PORTFOLIO

ANALYSIS
Portfolio models BCG Matrix, GE McKinsey Matrix

 In financial terms, portfolio analysis is a study of the performance of specific portfolios under different circumstances. It includes the efforts made to achieve the best trade-off between risk tolerance and returns.

What is a portfolio?
A business portfolio is the collection of Strategic Business Units that together form a corporation. The optimal business portfolio is one that fits perfectly to the company's strengths and helps to exploit the most attractive industries or markets.

What is Business Portfolio Analysis?

Business portfolio analysis is an enterprise strategy development tool based primarily on the market share of your business and the growth of market in which your business exists.

What is Portfolio Analysis?

Portfolio analysis involves quantifying the operational and financial impact of the portfolio. It is vital to evaluate the performances of investments and timing the returns effectively. The analysis of a portfolio extends to all classes of investments such as bonds, equities, indexes, commodities, funds, options and securities. Portfolio analysis gains importance because each asset class has peculiar risk factors and returns associated with it. Hence, the composition of a portfolio affects the rate of return of the overall investment.

 Portfolio analysis is a systematic way to analyze the products and services that make up an association's business portfolio. All associations (except the simplest and the smallest) are involved in more than one business. Some of these include publishing, meetings and conventions, education and training, government representation, research, standards setting, public relations, etc. Each of these is one of the association's strategic business units (SBUs). Each business consists of a portfolio of products and services. For example, an association's publishing business might include a professional journal, a lay magazine, specialized newsletters geared to different member segments, CDs, a website, social networking sites, etc.

Why is Business Portfolio Analysis?

Business portfolio analysis as an organizational strategy formulation technique is based on the philosophy that organizations should develop strategy much as they handle investment portfolios. Just as sound financial investments should be supported and unsound ones discarded, sound organizational activities should be emphasized and unsound ones deemphasized.

The aim of Portfolio analysis

Analyze its current business portfolio and decide which SBU's should receive more or less investment Develop growth strategies for adding new products and businesses to the portfolio Decide which businesses or products should no longer be retained.

Most Popular Business Portfolio Tools

Two most popular business portfolio tools are The BCG Growth -Share Matrix, The GE Portfolio Matrix,

Advantages and Disadvantages of Portfolio Analysis

Portfolio analysis offers the following advantages:

It encourages management to evaluate each of the organization's businesses individually and to set objectives and allocate resources for each. It stimulates the use of externally oriented data to supplement management's intuitive judgment. It raises the issue of cash flow availability for use in expansion and growth.

Portfolio analysis does, have some limitations.

It is not easy to define product/market segments. It provides an illusion of scientific rigor when some subjective judgments are involved.

"The BCG matrix"

 BCG matrix method is based on the product life cycle theory that can be used to determine what priorities should be given in the product portfolio of a business unit. To ensure long-term value creation, a company should have a portfolio of products that contains both highgrowth products in need of cash inputs and low-growth products that generate a lot of cash. It has 2 dimensions: Market share and Market growth . The basic idea behind it is that the bigger the market share a product has or the faster the product's market grows the better it is for the company.

 Placing products in the results in 4 categories in a portfolio of a company: Stars Cash Cows Dogs Question Marks Stars(high growth,high market share) use large amounts of cash and are leaders in the business so they should also generate large amounts of cash. Frequently roughly in balance on net cash flow. However if needed any attempt should be made to hold share, because the rewards will be a cash cow if market share is kept.

 Cash Cows (low growth, high market share)profits and cash generation should be high , and because of the style low growth, investments needed should be low. Keep profits high. Foundation of a company

 Dogs (low growth, low market share) Avoid and minimize the number of dogs in a company. Beware of expensive turn around plans. Deliver cash, otherwise liquidate.

 Question Marks (high growth, low market share) Have the worst cash characteristics of all, because high demands and low returns due to low market share If nothing is done to change the market share, question marks will simply absorb great amounts of cash and later, as the growth stops, a dog. Either invest heavily or sell off or invest nothing and generate whatever cash it can. Increase market share or deliver cash

 BCG Matrix method can help understand a frequently made strategy mistake: having a one-size-fits-all-approach to strategy, such as a generic growth target (9 percent per year) or a generic return on capital of say 9,5% for an entire corporation.

In such a scenario:
Cash Cows Business Units will beat their profit target easily; their management have an easy job and are often praised anyhow. Even worse, they are often allowed to reinvest substantial cash amounts in their businesses which are mature and not growing anymore. Dogs Business Units fight an impossible battle and, even worse, investments are made now and then in hopeless attempts to 'turn the business around'.

