Chapter 4

Strategy Formulation Models

1
 Chapter Content

4.1 Portfolio Decision Models

BCG Matrix
GE Metrix
4.2 Operational Level Decision Models
Porter’s Five Forces Analysis
Generic Strategies
Ansoff’s Matrix

2
 Portfolio Decision Model
• Once an organization’s SBUs are identified,
strategic planning can be carried out for each.
However, care must be exercised to ensure
that the activities of each SBU are interrelated
to the corporate level objectives and purpose.

3
 BCG Matrix
• The Boston Consulting Group (BCG), a well-known
consulting organization, has developed an approach to
strategic planning that permits classifying SBUs on the
basis of their relative market share and market growth
rate.
• Developed in 1968 by Bruce Henderson
• This approach, depicted in Figure 4.1, permits
development of strategies for each SBU based on its
classification within the matrix.
• The vertical axis shows annualized market growth rates
for each SBU in its respective market. The division of
high-low rates at 10 percent represents the midpoint of
4
the range of growth rates for SBUs under consideration.
 Cont’d….
• The horizontal axis shows the market share of each SBU in
relation to the industry leaders. Thus it is relative market
share and not absolute market share.
• If relative market share for an SBU is 1.5, that SBU is the
market leader and its share is one and a half times greater
than the next closest competitor.
• A relative market share of .8 would indicate that the SBU’s
market share was 80 percent of the market leader’s share.
Relative market share places each SBU in relation to the
leader and provides more information about market position
than absolute market share. The 1.0x division is the generally
accepted point for separating SBUs into high-low relative
market shares.
• The size of each circle in the figure represents the
proportional dollar contribution of each SBU to total
company sales. The larger the circle, the larger the SBU’s
contribution to total company sales.
5
 FIGURE 4.1.
Boston Consulting Group Business Portfolio Matrix

(Source: Adapted from B. Hedley, “Strategy and the Business Portfolio,” Long Range Planning, February 1977, p. 12.)
6
 Cash cows
• 1. Cash cows —A cash cow is an SBU with a high
relative market share compared to other
competitors in the market, but it is in an industry
that has a low annual growth rate.
• These SBUs generate more than enough cash to
cover operating expenses, and their growth rate
does not warrant large investments in that
industry.
• The cash generated can therefore be used to
support other SBUs which offer more potential for
growth.
– May be for stars and problem children/question marks 7
 Stars
• 2. Stars—Stars are SBUs that have a high
relative market share and are also in an
industry with expected high rates of growth.
• Stars usually have a high demand for cash to
finance their growth.

8
 Problem children
• 3. Problem children —Problem children are
SBUs that have a low relative market share but
are in industries with a high annual rate of
growth.
• The potential exists for them to become stars
but their low relative share represents a major
challenge to management to create strategies
capable of increasing relative market share

9
 Dogs
• 4. Dogs—Dogs are SBUs that not only have
low relative market share but also are in
industries with low growth potential.
• They may not be operating at a loss but they
generate only enough cash to maintain their
operations and market share.

10
 Cont’d…
• Classifying a company’s SBUs into such a matrix
helps define the current position of each SBU
and also suggests strategic options for
management to improve performance.
• Although the position of an SBU will change over
time because of changes in growth rates or
market composition, the following four strategic
actions are implied for the four cells:
– (1) “milk” the cows,
– (2) “shine” the stars,
– (3) “solve” the problems, and
– (4) “divest” the dogs.
11
 Cont’d…
• 1. “Milk”the cows —The strategy for cash cows is to spend
enough on them to maintain their market share and “keep
them healthy” so they can continue to generate cash.
• 2. “Shine” the stars —The strategy for stars is to continue to
invest funds to support their growth rate and high market
shares. They will eventually slow in growth and become cash
cows and help generate funds for new stars.
• 3. “Solve” the problems —The strategy for these SBUs
involves one of two options:
(a) develop and test strategies for improving market share,
(b) divest and use the cash to support other more promising
SBUs.
• 4. “Divest” the dogs —Dogs SBUs with low share and low
growth potential are prime prospects for divestiture. Cash
generated by divesting these SBUs can be reinvested into
other SBUs with more potential. 12
 Pros of the Boston matrix
➡ It is an easy-to-use guide that helps managers
to think about the investment needs of a
portfolio of businesses
➡ It provides a useful basis for thinking about
priorities across a spread of activities

