BCG's approach to portfolio strategy

Evolution from the 1960's growth/share matrix to today's frameworks

Introduction to Strategic Management Course

Aalto University, November 7, 2016
It all started in the 1960s from the revelation of the
experience curve

At Industry Level
Unit price (constant US$)
10,000
BCG
Slope1 (%) Years

1,000 Color TV 76 6889

VCR 83 7689

Handheld calculator 64 7484

100
Digital watch 75 7484

Cellular telephone 77 8589

10
Answering machine 78 7589

1
0.1 1 10 100 1,000

Cumulative volume (M)

1. For each doubling of cumulative volume, unit price falls by (100 - scale)%
Source: Merchandising; Dealerscope Merchandising; BCG analysis
1
What causes it?

Total unit
costs

Scale
Annual
volume

Labor etc Total unit

costs cost
Experience
Learning
curve
Cumulative Cumulated
volume volume

Total cost
per value
Investment in
innovation and
substitution
Cumulative
volume
labor/capital

2
Experience curve: insight on competitive advantage
Company versus industry level

Steam turbine production cost example

Direct cost per megawatt (constant $)

380

350 95% slope

320 Allis Chalmers

Westinghouse
General Electric
290

260
0 25 50 75 100

Firm cumulative megawatts

Source: BCG analysis

3
The BCG portfolio matrix
Portfolio strategy on product level

High
Stars Question marks

?
Cash
Market growth use
Cash cows Dogs

Low
Cash generation
High Low
Relative
market share

4
 The BCG portfolio matrix
How it works

20
Capital employed,
or revenue as a
15 proxy for size

10

Real market
growth
5
(%)

0
Deflated monetary
CAGR(1) over
Positive cash
several years
-5 generation
Negative cash
generation
-10
Logarithmic scale,
10 1 0,1
from right to left
Relative market share
In comparison to the largest
player (by market segment)
(1) Cumulative Annual Growth Rate
5
Implications of early concepts

Business unit strategy Corporate portfolio management

Aggressively add capacity during High share means high cash return in
growth phase of new business long run

Cut price to maximize share Corporations should target market

leadership in each business/segment
Fund negative cash flow or exit

Rewards will accrue in end game as Profit margins irrelevant when share
growth slows is changing rapidly

Choose battles you can win and a

number you can afford

Applicability depended on careful definition of a business/segment

6
 Illustration

The matrix helps analysing a portfolio of activities...

BIC USA (1976) Gillette USA (1976)

? ?
Disposable
lighter
Disposable
razor Disposable
Disposable razor
lighter

Writing

Blade
and razor
Writing
Toilette

A useful overview to define a strategic plan

7
 Illustration

...And decide on strategic resource allocation

Take actions
Grow the market
Invest, reposition,
Invest Gillette 19761979 or abandon
?
1977
1976
Disposable Disposable
razor lighter
33
1979

Development of the
Writing
disposable razor
3
100

18
Blade and razor
Cash generation
Toilette Cash use

43
"Milk" position Dividends Abandon, divest,
Protect position or harvest
8
Strengths and limits of BCG portfolio matrix

Strengths Limits

Quick synthetic diagnostic tool Does not provide ready-made answer

Competitive position Is a starting point rather than an answer
Cash flow control
Provides a static image of competitive
Widely known and understood framework position

Data are relatively easy to find or estimate Focused on cost competitiveness based on
Think twice about market boundaries costs rather than differentiation

Helps to talk about different BUs in Does not take intrinsic business risk into
comparison of positioning account

It should only be a starting point

for strategic discussion

9
BCG approach to Corporate Portfolio Management today
Overview

Corporate context Corporate

Company starting implementation
point Alternative Financial and
Top-down

Corporate feasible portfolio investor

aspirations development strategy
options Corporate
initiatives
Portfolio Portfolio
evaluation strategy
Achievement BU portfolio
of corporate roles
Baseline objectives Options Portfolio Implementation
Protection of development
portfolio
balance
Portfolio review BU
Market-based implementation
view BU strategic
Bottom-up

Alternative
Value-based view planning
strategic options
Resources-based Financial
for the individual
view performance
BUs
targets

