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8 - Dlagnoslng the Product Portfollo I 29 George S Day...

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Unformatted text preview: Dlagnoslng the Product Portfollo I 29 George S. Day Diagnosing the Product Portfolio How to use scarce cash and managerial resources for maximum long-run gains HE PRODUCT portfolio approach to marketing strategy formulation has gained wide accep- tance among managers of diversified companies. They are first attracted by the intuitively appealing concept that long-run corporate performance is more than the Sum of the contributions of individ— ual profit centers or product strategies. Secondly. a product portfolio analysis suggests specific market- ing strategies to achieve a balanced mix of products that will produce the maximum long-run effects from scarce cash and managerial resources. Lastly the concept employs a simple matrix representation which is easy to communicate and comprehend. Thus it is a useful tool in a headquarters campaign to demonstrate that the strategic issues facing the firm justify more centralized control over the plan- ning and resource allthation process. With the growing acceptance of the basic ap- proach has come an increasing sensitivity to the limitations of the present methods of portraying the product portfolio, and a recognition that the ap- proach is not equally useful in all corporate circum- stances. Indeed, the implications can sometimes be grossly misleading. Inappropriate and misleading applications will result when: ° The basic assumptions (especially those con- cerned with the value of market share domi- nance and the product life cycle) are violated. ° The measurements are wrong, or ' The strategies are not feasible. This article identifies the critical assumptions and the measurement and application issues that may About the Author GEORGE 8. DAY is Professor of Marketing. University of Toronto. distort the strategic insights. A series of questions are posed that will aid planners and decision- makers to better understand this aid to strategic thinking, and thereby make better decisions. What Is the Product Portfolio? Common to all portrayals of the product portfolio is the recognition that the competitive value of market share depends on the structure of competition and the stage of the product life cycle. Two examples of this approach have recently appeared in this jour- nai.1 However, the earliest, and most widely im- plemented is the cash quadrant or sharelgrowth ma- trix developed by the Buston Consulting Group.2 Each product is classified jointly by rate of present or forecast market growth (a proxy for stage in the product life cycle) and a measure of market share dominance. The arguments for the use of market share are familiar and well docunrtented.a Their basis is the cumulation of evidence that market share is strongly and positively correlated with product profitability. This theme is varied somewhat in the ECG approach by the emphasis on relative share—measured by the ratio of the company's share of the market to the share of the largest com- petitor. This is reasonable since the strategic impli- cations of a 20% share are quite different if the largest competitor’s is 40% or if it is 5%. Profi tabil- ity will also vary, since according to the experience curve concept the largest competitor will be the most profitable at the prevailing price level.4 The product life cycle is employed because it highlights the desirability of a variety of products or services with different present and prospective growth rates. More important, the concept has some direct implications for the cost of gaining andlor holding market share: 30 I Journal of Marketlng, April 1977 y During the rapid growth stage, purchase pat- terns and distribution channels are fluid. Market shares can be increased at “relative- ly" low cost by- capturing a disproportionate share of incremental sales (especially where these sales come from new users of applica- tions rather than heavier usage by existing users). D By contrast, the key-note during the matur- ity stage swings to stability and inertia in distribution and purchasing relationships. A substantial growth in share by one com- petitor will come at the expense of another competitor's capacity utilization, and will be resisted vigorously. As a result, gains in share are both time-consuming and costly (unless accompanied by a breakthrough in product value or performance that cannot be easily matched by competition). Product Portfolio Strategies When the share and growth rate of each of the products sold by a firm are jointly considered, a new. basis for strategy evaluation emerges. While there are many possible combinations, an arbi- trary classification of products into four share! growth categories (as shown in Exhibit 1) is sufficient to illustrate the strategy implications. Low Growtthominant Share (Cash Cows) These profitable products usually generate more cash than is required to maintain share. All