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.

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. 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. The lines dividing the matrix into four quadrants are arbitrary. Usually, high growth is taken to include all businesses growing in excess of 10 percent annually in volume. The line separating areas of high and low relative competitive position is set at 1.0. The importance of growth variables for strategy development is based on two factors. First, growth is a major influence in reducing cost because it is easier to gain experience or build market share in a growth market than in a low-growth situation. Second, growth provides opportunity for investment. The relative market share affects the rate at which a business will generate cash. The stronger the relative market share position of a product, the higher the margins it will have because of the scale effect.

Stars. High-growth market leaders are called stars. They generate large amounts of cash, but the cash they generate from earnings and depreciation is more than offset by the cash that must be put back in the form of capital expenditures and increased working capital. Such heavy reinvestment is necessary to fund the capacity increases and inventory and receivable investment that go along with market share gains. Thus, star products represent probably the best profit opportunity available to a company, and their competitive position must be maintained. If a star’s share is allowed to slip because the star has been used to provide large amounts of cash in the short run or because of cutbacks in investment and rising prices (creating an umbrella for competitors), the star will ultimately become a dog. The ultimate value of any product or service is reflected in the stream of cash it generates net of its own reinvestment.

For a star, this stream of cash lies in the future sometimes in the distant future. To obtain real value, the stream of cash must be discounted back to the present at a rate equal to the return on alternative opportunities. It is the future payoff of the star that counts, not the present reported profit. For GE, the plastics business is a star in which it keeps investing. As a matter of fact, the company even acquired Thomson’s plastics operations (a French company) to further strengthen its position in the business.

Cash Cows. Cash cows are characterized by low growth and high market share. They are net providers of cash. Their high earnings, coupled with their depreciation, represent high cash inflows, and they need very little in the way of reinvestment. Thus, these businesses generate large cash surpluses that help to pay dividends and interest, provide debt capacity, supply funds for research and development, meet overheads, and also make cash available for investment in other products. Thus, cash cows are the foundation on which everything else depends. These products must be protected. Technically speaking, a cash cow has a return on assets that exceeds its growth rate. Only if this is true will the cash cow generate more cash than it uses. For NCR Company, the mechanical cash register business is a cash cow. The company still maintains a dominant share of this business even though growth has slowed down since the introduction of electronic cash registers. The company uses the surplus cash from its mechanical cash registers to develop electronic machines with a view to creating a new star. Likewise, the tire business can be categorized as a cash cow for Goodyear Tire and Rubber Company. The tire industry is characterized by slow market growth, and Goodyear has a major share of the market.

Question Marks. Products in a growth market with a low share are categorized as question marks. Because of growth, these products require more cash than they are able to generate on their own. If nothing is done to increase market share, a question mark will simply absorb large amounts of cash in the short run and later, as the growth slows down, become a dog. Thus, unless something is done to change its perspective, a question mark remains a cash loser throughout its existence and ultimately becomes a cash trap. What can be done to make a question mark more viable? One alternative is to gain share increases for it. Because the business is growing, it can be funded to dominance. It may then become a star and later, when growth slows down, a cash cow. This strategy is a costly one in the short run. An abundance of cash must be poured into a question mark in order for it to win a major share of the market, but in the long run, this strategy is the only way to develop a sound business from the question mark stage. Another strategy is to divest the business. Outright sale is the most desirable alternative. But if this does not work out, a firm decision must be made not to invest further in the business. The business must simply be allowed to generate whatever cash it can while none is reinvested. When Joseph E. Seagram and Sons bought Tropicana from Beatrice Co. in 1988, it was a question mark. The product had been trailing behind Coke’s Minute Maid and was losing ground to Procter & Gamble’s new entry in the field, Citrus Hill. Since then, Seagram has invested heavily in Tropicana to develop it into a star product. After just two years, Tropicana has emerged as a leader in the notfrom- concentrate orange juice market, far ahead of Minute Maid, and has been trying to make inroads into other segments.

Dogs. Products with low market share positioned in low-growth situations are called dogs. Their poor competitive position condemns them to poor profits. Because growth is low, dogs have little potential for gaining sufficient share to achieve viable cost positions. Usually they are net users of cash. Their earnings are low, and the reinvestment required just to keep the business together eats cash inflow. The business, therefore, becomes a cash trap that is likely to regularly absorb cash unless further investment is rigorously avoided. An alternative is to convert dogs into cash, if there is an opportunity to do so. GE’s consumer electronics business had been in the dog category, maintaining only a small percentage of the available market in a period of slow growth, when the company decided to unload the business (including the RCA brand acquired in late 1985) to Thomson, France’s state-owned, leading electronics manufacturer.

Strategy Implications In a typical company, products could be scattered in all four quadrants of the portfolio matrix. The first goal of a company should be to secure a position with cash cows but to guard against the frequent temptation to reinvest in them excessively. The cash generated from cash cows should first be used to support those stars that are not self-sustaining. Surplus cash may then be used to finance selected question marks to dominance. Any question mark that cannot be funded should be divested. A dog may be restored to a position of viability by shrewdly segmenting the market; that is, by rationalizing and specializing the business into a small niche that the product may dominate. If this is not practical, a firm should manage the dog for cash; it should cut off all investment in the business and liquidate it when an opportunity develops. On the other hand, if a star is not appropriately funded, it may become a question mark and finally a dog (disaster sequence). Top management needs to answer two strategic questions: (a) How promising is the current set of businesses with respect to long-term return and growth? (b) Which businesses should be developed? maintained as is? liquidated? Following the portfolio matrix approach, a company needs a cash-balanced portfolio of businesses; that is, it needs cash cows and dogs to throw off sufficient cash to fund stars and question marks. It needs an ample supply of question marks to ensure long-term growth and businesses with return levels appropriate to their matrix position. In response to the second question, capital budgeting theory requires the lining up of capital project proposals, assessment of incremental cash flows attributable to each project, computation of discounted rate of return on each, and approval of the project with the highest rate of return until available funds are exhausted. But the capital budgeting approach misses the strategic content; that is, it ignores questions of how to validate assumptions about volume, price, cost, and investment and how to eliminate natural biases. This problem is solved by the portfolio matrix approach.