 As a result (all) Question Marks and Stars Business Units get mediocre size investment funds. In this way they are unable to ever become cash cows. These inadequate invested sums of money are a waste of money. Either these SBUs should receive enough investment funds to enable them to achieve a real market dominance and become a cash cow (or star), or otherwise companies are advised to disinvest and try to get whatever possible cash out of the question marks that were not selected.

 Cash Cows Business Units will beat their profit target easily; their management have an easy job and are often praised anyhow. Even worse, they are often allowed to reinvest substantial cash amounts in their businesses which are mature and not growing anymore. Dogs Business Units fight an impossible battle and, even worse, investments are made now and then in hopeless attempts to 'turn the business around'

 As a result (all) Question Marks and Stars Business Units get mediocre size investment funds. In this way they are unable to ever become cash cows. These inadequate invested sums of money are a waste of money. Either these SBUs should receive enough investment funds to enable them to achieve a real market dominance and become a cash cow (or star), or otherwise companies are advised to disinvest and try to get whatever possible cash out of the question marks that were not selected.

The balanced portfolio has:

Stars whose high share and high growth assure the future; Cash cows that supply funds for that future growth; and Question marks to be converted into stars with the added funds.

The GE/McKinsey Matrix

 The GE/McKinsey Matrix is a nine-cell (3 by 3) matrix used to perform business portfolio analysis as a step in the strategic planning process. The GE/McKinsey Matrix is a nine-cell (3 by 3) matrix used to perform business portfolio analysis as a step in the strategic planning process. The GE/McKinsey Matrix identifies the optimum business portfolio as one that fits perfectly to the company's strengths and helps to exploit the most attractive industry sectors or markets. Thus, the objective of the analysis is to position each SBU on the chart depending on the SBU's Strength and the Attractiveness of the Industry Sector or Market on which it is focused. Each axis is divided into Low, Medium and High, giving the nine-cell matrix as depicted below.

 SBUs are portrayed as a circle plotted on the GE/McKinsey Matrix, where the size of the circle represents a factor such as Market Size. The GE/McKinsey Matrix differs from other tools, like the Boston Consulting Group Matrix, in that multiple factors are used to define Industry Attractiveness and Business Unit Strength.

 Each factor can be given a different weighting in calculating the overall attractiveness of a particular industry. Typically: Industry Attractiveness = Attractiveness Factor 1 Value by Factor 1 weighting + Attractiveness Factor 2 Value by Factor 2 weighting, etc. Business Unit Strength = Strength Factor 1 Value by Factor 1 weighting + Strength Factor 2 Value by Factor 2 weighting, etc.

 McKinsey matrix is a model to perform a business portfolio analysis on the Strategic Business Units. A business portfolio is the collection of Strategic Business Units that make up a corporation. The optimal business portfolio is one that fits perfectly to the company's strengths and helps to exploit the most attractive industries or markets. Strategic Business Unit (SBU) can either be an entire mid-size company or a division of a large corporation, that formulates its own business level strategy and has separate objectives from the parent company.

The aim of a portfolio analysis is:

Analyze its current business portfolio and decide which SBU's should receive more or less investment, and Develop growth strategies for adding new products and businesses to the portfolio. Decide which businesses or products should no longer be retained. The GE / McKinsey Matrix is a later and more advanced form of the BCG Matrix.

 GE / McKinsey Matrix is more sophisticated than the BCG Matrix in three aspects: Market (Industry) attractiveness replaces market growth as the dimension of industry attractiveness. Market Attractiveness includes a broader range of factors other than just the market growth rate that can determine the attractiveness of an industry / market.

 Competitive strength replaces market share as the dimension by which the competitive position of each SBU is assessed. Competitive strength likewise includes a broader range of factors other than just the market share that can determine the competitive strength of a Strategic Business Unit. Finally the McKinsey Matrix works with a 3*3 grid while the BCG Matrix has only 2*2. This also allows for more sophistication.

 A six-step approach to implementation of portfolio analysis (using the GE / McKinsey Matrix) could look like this: Specify drivers of each dimension. The corporation must carefully determine those factors that are important to its overall strategy Weight drivers. The corporation must assign relative importance weights to the drivers Score SBU's each driver Multiply weights times scores for each SBU View resulting graph and interpret it. Perform a review/sensitivity analysis using adjusted other weights (there may be no consensus) and scores.

Some important limitations of the GE matrix / McKinsey Matrix are:

Valuation of the realization of the various factors Aggregation of the indicators is difficult Core competencies are not represented Interactions between Strategic Business Units are not considered