Source: BCG
10
BCG approach to Corporate Portfolio Management today
Agenda

Corporate context Corporate

Company starting implementation
point Alternative Financial and
Top-down

Corporate feasible portfolio investor

aspirations development strategy
options Corporate
initiatives
Portfolio Portfolio
evaluation strategy
Achievement BU portfolio
of corporate roles
Baseline objectives Options Portfolio Implementation
Protection of development
portfolio
balance
Portfolio review BU
Market-based implementation
view BU strategic
Bottom-up

Alternative
Value-based view planning
strategic options
Resources-based Financial
for the individual
view performance
BUs
targets

Source: BCG
11
Market-based view: What is the strategic potential
of the businesses in the portfolio?

Market attractiveness
Market size
Market growth
Industry profitability
Competitive dynamics
Entry barriers
Industry trends

Competitive position
Relative market share
Relative profitability
Fulfillment of success factors

Source: BCG
Business Unit (invested assets in B) 12
 BCG project example
Assessment of strategic potential
is frequently summarized with a simple scoring model

Scale
Criteria Metrics Weighting
1 2 3 4 5

Sales in
Market size
(2010)
25% < 500M < 1,000M < 5,000M < 10,000M > 10,000M

Average EBIT / Sales

Market profitability 25% < 2% < 4% < 6% < 10% > 10%
Market (2010)
attrac-
tiveness Growth rate
Market growth 25% < 0% < 2% < 4% < 6% > 6%
(2006-2010)

Top 5 trends Very Very

Market trends 25% Negative Neutral Positive
(impact on client) negative positive

Relative market share

Market share 25% < 0.2 < 0.4 < 0.6 < 1.0 > 1.0
(2010)

EBIT margin vs. market

Relative profitability 25% < - 6% < -2% < +2% < +6% > +6%
Compe- average (2010)
titive
position Growth rate vs. market
Relative growth rate 25% < -4% < -2% < 0% < +2% > +2%
(2006-2010)

Performance vs.
Fulfillment of key
competitors along top 5 25% << < = > >>
success factors
success factors

Source: BCG project example

13
 BCG project example
Assessments are supported by a set of pre-defined
analyses for each SBU

Market
attractiveness
Market size Market growth Market Market risk Market trends
profitability

Competitive
position
Market share Offer and cost Key success
position factors

Revenues by Sales drivers EBITA by Profitability

segment segment drivers
Financial
performance

Cash flows Major investment Planned value + additional free-format

projects creation
analyses and backups
Source: BCG project example
14
Value-based view: How does strategic potential translate
into financial value creation?

Current return on capital 22

(e.g., Cash Flow ROI or
ROCE in 2011 in %) 20

18

16

14 Cost of capital

12

10

6
-10 0 10
Planned value creation
(e.g., iTSR 20112015 in %)

Source: BCG
Business Unit (invested assets in B) 15
Financial health matrix a diagnostic tool BCG Project Example

defines the questions, does not give "answers"

Large legacy businesses with

shrinking end-markets
Newly acquired businesses
Can we leverage the advantage benefiting from distribution synergies
elsewhere or rethink the
business to arrest decline? Why can't we grow this faster? Is
there an acquisition that will
Financial health

2013 ROGI accelerate? How can we "win it all"?

40 Unhealthy businesses in
"turnaround mode"

30 Are we confident in the

urgency and robustness of
the plan? What is the
endgame?
20

10

Cost of capital
1
0 Legacy business with weak
turnaround plan

-10 Is this worth the effort? What's the

logic for us owning? Who would
-10 0 10 20 30 40 50
want to buy it; for what ?
2013-2017 TBR
Value creation

Source: BCG analysis

16
Resource-based view: What is the ownership advantage from
parent characteristics and linkages between the businesses?

Parent advantage
Central expertise and
experience
Central functions and
services
Cheap internal or
external financing
A strong corporate
brand
Good governmental
relationships
...

