The question of how to allocate profits is linked to where a company is in its life cycle

One of the most important decisions management makes is how to allocate profits.

The decision of what to do with earnings is linked to where a company is in its life cycle.

The question of how to allocate profits is linked to where a company is in its life cycle.

1.  Development Stage

In the development stage, a company loses money as it develops products and establishes markets.

2.  Rapid Growth Stage.

The next stage would be rapid growth, in which a company is profitable but growing so fast that it may need to retain all earnings and also borrow funds or issue equity to finance this growth.

3.  Maturity and Decline

In later stages, maturity and decline, a company will continue to generate excess cash, and the best use of this cash may be allocating it to shareholders.

Product portfolio - the Boston Matrix (or Boston Box)

Introduction

The business portfolio is the collection of businesses and products that make up the company. The best business portfolio is one that fits the company's strengths and helps exploit the most attractive opportunities.

The company must:

(1) Analyse its current business portfolio and decide which businesses should receive more or less investment, and

(2) Develop growth strategies for adding new products and businesses to the portfolio, whilst at the same time deciding when products and businesses should no longer be retained.

Methods of Portfolio Planning

The two best-known portfolio planning methods are from the Boston Consulting Group (the subject of this revision note) and by General Electric/Shell. In each method, the first step is to identify the various Strategic Business Units ("SBU's") in a company portfolio. An SBU is a unit of the company that has a separate mission and objectives and that can be planned independently from the other businesses. An SBU can be a company division, a product line or even individual brands - it all depends on how the company is organised.

The Boston Consulting Group Box ("BCG Box")

Using the BCG Box (an example is illustrated above) a company classifies all its SBU's according to two dimensions:

On the horizontal axis: relative market share - this serves as a measure of SBU strength in the market

On the vertical axis: market growth rate - this provides a measure of market attractiveness

By dividing the matrix into four areas, four types of SBU can be distinguished:

Stars - Stars are high growth businesses or products competing in markets where they are relatively strong compared with the competition. Often they need heavy investment to sustain their growth. Eventually their growth will slow and, assuming they maintain their relative market share, will become cash cows.

Cash Cows - Cash cows are low-growth businesses or products with a relatively high market share. These are mature, successful businesses with relatively little need for investment. They need to be managed for continued profit - so that they continue to generate the strong cash flows that the company needs for its Stars.

Question marks - Question marks are businesses or products with low market share but which operate in higher growth markets. This suggests that they have potential, but may require substantial investment in order to grow market share at the expense of more powerful competitors. Management have to think hard about "question marks" - which ones should they invest in? Which ones should they allow to fail or shrink?

Dogs - Unsurprisingly, the term "dogs" refers to businesses or products that have low relative share in unattractive, low-growth markets. Dogs may generate enough cash to break-even, but they are rarely, if ever, worth investing in.

Using the BCG Box to determine strategy

Once a company has classified its SBU's, it must decide what to do with them. In the diagram above, the company has one large cash cow (the size of the circle is proportional to the SBU's sales), a large dog and two, smaller stars and question marks.

Conventional strategic thinking suggests there are four possible strategies for each SBU:

(1) Build Share: here the company can invest to increase market share (for example turning a "question mark" into a star)

(2) Hold: here the company invests just enough to keep the SBU in its present position

(3) Harvest: here the company reduces the amount of investment in order to maximise the short-term cash flows and profits from the SBU. This may have the effect of turning Stars into Cash Cows.

(4) Divest: the company can divest the SBU by phasing it out or selling it - in order to use the resources elsewhere (e.g. investing in the more promising "question marks").

http://tutor2u.net/business/strategy/bcg_box.htm

http://en.wikipedia.org/wiki/Growth-share_matrix

Strategies and finance for all stages of the business life cycle

The business life cycle theory is very much alive and kicking. Most of us are well aware of the failure rate of starts-ups. Around the world, the statistics tell the same story – 50 per cent of privately owned businesses fail in the first year and 95 per within the first five years.

While a certain amount of attrition is inevitable, it is important to understand the life cycle of a business and where strategy and finance can have the greatest impact.

What life cycle are we talking about - business, industry or product? Well they all typically follow a pattern: start-up stage, growth, maturity and then decline. And all are important. The business life cycle tracks how a business starts, grows and eventually declines. Clearly, the start-up stage is a high-risk time and the causes for business failure can vary from a lack of capital, poor management or because it was just not a good business idea from the beginning. 

What are less understood are the reasons why later on in its life a business plateaus out, and stagnation occurs, with the result that the rates of growth experienced earlier in the cycle become unsustainable. Most evidence around this problem points to an implicit change in the objectives of the shareholder/owner/manager as they become stale and lose focus. Rather than being the driving force behind the business, the owner/manager becomes a handbrake, forgetting or simply unaware that continuous value innovation, monitoring and improvement lead to growth and success. 

Just like people, a business needs rejuvenation from time to time and this is typically achieved through a change of the CEO, a merger, a take-over or an insolvency event that can cut away the dead wood. 

 

So how do strategy and finance change over the different stages of the business life cycle?



A moment’s reflection on the table above shows that it is important to understand where we are in the business life cycle, as it determines what strategy we should follow. In addition, our reaction to a particular KPI can differ greatly depending on the life cycle stage of the business.

 

The industry life cycle follows the way aggregated businesses within an industry trend over time. There are no rules for defining an industry, but it is typically classified through one of the stages of the overall value chain, or the nature of the products the business sells. 

For example, a grape producer growing grapes for wine is simultaneously in the wine industry and the primary production industry. So the grape producer would need to observe what is happening with trends and issues in the manufacture, distribution, retailing and consumption of wine, in addition to the trends and issues impacting on primary producers.

While all industries do follow a life cycle, some move through it quicker than others. Agriculture as an industry is certainly changing. If one were to study the history of agriculture, human beings only started to trade when they had agricultural surpluses. Leap ahead to today and a return on investment is very difficult to achieve without the ability to mass produce. That’s the reason the ‘family farm’ is no longer a viable model and why agribusiness is now controlled by large corporate organizations. The change in the business model of a primary producer has shifted enormously as the industry has moved through its life cycle. 



Further observation as described in the table above shows it is important to understand where we are in the industry life cycle as it determines what strategy we should follow. Also our reaction to a particular Return on Investment KPI differs greatly depending on our stage in the cycle.

 

The product life cycle is somewhat different – it is certainly shorter than the other two, and can take a terminal turn at very short notice (i.e. the product can drop out of favor with consumers very quickly).

The interesting thing about product life cycles is that typically there is a lot of activity that happens before the product is released to the market, i.e. research, concept development, design, testing, manufacture and launch. In many respects this is the invisible part of the product life cycle – the more visible part is the product launch, early penetration, early adoption, mature and then decline. 

As the table above shows, the strategies to follow – and what should be measured and managed – can change significantly depending on the product’s position in its life cycle.

Importantly, all businesses, irrespective of whether they are smaller single businesses or business units within a large corporation, can learn a great deal from studying the life cycle theory. Having distinguished what stage your business is at, industry and product life cycles can help you to determine your strategic focus, and provide a greater understanding of some of the trends your financial KPIs reveal.

http://business-transition.com/article/strategies-and-finance-all-stages-business-life-cycle

Product Life Cycle

Product life cycle patterns (Rink & Swan 1979).