strat- egies should be directed toward maintaining mar ket dominance—including investments in techno- logical leadership. Pricing decisions should be made cautiously with an eye to maintaining price leadership. Pressure to over-invest through prod- uct proliferation and market expansion should be resisted unless prospects for expanding primary demand are unusually attractive. Instead, excess cash should be used to support research activities and growth areas elsewhere in the company. High Growtthominant Share (Stars) Products that are market leaders, but also growing fast, will have substantial reported profits but need a lot of cash to finance the rate of growth. The appropriate strategies are designed primarily to protect the existing share level by reinvesting earnings in the form of price reductions, product improvement, better market coverage, production efficiency increases, etc. Particular attention must be given to obtaining a large share of the new users or new applications that are the source of growth in the market. Low GrowthJSubordinate Share (Dogs) Since there usually can be only one market leader and because most markets are mature, the grEatest number of products fall in this category. Such products are usually at a cost disadvantage and have few opportunities for growth at a reasonable cost. Their markets are not growing, so there is little new business to compete for, and market share gains will be resisted strenuously by the dominant competition. The slower the growth (present or prospec~ tive) and the smaller the relative share, the greater the need for positive action. The possibilities in— clude: 1. Focusing on a specialized segment of the market that can be dominated, and protected from competitive inroads. 2. Harvesting, which is a conscious cutback of all support costs to some minimum level which will maximize the cash flow over a foreseeable lifetime—which is usually short. 3. Divestment, usually involving a sale as a going concern. 4. Abandonment or deletion from the product line. High Growth/Subordinate Share (Problem Children) The combination of rapid growth and poor profit margins creates an enormous demand for cash. If the cash is not forthcoming, the product will be- come a “Dog" as growth inevitably slows. The basic strategy options are fairly clear-cut; either invest heavily to get a disproportionate share of the new sales or buy existing shares by acquiring competitors and thus move the product toward the "Star” category or get out of the business using some of the methods just described. Consideration also should be given to a market segmentation strategy, but only if a defen- sible niche can be identified and resources are available to gain dominance. This strategy is even more attractive if the segment can provide an en- trée and experience based from which to push for dominance of the whole market. Overall Strategy The longer-on health of the cOrporation depends on having some products that generate cash (and provide acceptable reported profits), and others that use cash to support growth. Among the indi- cators of overall health are the size and vulnerabil— ity of the ”Cash Cows" (and the prospects for the "Stars," if any), and the number of "Problem Children" and ”Dogs." Particular attention must be paid to those products with large cash appe~ tites. Unless the company has abundant cash flow, it cannot afford to sponsor many such prod- ucts at one time. If resources (including debt capacity) are spread too thin, the company simply will wind up with too many marginal products and suffer a reduced capacity to finance promising new product entries or acquisitions in the future. The sharefgrowth matrix displayed in Exhibit 2 shows how one company (actually a composite of a number of— situations) might follow the strategic implications of the product portfolio to achieve a better balance of sources and uses of cash. The present position of each product is de— fined by the relative share and market growth rate during a representative time period. Since busi- ness results normally fluctuate, it is important to use a time period that is not distorted by rare events. The future position may be either (a) a momentum forecast of the results of continuing the present strategy, or (b) a forecast of the con- sequences of a change in strategy. It is desirable to do both, and compare the results. The specific display of Exhibit 2 is a summary of the following strategic decisions. 5 Aggressively support the newly introduced product A, to ensure dominance (but antici- pate share declines due to new competitive entries). F Continue present strategies of products B and C to ensure maintenance of market share. 5 Gain share of market for product D by in» vesting in acquisitions. 