13
 Cons of the Boston matrix
➡ It is a guide to investment rather than strategy
➡ It rests on the implicit assumption that business planning is driven by just
two factors, growth rate and market share, and in doing this ignores the
spectrum of factors that influence profitability, such as competitive
intensity, competitive advantage and customer needs
 market growth is not only indicator of attractive market
➡ Cash flow is seen to be dependent upon market growth and market
share. In practice, this is not necessarily the case. Eg. Margins
 High market share does not necessarily lead to profitability
➡ Market share is rarely as easily defined as the model suggests. With the
erosion of geographic boundaries and the emergence of a radically
different competitive environment, share is often far more fluid and
difficult to measure.
 Problems of getting data on relative market share and market growth
➡ The model fails to come to terms with the nature of the strategy and
form of competitive advantage that will lead to success 14
 The Business Screen
• An alternative matrix approach has been
developed by General Electric with the help of the
consulting firm of McKinsey & Company.
• This matrix is based on two dimensions: long-
term industry attractiveness and the business
strength/competitive position of the firm in the
industry.
• Known also as 9 cell matrix
• This matrix is shown in Figure 4.2. The “red,
yellow, and green” areas each represent different
combinations of industry attractiveness and
company strength/position. 15
 Cont’d…
• The “red” zone represents SBUs of low to medium industry
attractiveness and average to weak business
strength/position.
• These are prime candidates for harvesting or divestment
unless some type of turnaround strategy is developed.
• The “yellow” zone consists of the three diagonal cells
stretching from the lower left to the upper right.
• These SBUs warrant only a medium investment allocation
and the strategy is usually “hold and maintain”
• The “green” zone represents SBUs that are in the most
attractive industries where the company has relatively
favorable strength/ position. These SBUs are in the highest
investment priority. The strategy for these SBUs is “grow
and build.” 16
FIGURE 4.2 The Business Screen

17
 Cont’d…
• Although considerably more time and effort is
needed to collect the data and rank each
business using the GE approach, the results are
much more detailed in terms of strategy
implications. This approach allows for
intermediate rankings of firms on the two
dimensions and clearly identifies the SBUs
which should be built and those which should
be harvested or divested.

18
 Pros and Cons Of GE
 One advantage of the GE approach is that it allows for more
classifications of SBUs including a medium range. It also
involves analysis of many factors to evaluate business
strength and industry attractiveness and not just market share
and industry growth rates.
 The detail and richness of this type of analysis provide a more
in-depth perspective of an SBU’s current position.
 Eg. Market attractiveness( external factors)
 Size of the market
 Expected growth of the market
 Matters of competition
 Entry barriers
 Eg. business attractiveness or company position( internal factors)
 Relative market share
 Growth of share
 Brand awareness
 Mission, vision and effective strategy
 Strength and weakness
 Current financial position

19
 Cons of GE
• This matrix approach, like all such approaches,
yields only general strategy implications.
Detailed strategies must be developed for
each SBU. For example, an SBU in the grow
and build green zone would still require a
specific strategy

20
 4.2 Operational Level Decision Models

4.2.1 Porter’s Five Forces Analysis

• Porter’s five forces framework is rooted in
microeconomics
• Michael Porter’s Five-Forces framework
identifies the economic forces that affect
industry profits

