The eleventh case study for CMA (Final) Group 3 students-

Paper 15 - Business Strategy and Strategic Cost Management

CASE STUDY ON BCG MATRIX

Hassan is one of the India‘s leading detergent manufacturing companies. The firm has more than twenty-five product types. These have been developed over a period of its ten year existence. Some products are very successful while others have not performed well. The challenge for the board has been the formulation of strategy policy in the way the company manages the portfolio of products. As a newly recruited qualified Cost Accountant, your advice is being sought to address the following questions the Product manager has prepared as input into his paper to the Board. 

(a) Describe the Boston Consulting Group (BCG) growth vector matrix. 

(b) Explain what strategic options are available to Hassan in accordance to the BCG Matrix. 

(c) Outline what limitations the model poses to the Product Manager as he prepares his paper to the Board.

Answer:

(a) The BCG Matrix is a model used to analyze the portfolio of strategic business units, investments and products according to their cash generating capabilities whose function is relative market share and market growth rate. This results into 4 categories being: question marks (future potential earners), stars (increasing good positive cash flow), cash cows (cash rich) and dogs (declining cash flows). 

The BCG Growth-Share Matrix is a portfolio planning model developed by Bruce Henderson of the Boston Consulting Group in the early 1970's. It is based on the observation that a company's business units can be classified into four categories based on combinations of market growth and market share relative to the largest competitor, hence the name "growth-share". Market growth serves as a proxy for industry attractiveness, and relative market share serves as a proxy for competitive advantage. The growth-share matrix thus maps the business unit positions within these two important determinants of profitability. 

BCG Growth-Share Matrix

This framework assumes that an increase in relative market share will result in an increase in the generation of cash. This assumption often is true because of the experience curve; increased relative market share implies that the firm is moving forward on the experience curve relative to its competitors, thus developing a cost advantage. A second assumption is that a growing market requires investment in assets to increase capacity and therefore results in the consumption of cash. Thus the position of a business on the growth-share matrix provides an indication of its cash generation and its cash consumption. Henderson reasoned that the cash required by rapidly growing business units could be obtained from the firm's other business units that were at a more mature stage and generating significant cash. By investing to become the market share leader in a rapidly growing market, the business unit could move along the experience curve and develop a cost advantage. From this reasoning, the BCG Growth-Share Matrix was born. The four categories are:

 Dogs - Dogs have low market share and a low growth rate and thus neither generate nor consume a large amount of cash. However, dogs are cash traps because of the money tied up in a business that has little potential. Such businesses are candidates for divestiture. 

Question marks - Question marks are growing rapidly and thus consume large amounts of cash, but because they have low market shares they do not generate much cash. The result is a large net cash comsumption. A question mark (also known as a "problem child") has the potential to gain market share and become a star, and eventually a cash cow when the market growth slows. If the question mark does not succeed in becoming the market leader, then after perhaps years of cash consumption it will degenerate into a dog when the market growth declines. Question marks must be analyzed carefully in order to determine whether they are worth the investment required to grow market share.

 Stars - Stars generate large amounts of cash because of their strong relative market share, but also consume large amounts of cash because of their high growth rate; therefore the cash in each direction approximately nets out. If a star can maintain its large market share, it will become a cash cow when the market growth rate declines. The portfolio of a diversified company always should have stars that will become the next cash cows and ensure future cash generation. 

Cash cows - As leaders in a mature market, cash cows exhibit a return on assets that is greater than the market growth rate, and thus generate more cash than they consume. Such business units should be "milked", extracting the profits and investing as little cash as possible. Cash cows provide the cash required to turn question marks into market leaders, to cover the administrative costs of the company, to fund research and development, to service the corporate debt, and to pay dividends to shareholders. Because the cash cow generates a relatively stable cash flow, its value can be determined with reasonable accuracy by calculating the present value of its cash stream using a discounted cash flow analysis.

 Under the growth-share matrix model, as an industry matures and its growth rate declines, a business unit will become either a cash cow or a dog, determined soley by whether it had become the market leader during the period of high growth. While originally developed as a model for resource allocation among the various business units in a corporation, the growth-share matrix also can be used for resource allocation among products within a single business unit. Its simplicity is its strength - the relative positions of the firm's entire business portfolio can be displayed in a single diagram.

(b) Hassan has four strategic choices when we look at the BCG Matrix. They include: Build - this is where Hassan uses funds from other products to invest in question marks or stars. These funds are usually harvested from cash cows. This is about moving excess cash around various product lines especially those with potential for growth but lacking own funds for reinvestments. Hold - this is where funds are ploughed back or profits reinvested. This is applicable to question marks and stars. Harvest - this is where funds are milked out of cash cows and used to build question marks and stars. Divest - this is applicable in cases where Hassan discontinues operations of product lines that are no longer profitable. 

(c) The limitations include: (i) Market information regarding aggregate demand and market shares held by competing firms may not be readily available or too expensive to obtain. (ii) Too simplistic by assuming that cash flow is affected by only market growth rate and relative market share. (iii) Assumes that only longer staying firms in the market can build competitive edge. In modern business environments, this is not possible. We have seen new entrants easily overtaking long established firms. . 

Source: PTP - December 2013 of ICAI