5 Narrow and modify the range of models of product E to focus on one segment. D Divest products 1-" and G. Pitfalls in the Assumptions The starting point in the decision to follow the implications of a product portfolio analysis is to ask whether the underlying assumptions make sense. The most fundamental assumptions relate Diagnosing the Product Portfolio 1 31 to the role of market share in the businesses being portrayed in the portfolio. Even if the an- swers here are affirmative one may choose to not follow the implications if other objectives than balancing cash flows take priority, or there are barriers to implementing the indicated strategies. What Is the Role of Market Share? All the competitors are assumed to have the same overhead structures and experience curves, with their position on the experience curve correspond- ing to their market share position. Hence market share dominance is a proxy for the relative profit performance (e.g., GM vs. Chrysler). Other factors beyond market share my be influential in dictat- ing absolute, profit performance (2.3., calculators versus cosmetics). The influence of market share is most appar- ent with high value—added products, where there are significant barriers to entry and the competi- tion consists of a few, large, diversified corpora- tions with the attendant large overheads (e.g., plastics, major appliances, automobiles, and semi-conductors). But even in these industrial en- vironments there are distortions under conditions such as: 0 One competitor has a significant technolog- ical advantage which can be protected and used to establish a steeper cost reduction:r experience curve. 0 The principal component of the product is produced by a supplier who has an inherent cost advantage because of an integrated pro- cess. Thus Dupont was at a cost disadvan- tage with Cyclohexane vis-a-vis the oil com- panies because the manufacture of the prod- uct was so highly integrated with the opera- tions of an oil refinery.5 o Competitors can economically gain large amounts of experience through acquisitions or licensing, or shift to a lower (but parallel) cost curve by resorting to off-shore produc- tion or component sourcing. 0 Profitability is highly sensitive to the rate of capacity utilization, regardless of size of plant. There are many situations where the positive profitability and share relationship becomes. very tenuous, and perhaps unattainable. A recent illus- tration is the building industry where large corporations—Chili with Larwin and HT with Levitt—have suffered because of their inability to adequately offset their high overhead charges 32 I Journal of Marketing. April 1977 EXHIBIT 1 The Cash Quadrant Approach to Describing the Product Portfolio- Cash generated case use N at Cash Hlflh. Market N at Growth Rate (annual rate in constant dollars relative to GNP growth) Net 10! generated it 5 Cash. Low generated Cash Use Cash 9 enerated Cash generated Cash Use High 1.0x Low .tx Market Share Dominance (Ratio of company share to share 01 largest competitor) 'Arrows indicate principal cash flows. with a corresponding reduction in total costs.‘ Similar problems are also encountered in the ser- vice sector, and contribute to the many reasons why services which are highly labor-intensive and involve personal relationships must be ap- proached wth extreme caution in a product port- folio analysis} There is specific evidence from the Profit Impact of Market Strategies (PIMS) study“ that the value of market share is not as significant for con— sumer goods as for industrial products. The rea- sons are not well understood, but probably reflect differences in buying behavior, the importance of' product differentiation and the tendency for pro- liferation of marginally different brands in these categories. The strategy of protecting a market po- sition by introducing line extensions, flankers, and spin-offs from a successful core brand means that product class boundaries are very unclear. Hence shares are harder to estimate. The individ- ual brand in a category like deodorants or pow- dered drinks may not be the proper basis for evaluation. A related consequence is that joint costing problems multiply. For example, Unilever in the UK has 20 detergent brands all sharing production facilities and marketing resources to some degree. When Do Market Shares Stabilize? The operating assumption is that shares tend to- ward stability during the maturity stage, as the dominant competitors concentrate on defending their existing position. An important corollary is that gains in share are easier and cheaper to achieve during the growth stage. There is scattered empirical evidence, includ— ing the results of the PIMS project, which sup- ports these assumptions. Several qualifications must be made before the implications can be pur- sued in depth: P While market share gains may be costly, it is pessible to mismanage a dominant position. The examples of AdrP in food retailing, and Diagnosing the Product Portfolio I 33 __________—_____—_____.