The BCG matrix, also known as the Boston growth-share matrix, is a tool to assess a company’s current product portfolio. Based on this assessment, the Boston matrix helps in the long-term strategic planning of the company’s portfolio, as it indicates where to invest, to discontinue or develop products. As the name suggests, the BCG matrix has been developed by the Boston Consulting Group, and it has become a very popular tool to assess a company’s portfolio and derive strategic investment decisions. But how does the BCG matrix work?
How does the BCG matrix work?
The BCG matrix assesses the company’s product portfolio by placing each product, division or SBU (strategic business unit) on a 2×2 grid. How does the BCG matrix work in detail? The placement of products on the grid is done by investigating two dimensions, which are the axes of the grid: the product life cycle and the experience curve. Since both criteria are rather hard to quantify, proxy values are used to illustrate these two dimensions. The product life cycle is reflected by market growth, and the experience curve is mirrored by the relative market share. These two values have to be identified for each product/division/SBU to place them on the grid. Based on the position of each product/division/SBU on the BCG matrix, investment or disinvestment decisions can be taken. The graphic below shows the BCG matrix.
The dimensions/axes of the BCG Matrix
How does the BCG matrix work? To understand this, you first need to understand what the BCG matrix actually shows. The two axes have been introduced before. On the vertical axis, the market growth rate provides a measure of the market’s attractiveness. On the horizontal axis, relative market share serves as a measure of the company’s strength in the market. By dividing the BCG matrix into four fields, four types of SBU can be distinguished. These are explained in detail below.
If you want or have to conduct a portfolio analysis using the BCG matrix, you need to know where to get these two numbers for each SBU. The market growth rate can easily be researched: usually, you will find plenty of data for almost every industry and market online. The relative market share is computed by dividing the company’s market share by the market share of the strongest competitor in that market: Relative market share = Company’s market share ÷ largest competitor’s market share.
How to use the BCG Matrix
Now that we have plotted the different products, divisions or SBUs on the BCG matrix, we need to know what to do next. So how does the BCG matrix work and help to derive strategic decisions?
To arrive at these decisions, we need to understand the four types of SBU that are distinguished by the Boston growth-share matrix.
Question marks are low-share business units in high-growth markets. They require cash to hold their share, let alone increase it. The company needs to think hard about question marks – which ones should be built into stars, and which ones should be phased out? Question marks have the following characteristics:
- Low relative market share in a relatively young but promising market (growing)
- Potential of becoming stars if the market share can be increased
- If necessary market share is not reached, question marks are likely to turn into dogs as soon as the market gets more mature
- Careful analysis is needed to determine whether to invest or not.
Stars are high-growth, high-share businesses or products. They often need heavy investment to finance their rapid growth. Eventually, their growth will slow down, and they will turn into cash cows. Stars have the following characteristics:
- High market share in a promising market
- To turn a star into a future cash cow, heavy investment is needed to fight competition and expand market share.
Cash cows are low-growth, high-share businesses or products. These established and successful SBUs need less investment to maintain their market share. As a result, they produce cash that the company uses to pay its bills and to support other SBUs that need investment. As we have learned, question marks and stars require heavy investment, which usually comes from the profitable cash cows. Cash cows have the following characteristics:
- High market share in a slowly growing or mature market
- Create the highest cash flow
- No further investment should be undertaken due to limited or non-existent growth potential
- The company should try to “milk” the cash cows as long as possible.
Dogs are low-growth, low-share businesses and products. They may generate enough cash to maintain themselves, but do not promise to be large sources of cash flow. Dogs have the following characteristics:
- Low relative market share in a slowly growing or declining market
- Products do mostly not generate large profit and may usually just break even
- The company should divest dogs, as these products have a negative effect on the overall profitability of the company. Instead of carrying dogs along, the company should better focus on products or SBUs with greater potential.
The ideal circle of the BCG matrix
The ideal situation as suggested by the BCG matrix is the following: The company invests in promising Question marks to turn them into Stars. By further investing, Stars are turned into Cash cows. The company harvests all the cash until the Cash cows eventually turn into dogs. At that point, the company divests the product or SBU and focuses on more profitable opportunities.
The table below summarizes the characteristics of the four types of SBUs in the BCG matrix and shows the strategic implications for the company’s long-term planning.