21
Porter’s ‘Five Forces’ analysis

22
 Internal Rivalry
• Internal rivalry is the competition for market share
among the firms in the industry
• Competition could be on price or some non-price
dimension
• Price Competition erodes the price cost margin
and profitability
• Competition on non-price dimension can drive up
costs.
• Non-price competition does not erode profits as
severely as price competition if customers are
willing to pay a higher price for the improvements.
23
 Entry
• Entry hurts the incumbents by
– by cutting into the incumbents’ market share and
– by intensifying internal rivalry and leads to a
decline in price cost margin

24
 The factors that limit new entrants are:
• How loyal are consumers in the industry?
• How difficult it is for the consumer to switch to the new
product?
• How large is the amount of capital required to enter
into the industry?
• How difficult it is to access distribution channel?
• How hard it is to acquire new skills for the staff?
• economies of scale,
• Likely retaliation of existing competitors,
• the existence of government regulation and legal
limitations

25
 Threat of substitutes
• Substitutes are the products or services that
provide the same functionality. A successful
product leads to creating other similar products.

For example, Google+ and Facebook both are social platforms the
consumers use for socializing. They provide similar features such
as posts, chat, share text, graphics and media content, forming
groups, etc.
26
Substitute threat is high Substitute threat is low
when… when…
Products of the company Products of the company are
are not differentiated. differentiated.

Products are costly. Products are inexpensive.

Consumer’s brand loyalty is Consumer’s loyalty is high.

low.
Cheaper parallel products No cheaper parallel products are
of the same category are available.
available.

27
 Cont’d…..

• While entering into the business, one should think

of:
How many near substitutes are available in the
market?
What is the price of the substitute?
What is the consumer perception about those
substitutes?
• By advertising, marketing, and investing in R&D
for the product or service, a business can
elevate its position in the industry.
28
 Bargaining power of suppliers
• Supplier power is likely to be high when there is a
– concentration of large suppliers with strong established
brands.
– High industry demand to suppliers
– A high cost of switching from one supplier to another
increases power, as does technological ‘tie-in’.
– likelihood of forward integration in the marketing channel.

29
 Bargaining power of buyers
• Buyer power is clearly likely to be high when there is a
– concentration of buyers and volume of purchases is high, and
– where the goods being bought are difficult to differentiate in
the eyes of the end customer.
– The amount of information possessed by buyers has also a
significant impact on their bargaining power.
– potential for buyers to integrate backwards in the distribution
channel.

30
 Generic Strategy Picture
Porter's Generic Strategies
Advantage
Target Scope
Low Cost Product Uniqueness

Cost Leadership Differentiation

Broad
(Industry Wide) Strategy Strategy

Narrow
(Market
Segment) Focus Focus
Strategy Strategy
(low cost) (differentiation)

31
 Cost Leadership Strategy
• Firms that succeed in cost leadership often have the following
internal strengths:
– Access to the capital required to make a significant
investment in production assets; this investment represents a
barrier to entry that many firms may not overcome.
– Skill in designing products for efficient manufacturing, for
example, having a small component count to shorten the
assembly process.
– High level of expertise in manufacturing process engineering.
– Efficient distribution channels.
• Risks
– For example, other firms may be able to lower their costs as
well. As technology improves, the competition may be able to
leapfrog the production capabilities, thus eliminating the
competitive advantage.
– Additionally, several firms following a focus strategy and
targeting various narrow markets may be able to achieve an
even lower cost within their segments and as a group gain
significant market share. 32
 Differentiation Strategy
• Firms that succeed in a differentiation strategy often
have the following internal strengths:
– Access to leading scientific research.
– Highly skilled and creative product development team.
– Strong sales team with the ability to successfully
communicate the perceived strengths of the product.
– Corporate reputation for quality and innovation.
• Risks
– include imitation by competitors and changes in customer
tastes.
– Additionally, various firms pursuing focus strategies may
be able to achieve even greater differentiation in their
market segments.
33
 Focus Strategy
• Concentrates on a narrow segment and within that segment attempts
to achieve either a cost advantage or differentiation.
– The premise is that the needs of the group can be better serviced
by focusing entirely on it.
– A firm using a focus strategy often enjoys a high degree of
customer loyalty, and this entrenched loyalty discourages other
firms from competing directly.
• Because of their narrow market focus, firms pursuing a focus strategy
have lower volumes and therefore less bargaining power with their
suppliers.
• However, firms pursuing a differentiation- focused strategy may be
able to pass higher costs on to customers since close substitute
products do not exist.
• Firms that succeed in a focus strategy are able to tailor a broad range
of product development strengths to a relatively narrow market
segment that they know very well.
• Risks
– include imitation and changes in the target segments.
Furthermore, it may be fairly easy for a broad-market cost leader
to adapt its product in order to compete directly. Finally, other
focusers may be able to carve out sub-segments that they can
serve even better.
34
 Ansoff’s Matrix
• This matrix was developed by Igor Ansoff
• It is a framework for identifying corporate growth
opportunities
• Two dimensions determine the scope of options;
namely products and markets
• Four generic growth strategies are identified:
– Market penetration: more of the same to the same
customers
– Market development: new customers for existing products
– Product development: new products for existing
customers
– Diversification: new products and new customers