——————————-— British Leyland in the U.I(. automobile mar- ket provide new benchmarks on the extent to which strong positions can erode unless vig- orously defended. F When the two largest competitors are of roughly equal size, the share positions may continue to be fluid until one is finally dom- inant. F There are certain product categories, fre- quently high technology oriented, where a dominant full lineifull service competitor is vulnerable if there are customer segments which do not require all the services, techni— cal assistance, etc., that are provided. As markets mature this “sophisticated" segment usually grows. Thus, Digital Equipment Corp. has prospered in competition with IBM by simply selling basic hardware and depending on others to do the applications programming.9 By contrast, IBM provides, for a price, a great deal of service backup and software for customers who are not self-sufficient. The dilemma for the dominant- producer lies in the difficulty of serving both segments simultaneously.” What Is the Objective of a Product Portfolio Strategy? The strategies emerging from a product portfolio analysis emphasize the balance of cash flows, by ensuring that there are products that use cash to sustain growth and others that supply cash. Yet corporate objectives have many more dimensions that require consideration. This point was recognized by Seymour Tilles in one of the earliest discussions of the portfolio approach.11 It is worth repeating to avoid a possible myopic focus on cash flow considerations. Tilles’ point was that an investor pursues a balanced combina- tion of risk, income, and growth when acquiring a portfolio of securities. He further argued that ”the same basic concepts apply equally well. to product planning." The problem with concentrat- ing on cash flow to maximize income and growth is that strategies to balance risks are not explicitly considered. What must be avoided is acessive exposure to a specific threat from one of the following areas of vulnerability: o The economy (e-.g., business downturns). 0 Social, political, environmental pressures. 0 Supply continuity. o Technological change. 0 Unions and related human factors. It also follows that a firm should direct its new product search activities into several different op- portunity areas, to avoid intensifying the degree of vulnerability. Thus, many companies in the power equipment market, such as Brown Boveri, are in a quandry over whether to meet the enor- mous resource demands of the nuclear power equipment market, because of the degree of vul- nerability of this business compared to other pos- sibilities such as household appliances. The desire to reduce vulnerability is a possi- ble reason for keeping, or even acquiring, a "Dog.” Thus, firms may integrate backward to as- sure supply of highly leveraged materials.12 If a ”Dog" has a high percentage of captive business, it may not even belong as a separate entity in a portfolio analysis. A similar argument could be used for prod- ucts which have been acquired for intelligence reasons. For example, a large Italian knitwear manufacturer owns a high-fashion dress company selling only to boutiques to help follow and inter- pret fashion trends. Similarly, because of the complex nature of the distribution of lumber products, some suppliers have acquired lumber retailers to help learn about patterns of demand and changing end-user requirements. In both these cases the productsfbusinesses were acquired for reasons outside the logic of the product port- folio, and should properly be excluded from the analysis. Can the Strategies Be Implemented? Not only does a product portfolio analysis provide insights into the long-run health of a company; it also implies the basic strategies that will strengthen the portfolio. Unfortunately, there are many situations where the risks of failure of these strategies are unacceptably high. Several of these risks were identified in a recent analysis of the dangers in the pursuit of market share.13 One danger is that the company‘s financial resources will not be adequate. The resulting problems are enormously compounded should the company find itself in a vulnerable financial posi- tion if the fight were stopped short for some rea- son. The fundamental question underlying such dangers is the likelihood that competitors will pursue the same 'strategy, because they follow the same logic in identifying and pursuing oppor- tunities, As a result, there is a growing premium on the understanding of competitive responses, and especially the degree to which they will be 34 I Journal of Marketing, April 1977 —-———__—__—_—____E__ M EXHIBIT 2 Balancing the Product Portfolio (Diameter of circle is proportional to products contribution to total company sales volume) New Product Market Growth Introduction Rate (in constant dollars. relative to GNP growth) High Low 1 0x PROBLEM CHILD divestment divestment 1x .1): Market Share Dominance (Share relative to largest competitor) Forecast position of product discouraged by aggressive action. An increasingly important question is whether government regulations will permit the corporation to follow the strategy it has chosen. Antitrust regulations—especially in the U.S.—now virtually ...
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