Linkage advantage
Sales synergies
Operational synergies
Managerial synergies
...
Source: BCG
Business Unit (invested assets in B) 17
 BCG project example

Parenting advantage quick check

Assessment of the net corporate value added for each SBU

Value added by the corporate center Value destruction by the corporate center

To which extent does the SBU benefit from the To which extent does the SBU suffer from the following
following potential sources of corporate value added? potential sources of value destruction by the center?

Strategic direction 1 2 3 4 5 Weak understanding of SBU 1 2 3 4 5

(e.g., overall vision) success factors
Efficient allocation of resources 1 2 3 4 5 Conflicts of interests between 1 2 3 4 5
(e.g., capital) center and SBU
Improved operations 1 2 3 4 5 Insufficient investment budgets 1 2 3 4 5
(e.g., perf. monitoring)
Strategic expertise 1 2 3 4 5 Missing pressure from 1 2 3 4 5
(e.g., planning methods) capital markets
Central assets/capabilities 1 2 3 4 5 Low motivation from little 1 2 3 4 5
(e.g., brands) execution autonomy
Bundled functions 1 2 3 4 5 Expensive services 1 2 3 4 5
(e.g., accounting, IT) (i.e., overhead charges)
Financial benefits 1 2 3 4 5 High indirect costs 1 2 3 4 5
(e.g., debt funding, tax) (e.g., central reporting)
HR benefits 1 2 3 4 5 Slow decision-making 1 2 3 4 5
(e.g., access to talent) (e.g., processes)

Overall Net corporate value added -30% -20% -10% 0% +10% +20% +30%

assessment Is there a significantly better other owner (parenting perspective)? Yes No

Source: BCG project example

18
 BCG project example
Mapping the different kinds of linkages between
the businesses in the portfolio

Technology platform

100 100 100 100 100

1st platform Integrated materials
200 200 end-user
end-user industry 1 network
AG S T R AD O J industry 3
Shared technological
100 100 300 100 and production
2nd platform 100 200 200 400 200 competencies
AQ AO I X AC(1) E
100 100 Q L AB
3rd platform Shared customer
end-user and/or
industry 2 Y XXX AI
application expertise
100
4th platform 400 200 300 300
600 300
Supply relationship
AF P W G B
AE N
100 200
Shared end-user
100
300
industry
K
F D J V

100
5th platform 300
K
A H

800
XXX 100
Weak links to 100 200
K 100 200
other business 700 500 400 300
AH C AR
AN Z U
AL AA M

Met return target, stable or Return target achievable/ Realization of return target
further potential deterioration possible not possible

Source: BCG project example

19
 BCG project example

Strategic conclusions require an integrated view

Example: SBU 1 of a multi-business firm

Strategic perspective Financial perspective Ownership perspective

Dominant competitive position Very weak financial Strong synergies with a number
in a mature and strongly performance and no significant of other businesses in the
consolidated market improvement planned portfolio

Parenting
advantage
attractiveness
Market

on capital
Current return

Competitive Planned value Linkage

position creation advantage

Develop a convincing turnaround plan

Strategic
Manage more consequently as cash cow
conclusions
Reduce linkages to other businesses (arm's length transactions)
Source: BCG project example
20
How do you recognize a good portfolio?

Sure, it consists of "good" businesses

"Good on a standalone basis": Strong competitive positions in attractive markets

"High value creation (potential)": Significant value creation planned, based on plausible assumptions

"Good for us as an owner": Positive net corporate value added (best owner?)

But there is more to a good portfolio ("the system perspective")

The individual businesses in the portfolio can be developed for their maximum value creation

The portfolio enables the company to achieve its (short- and long-term) goals

The portfolio is balanced with respect to key strategic trade-offs

CPM is not limited to a review of the businesses in the

portfolio; it's about how they fit together
Source: BCG
22
Is the balance of the portfolio consistent with objectives?
Potential balance criteria

Balance of value contributions of the individual businesses

"Don't put all eggs in one basket"

Balance between cash generation and cash consumption

"Don't live beyond your means"

Balance between risk and return

"There is nothing like a free lunch"

Balance between short-term and long-term value creation

"A bird in the hand and two in the bush"

Balance between exploiting existing capabilities and developing new capabilities

"Don't forget to re-charge the battery"

Balance will mean very different things to different

companies in different situations
Source: BCG
23