent growth in earnings or 15 percent return on equity—and then expects each business to meet those goals year in and year out. The portfolio matrix approach has given top management the tools to evaluate each business in the context of both its environment and its unique contribution to the goals of the company as a whole and to weigh the entire array of business opportunities available to the company against the financial resources required to support them.
The portfolio matrix concept addresses the issue of the potential value of a particular business for the firm. This value has two variables: first, the potential for generating attractive earnings levels now; second, the potential for growth or, in other words, for significantly increased earnings levels in the future. The portfolio matrix concept holds that these two variables can be quantified. Current earnings potential is measured by comparing the market position of the business to that of its competitors. Empirical studies have shown that profitability is directly determined by relative market share.
Growth potential is measured by the growth rate of the market segment in which the business competes. Clearly, if the segment is in the decline stage of its life cycle, the only way the business can increase its market share is by taking volume away from competitors. Although this is sometimes possible and economically desirable, it is usually expensive, leads to destructive pricing and erosion of profitability for all competitors, and ultimately results in a market that is ill served. On the other hand, if a market is in its rapid growth stage, the business can gain share by preempting the incremental growth in the market. So if these two dimensions of value are arrayed in matrix form, we have the basis for a business classification scheme. This is essentially what the Boston Consulting Group portfolio matrix is. Each of the four business categories tends to have specific characteristics associated with it. The two quadrants corresponding to high market leadership have current earnings potential, and the two corresponding to high market growth have growth potential.
Exhibit 10-3 shows a matrix with its two sides labeled product sales growth rate and relative market share. The area of each circle represents dollar sales. The market share position of each circle is determined by its horizontal position. Each circle's product sales growth rate (corrected for inflation) in the market in which it competes is shown by its vertical position.
With regard to the two axes of the matrix, relative market share is plotted on a logarithmic scale in order to be consistent with the experience curve effect, which implies that profit margin or rate of cash generation differences between two competitors tends to be proportionate to the ratio of their competitive positions. A linear axis is used for growth, for which the most generally useful measure is volume growth of the business concerned; in general, rates of cash use should be directly proportional to growth.
Was this article helpful?
Your online business plan needs to make sure it addresses the management and administration structure in other words your organization’s breakdown. Online businesses often have a simpler organization structure than a traditional business, but that’s not always the case, and it must be clearly defined.