In this lesson, you will learn about Portfolio Strategy and the most commonly used techniques to improve a company’s strategy formulation.
Portfolio Techniques to Improve Strategy
Portfolio Strategy pertains to the mix of business units and product lines that fit together in a logical way to provide synergy and competitive advantage for the corporation.
For example, an individual might wish to diversify in an investment portfolio with some high-risk stocks, some low-risk stocks, some growth stocks, and perhaps a few fixed-income bonds.
In much the same way, corporations like to have a balanced mix of business divisions called strategic business units (SBUs). An SBU has a unique business mission, product line, competitors, and markets relative to other SBUs in the corporation. Executives in charge of the entire corporation generally define the grand strategy and then bring together a portfolio of strategic business units to carry it out.
Portfolio models can help corporate management to determine how resources should be allocated among the various SBUs, consisting of product lines and/or divisions. The portfolio techniques are more useful at the corporate-level strategy than at the business-level or functional-level strategy.
Three widely used portfolio models are:
(1) the Boston Consulting Group (BCG) Matrix
(2) the General Electric (GE) Model
(3) the McKinsey 7-S Framework
Management Consulting firm, McKinsey & Company, developed the 7-S Framework in the late 1970s as criteria for an organization’s success.
This framework is a model that addresses the critical role of coordination, rather than structure, in organizational effectiveness.
It includes seven elements: structure, strategy, skills, staff, style, systems, and shared values.
In order to manage the change process and seek improvements needed, organizations are classifying these seven elements into two groups: hard S’s and soft S’s.
– Hard S’s include strategy, structure, and systems, which are easier to change than the soft S’s, and the change process can begin with hard S’s.
– Soft S’s include staffing, skills, style, and shared values, which are harder to change directly and take longer to do.
However, both hard and soft S’s are equally important to an organization.
The way in which tasks and people are specialized and divided and authority is distributed. It consists of the basic grouping of activities and reporting relationships into organizational sub-units.
It includes the mechanisms by which the activities of the members of the organization are coordinated. There are four basic structural forms—functional, divisional, matrix, and network, where the functional form is the most common of all.
The way in which competitive advantage is achieved. It includes taking actions to gain a sustainable advantage over the competition, adopting a low-cost strategy, and differentiating products or services.
The distinctive competencies that reside in the organization. They can be distinctive competencies of people, management practices, systems, and/or technology.
Includes employees, their backgrounds, and competencies. It consists of the organization’s approaches to recruitment, selection, and socialization. It focuses on how people are developed, how recruits are trained and integrated, and how their careers are managed.
Deals with the leadership style of top management and the overall operating style of the organization. Style impacts the norms employees follow and how they work/interact with each other and with customers.
The formal and informal processes and procedures used to manage the organization, including management control systems; performance measurement and reward systems; planning, budgeting, and resource allocation systems; information systems; and distribution systems.
The core set of values that are widely shared in the organization and serve as guiding principles of what is important. These values have great meaning to employees because they help focus attention and provide a broader sense of purpose.
Shared values are one of the most important elements of an organization’s culture.
The most common uses of the framework are:
– To facilitate organizational change.
– To help implement new strategy.
– To identify how each area may change in the future.
– To facilitate the merge of organizations.
The BCG Matrix (or Growth-Share Matrix) is a corporate planning/business tool, which is used to portray a firm’s brand portfolio or SBUs (Strategic Business Units)* on a quadrant along two dimensions – relative market share* (horizontal axis) and market growth rate* (vertical axis).
It is used to evaluate the potential of business brand portfolio and suggest further investment strategies.
– Relative Market Share:market share of a firm relative to that of the largest competitor in the industry.
– Market Growth Rate: pertains to how rapidly the entire industry is increasing.
The BCG matrix model utilizes a concept of experience curves, which are similar in concept to learning curves. The experience curve includes all costs associated with a product and implies that the per-unit cost of a product should fall due to cumulative experience, as production volume increases.
Stern, C.W. and Stalk, G. Jr, “Perspectives on Strategy: From the Boston Consulting Group”, The Boston Consulting Group on Strategy, 2006
– industry attractiveness (growth rate of the industry)
– competitive position (relative market share)
Here, growth means use of cash and market share means source of cash.
Each SBU is classified in terms of its relative market share and the growth rate of the market the SBU is in, and each product is classified as stars, cash cows, dogs, or question marks.
(2) Cash Cows are often market leaders (high market share), but the market they are in is a mature, slow-growth industry (low growth). They have a positive cash flow.
(3) Dogs are poorly performing SBUs that have a low market share of a low-growth market. They are modest cash users and need cash because of their weak competitive position.
(4) Question Marks are SBUs with a low market share of a new, high-growth market. They require large amounts of cash inflows to finance growth and are weak cash generators because of their poor competitive position.
– A Star SBU eventually becomes a Cash Cow.
– Cash Cow SBUs should be used to turn Question Marks into stars.
– Dog SBUs should either be harvested or divested from the portfolio.
– The Question Mark SBUs can be nurtured to become future Stars.
– Unqualified Question Mark SBUs should be harvested until they become Dogs.
Although the BCG analysis has lost its importance due to some limitations, it can still be a useful tool if performed by following these steps:
Step 1: Choose the unit
Step 2: Define the market
Step 3: Calculate relative market share
Step 4: Find out market growth rate
Step 5: Draw the circles on a matrix
The GE model emphasizes all the potential sources of business strength and all the factors that influence the long-term attractiveness of a market.
All SBUs are classified in terms of:
– business strength (i.e. strong, average, weak)
– industry attractiveness (i.e. high, medium, low).
Business Strength is made up of market share, quality leadership, technological position, company profitability, company strengths and weaknesses, and company image.
Overall strategic choices include either to invest capital to build position, to hold the position by balancing cash generation and selective cash use, or to harvest or divest. The GE model incorporates subjective judgment, and accordingly, it is vulnerable to manipulation. However, it can be made stronger with the use of objective criteria.
Industry Attractiveness indicates how hard or easy it will be for a company to compete in the market and earn profits. The more profitable the industry is, the more attractive it becomes.
Industry attractiveness consists of many factors that collectively determine the level of competition in it such as:
– Long run growth rate
– Industry size
– Industry profitability (use Porter’s Five Forces analysis to determine this)
– Industry structure
– Product life cycle changes
– Changes in demand
Step 1 –Determine industry attractiveness of each business unit.
Step 2 – Determine the competitive strength of each business unit.
Step 3 – Plot the business units on a matrix.
Step 4 – Analyze the information.
Step 5 – Identify the future direction of each business unit.
Step 6 – Prioritize your investments.