Economics 101: The Boston Matrix Model
Economists love models. I’m not talking about Claudia Schiffer or Gisele Bündchen, I’m talking about a simple diagram that helps them understand and become masters of a complex world. An economic model is a simple description of the real world upon which decisions can be based.
Take, for example, the “Boston Matrix Model”. Invented by the Boston Consulting Group in the 1970s, it presents a simple and apparently common sense description of a company’s product life-cycle.
In this model there are four categories into which a company’s products or business units can be placed:
- Cash Cows - products or business units with a high market share in a slow-growing industry. These units typically generate cash in excess of the amount of cash needed to maintain the business. The view is that they are to be “milked” continuously with as little investment as possible, since such investment would be wasted in an industry with low growth. The cash milked from the cow is used to support and grow the other business units.
- Stars - products or business units with a high market share in a fast-growing industry. The hope is that these stars become the next cash cows. Sustaining the star’s market leadership may require the input of cash from the cash cow, but this is considered worthwhile if this allows the star to grow market share. When growth slows, stars become cash cows if they have been able to maintain their category leadership, or they move from brief stardom to dogdom.
- The Problem Child (also known as the Question Mark) - a product or business unit that has the potential to become a star. Problem children consume a lot of cash and, if they do not become stars, can degenerate into scurvy dogs when the growth market declines.
- Dogs - products or business units in the declining stage of their usefulness. As a rule, these products do not generate much cash, but they do absorb cash. Dogs may be Cash Cows past their prime or Problem Children that didn’t quite make it – products/business units with minimal market share, operating in slow growing markets. The dog is a prime candidate for elimination!
Based on assessments of Market Share and Market Growth, the Boston Matrix positions business units or products according to these four categories. In this model, the Cash Cow feeds the other units, with cash being required to keep the Star’s high market share, to encourage the Problem Child to become a star, and to feed the Dog.
At face value that sounds reasonable, which is probably why this simple model is taught to first-year economics students. The trouble with all models, however, is that they can be too simplistic. If applied inappropriately, such models can become the basis of, and rationale for, poor business decisions.
An economic model like the Boston Matrix perhaps makes sense if a company’s products are separate and unrelated. For example, a company selling shoes and televisions can, reasonably, treat them as separate and unrelated products. In that case such a model may be a reasonable tool to help guide investment and product elimination decisions.
Problems, however, occur in the application of this model if a company’s products or business units are not truly independent.
“Modern” business practices have resulted in the mindset that whole companies should be “dis-integrated“, thereby creating separate compartmentalised business units. In such companies each business unit is treated like a separate entity which must then compete with the company’s other business units. Managers love this kind of restructuring because, although doing nothing to engender team spirit or big-picture thinking amongst their staff, it is perfect for generating bonus payments for managers who meet short term budget targets.
Further, now the business has been broken down into “separate” parts, first-year economists believe that they can apply simplistic models like the Boston Matrix. The problem is that the supposedly separate business units are not really separate at all.
For example, consider an airline’s frequent flyer program, often a highly profitable “separate” business unit. Blind Freddy can tell you that without a healthy airline the “separate” Frequent Flyer program isn’t worth two cents, and yet the airline and the program may be treated as separate units. In reality, of course, the health of each is dependent on the health of the other.
Similarly, an airline’s regional or low-cost operations derive much of their value from their affiliation with the parent airline. Again, these so-called “separate” businesses are intrinsically entwined.
It is the inter-dependence of the “separate” business units within a company that make the application of a simple models like as the Boston Matrix unhelpful and misleading.
Another problem with such a model is determining exactly how much to squeeze from the company’s cash cow. While the cow represents the solid strength of the company, excessive extraction to support the other segments can deplete and destroy the cow — turning it into a sickly dog. The motivation to create new stars, however, can cause managers to squeeze too hard.
“Milking the cow” implies a sustainable endeavour and, obviously, keeping the cow healthy should be a prime goal. Strangely, however, we sometimes see management more interested in harvesting rather than milking. Such short term thinking may aid the budget-bonus cycle of such managers and their advisors but, in the longer term, results in the destruction of the health of the cash cow. Then, if the business units are not truly independent, the result is an entire company that has become a sick and sorry mess.
While simplicity is an appealing ideal, it is vital that any economic model actually represents the reality it is trying to model. The consequences of a poorly fitting model, or an attempt to bend and chop reality to fit, will be flawed decisions based on incorrect interpretations. Simple models like the Boston Matrix simply do not fit the complex realities of entwined, interrelated businesses.
“This is obvious!” I hear you say. Why would company executives apply such a simplistic models to their business or make such obvious and fundamental mistakes? Perhaps they don’t, and perhaps their thinking is beyond simple first-year strategies like the Boston Matrix. But then again, perhaps not. If you can think of any examples of companies apparently being run in such a way — ask yourself this: why?
I’m sure I don’t know.
References:
Recent Comments