Portfolio Management

Strategy for the diversified corporation entails an evaluation of each Strategic Business Unit to assess how each contributes to the overall value and performance of the corporation. The corporation strives for synergy. Synergy means that the value and efficiencies of the whole corporation are greater that that of the sum of the individual businesses. Corporate strategy seeks to increase the value of the corporate whole through synergistic combination and management of diverse businesses - a portfolio of businesses. Portfolio analysis identifies methodologies which can assist in an evaluation of an appropriate and "optimal" mix of businesses in the portfolio.

The perspective of portfolio analysis is that the corporation is an internal capital market - resources are controlled and allocated to each business by a corporate headquarters, not the stock and bond markets. As portfolio manager, the modern corporation decides which businesses will obtain capital for growth and development, which businesses will not, and which will be divested.

The portfolio management perspective has raised a concern by some economic theorists that the modern corporation has replaced the historical and proper role of the market is choosing "winners" and "losers". Nevertheless, portfolio analysis, first developed in the 1960's, remains an important tool of strategic management. There are today many analytic techniques available for portfolio analysis. We examine the three techniques most widely used and most referenced in the business literature:

The BCG or Growth-Share matrix imposes a two-dimensional analysis on management of Strategic Business Units: a comparative analysis of business strength and an assessment of the environment. The business strength measure is the business's Relative Market Share. The environmental measure is the Market Growth Rate.

The analysis requires that both measures be calculated for each SBU. The business strength dimension, Relative Market Share, is intended to measure comparative advantages evidenced by market dominance. The underlying theory is that an experience curve exists and that efficiencies (Overall Cost Leadership) yield market share. An inability to achieve efficiencies that lead to market dominance consign the business to low profits and, eventually, failure. A corporation's business either has a market share larger than its most relevant rivals or is probably not viable (Henderson's rule of 3 and 4).

The market growth rate measures industry attractiveness. When the corporation's businesses are in different industries, the appropriate determinant is the growth rate of the industry in which the business is located relative to the overall economic growth rate. When SBU's are located in the same industry, the referent standard is the industry growth rate measured against the SBU's growth rate. The underlying theory for examining market growth rate is the industry life cycle. The BCG assumes that growth rates (life cycle stages) affect a firm's finances, seen in the illustration to the right.

The BCG Matrix, shown below, establishes four cells (a 2X2 matrix), with the midpoint for the Relative Market Share set at 1.0 (Key Rival's market share). Where the mid-point of the Market Growth Rate axis is set depends. If all SBU's are in the same industry, then the average growth rate of the industry is used. If the SBU's are located in different industries, then the mid-pont is set at the growth rate for the economy. Each quadrant is then labeled to describe a strategy, as follows:

Stars - SBU's placed in this cell are highly attractive because the industry in which they are located is robust and the business has a strong competitive position in the industry. Stars generate large amounts of cash, but also require heavy investment to continue to grow and to maintain competitive positioning. Net cash flow is usually modest.

Cash Cows - These SBU's are the corporation's key source of cash, and are typically the core business. They possess a strong competitive position, but are located in an industry that is mature, not growing or declining. A Cash Cow generates more cash than it requires, providing funds to the corporation to invest in other ventures.

Question Marks - When a business is located in a growing industry, but has not achieved a strong competitive position, an attempt to evaluate further investment is shrouded by ambiguity as to eventually becoming a "winner". These are termed "Question Marks" because they deserve attention to determine if the venture can be viable.

Dogs - A business situated in a low growth or declining industry, such as at the decline stage, has a precarious future. If the business has not already developed a strong competitive advantage, it should be divested.

Using these two dimensions, SBU's are evaluated and located within the matrix. When locating each SBU within a cell the convention is to draw each SBU as a circle. The circumference of the circle informs as to the relative importance of the business unit's contribution to the corporation. Therefore, Relative Contribution is measured by:

Type SBU	STRATEGY	SBU Profits	Required Investment	Net Cash Flow
STAR	Hold/Increase	High	High	- or +
CASH COW	Hold	High	Low	High +
QUESTION MARK	Increase/Divest	0 or -	Very High or Disinvest	High - or +
DOG	Harvest or Divest	Low or -	Disinvest	+

The strategies available using the BCG approach indicate the appropriate investment actions for each business unit. Applied to the Martin-Marietta Corporation in 1961, the BCG matrix is illustrated, below.

If Martin-Marietta were to follow the BCG approach, what decisions would be made for each SBU?