35
 Ansoff’s Matrix
Existing product New product

Existing Market penetration Product development

market Increase sales to the New product developed for
existing market existing markets
Penetrate more deeply
into the existing market
New market Market development Diversification
Existing products sold to New products sold in new
new markets markets
 Ansoff’s matrix and risk
• The greater the degree of newness the greater
the risk
Hence:
• Market penetration - little risk involved
• Market development - moderate risk
• Product development - moderate risk
• Diversification - high risk because both product
and market are new and unknown
37
 Market Penetration
• Aim of the strategy:
– To maintain or increase share of the current market with current
products
– To secure dominance of a growth market or restructure a mature
market by driving out competition
• Market penetration involves an increase in sales of existing
products to existing markets - selling more of the same to the
same people
• But it is difficult to achieve growth through increased market
penetration if the market is saturated
• In a stagnating market increase in sales is only possible by
grabbing market share from rivals. Hence competition will be
intense in such markets
• Risks are low but the prospects of success are low unless
there is strong growth in the market

38
 Market penetration strategies
• How is increased market penetration
achieved?
– Increase usage by existing customers
– Attract customers away from rivals
– Gain market share at the expense of rivals
– Encourage increase in frequency of use
– Devise and encourage new applications
– Encourage non buyers to buy
• Market penetration requires realignment of
the marketing mix

39
 Use market penetration when...
• The market is not saturated
• There is growth in the market
• Competitors’ share of the market is falling
• Increased volumes lead to economies of scale
• There is scope for selling more to existing
customers

40
 Market development
• This involves
– Selling the same product to different people
– Entering new markets or segments with existing products
– Gaining new customers, new segments, new markets
– Entering overseas markets
• Market development will require changes to
marketing strategy e.g. new distribution channels,
different pricing policy, new promotional strategy to
attract different types of customers

41
 Market development
• Market development is used when…
– Untapped/unused markets are beckoning
– The firm has excess capacity
– There are attractive channels to access new
market
• Market development involves moderate risk -
there is a lack of familiarity with customers
but at least the product is familiar

42
 Product development
• This is the development of new products for
the existing market
• New products come in the form of:
– New products to replace current products
– New innovative products
– Product improvements
– Product line extensions
– New products to complement existing products
– Products at a different quality level to existing
products

43
 Product development
• Product development is used when:
– The Firm has strong R&D capabilities
– The market is growing
– There is rapid change
– The firm can build on existing brands
– Competitors have better products
• But new product development is costly and
there are moderate risks associated with this
strategy

44
 Diversification
• Diversification in the Ansoff Matrix means:
– New products sold to new markets
– New products for new customers
• It is a risky strategy because it involves two unknowns
• Therefore new products and new markets should be selected
which offer the prospect for growth which the exiting product
market mix does not
• One problem is to identify real life examples of firms
developing new products for genuinely new groups of
customers

45
 The End

Thank you
46