The essence of strategic decision - making is the right Portfolio planning under corporate strategy.
Ashridge Portfolio Planning Matrix over BCG Share Matrix.
All of us are aware that a firm has to make a lot of strategic choices especially in today’s fast changing world of technology and the strategic choices can be made at multiple levels. They can be at the level of a single business or at the corporate level (multiple businesses).
The organization’s chief executives craft corporate-level strategy but many fail to address two crucial questions:
Which businesses should the company own and why?
And
What organizational structure, management processes, and philosophy will foster superior performance from its businesses?
The chief executives do not intentionally avoid or ignore those questions, but they simply lack the tools and processes for accomplishing the task.
Most planning processes focus on developing business-level, rather than corporate-level strategies.
Going ahead, I will try to address this problem as much as possible.
So, let’s start with some background on corporate level strategy.
Corporate level strategy addresses a key question –
Which businesses to compete in?
i.e.
What should be the scope of the firm?
This means, how should a firm go about deciding which businesses it should diversify into and which businesses it should divest?
A company should diversify into industries that are attractive, i.e., industries in which Market growth rate is presumed to be high.
However, there is a cost involved in entering such industries. These costs exist because a firm may have to either overcome entry barriers or pay a premium to acquire an incumbent firm.
Often, the extra profits that can be obtained by entering a profitable industry are negated by the costs of entering into such industries.
Thus, the advice that a firm should diversify into attractive industries may not be useful every time.
A much better approach is to follow the logic of corporate advantage.
A diversified firm is said to have a corporate advantage when the value of the firm is greater than the sum of its individual parts.
Consider a firm that is in two businesses, B1 and B2.
Let us say that the value of business B1 is V(B1),
the value of business B2 is V(B2) and
the combined value of the firm is V(B1B2).
The value of a business is the net present value of all of its future profits. The firm is said to have a corporate advantage if V(B1B2) > V(B1) + V(B2).
The extra value V(B1B2) — V(B1) — V(B2) is referred to as synergy.
One of the ways to create this extra value is obtained through economies of scope.
Economies of scope is not in the purview of this writeup, but I will cover it through another article which I plan to put into shape soon. As of now, to keep things simple, the following definition can be most appropriate to consider.
“Economies of scope is an economic principle in which a business’s unit cost to produce a product will decline as the variety of its products increases. “
Hence, to summarize the discussion so far, I would say diversification provides benefits for a firm when corporate advantage and synergy exist, and firms can make use of economies of scope.
One of the approaches used to address the question of diversification of a firm is the portfolio planning approach.
In this approach, the different businesses in which the firm has a presence are mapped along multiple dimensions. A big advantage of this approach is that it allows a firm to visualize all its businesses at one time and then see how a balance can be achieved.
One of the most well-known approaches to portfolio planning is the BCG share matrix.
Let me discuss this in detail.
In this approach, all the businesses are plotted on a 2X2 matrix.
The horizontal axis shows the relative market share that the firm has in that business.
If market share is taken as a proxy for performance, the horizontal axis shows the relative strength of the firm in that business.
The vertical axis shows the market growth rate, which is taken as a proxy for the attractiveness of the industry.
Businesses which have a high growth rate and in which the firm has a relatively high market share are considered as stars. These are the businesses that the firm should invest in for growth.
Businesses that have a less market growth potential rate and in which the firm has a high market share are considered as cows. These businesses should be “milked” and the profits from these businesses can be used to invest in stars or question marks to make them stars.
Businesses which have a low growth rate and in which the firm has a low market share are considered dogs. These are businesses that the firm should think of divesting.
Finally, businesses with high growth rates in which the firm has a low market share are considered as “question marks”. The firm should research enough to conclude whether these businesses will become stars in the future or will become dogs.
The big advantage of the growth share matrix is that it is simple to create and one single 2X2 matrix can show all the businesses that a firm has and their future prospects. It also shows how balance can be achieved between businesses in terms of cash flows.
However, this approach also suffers from two major weaknesses.
First, the dimensions along which firms are being plotted are too simple.
Also, market growth rate is a poor proxy for industry attractiveness and market share is a poor proxy for a firm’s strengths.
A second major weakness of this approach is that it ignores the connections among businesses.
That is, it ignores important ways in which a firm can create economies of scope and corporate advantage.
Because of these fundamental weaknesses, this approach has lost its appeal in recent years and is considered to be old school of thought now.
An alternative approach is the one developed by Goold, Campbell, and Alexander and is called Ashridge Portfolio Display.
Ashridge portfolio matrix is used to evaluate the attractiveness of potential acquisition target or existing business to the parent.
I will discuss a simplified version of this display.
The horizontal axis shows the potential for a parent to add value to a business.
The vertical axis shows the extent of fit between a parent’s management style and the needs of the business.
There can be multiple critical success factors (CSF) to be measured in order to justify this extent of fit and apply resources and capabilities more efficiently and effectively. In practice, variables, like previous experience, management attitudes and culture, stakeholders expectations and many other factors, influences the decision regarding potential acquisitions to be included in the portfolio of the business. All the relevant factors needs to be considered for making the decision. But for simplistic view I will not consider the above factors as of now.
Let me elaborate on the Ashridge Portfolio display matrix.
Heartland businesses are those with a high potential for value addition combined with high fit.
Value trap businesses are those with high potential for value addition but because of misfit, this potential is difficult to realize.
Ballast businesses that are those with high fit but with low potential for value addition.
And finally, alien territory businesses are those where the parent has a low potential for adding value but can also destroy value because of the misfit between its management style and the needs of the business.
Hence we conclude that, companies with sound corporate-level strategies create value from a close fit between the parent’s skills and the businesses’ needs. The best companies, however, do more. They strive to be the best parents for the businesses they own — to create more value than rivals would. They are always on a quest for parenting advantage.
Hope this article helped to capture the insights for which it is intended.
Thanks for reading!!!
