Strategy Evaluation. 4 Excellent techniques to consider

This article deals essentially with strategy evaluation. The need for evaluation of strategies being adopted is properly set out. Evaluation is necessary especially for corrective adjustment.

A good strategy may also need improvement since no condition or situation is permanent. There are many approaches to strategy evaluation as will be seen in this article.

Reasons for Strategy Evaluation

Strategy formation andstrategy implementationare done once and for- all-time in the life of an organisation. In both cases, situations arise which warrant corrective adjustment. For instance, a strategy may need to be modified because it is not working well or because the changing environmental conditions necessitate fine-tuning or major overhauling.

Also, a good strategy may require certain improvements. The condition that can require changes in a desirable strategy include changes in the industry”s competitive conditions, the emergence of new opportunities or threats, new executive leadership and reordering of objectives.

Similarly, the need for strategy implantation evaluation may arise when one or another aspect of implementation does not go well as planned. Other reasons may include changing internal conditions, experiences with currentstrategy implementationand execution.

Also, strategy evaluation is necessary when testing out new ideas and learning what works and what does not work through trial and error.

All this makes it incumbent on the management to always monitor not only how well the chosen strategy is working but also how well the implementation is going on. The outcome may necessities corrective adjustment if better ways of doing things can be spotted and supported. Consequently, the function of strategy management is ongoing and is not something to be done once and then forgotten or neglected. Strategy evaluation is necessary because success today is not a guarantee of success tomorrow. Success always creates new and different problems.

Evaluation of Business Strategy

This is the final stage instrategy management. All strategies must be subjected to future modifications because external factors are constantly changing. Three fundamental strategy evaluation activities include

(a) reviewing external and internal factors, which form the basis for the current strategies, (b) measuring performance and (c) taking corrective actions.

Since success always creates new and different problems and complacent organisations experience demise, strategy evaluation forms an essential step in the process of guiding an enterprise. It is an appraisal of how well a business performs; that is, how it grows and profits rate: normal, better or worse. This will assist the organisation in knowing whether or not the strategy is sound. Strategy evaluation is an attempt to look beyond the obvious regarding the short-term health of business.

The products of proper business strategy evaluation should provide vivid or clear answers to these three basic questions.

(i) Are the objectives of the business appropriate?

(ii) Are the major policies and plans appropriate?

(iii) Do the results obtained to date confirm or refute the critical assumptions on which the strategy rests?

An implemented strategy must be monitored in order to determine the extent to which it is resulting in the achievement of its set objectives.

Strategic managers must be on the watch out for early signs of the responsiveness of the market place to their strategies. They must also provide the means for monitoring and controlling to ensure that their strategic plan is followed adequately, properly and correctly. The underlining and ultimate test of a strategy is its proven ability to achieve its ends, i.e., the actual annual objectives, long-term objectives and mission.

In the final analysis, a company is said to be successful if only its strategy achieves its objectives.

Approaches to Strategy Evaluation

Approaches to strategy evaluation at the corporate level vary with a fiim”s make up. In an enterprise with a broad-based diverse revenue base, the main analytical considerations are

(i) appraising the health of the firm”s portfolio;

(ii) diagnosing the relative long-term attractiveness of each business coordinatedin the portfolio;

(iii) choosing when and how to upgrade the performance of the total business portfolio. This should be through stronger co-ordination and management of the existing business, the addition of new business units to the firm”s makeup and/or divestiture of the weak performers and misfits.

In diversified firms, corporate managers do little more than review and approve line-of-business strategies. On some occasions, they may suggest broad business strategy direction. However, the specifics of business level and functional area strategies are typically delegated to subordinate managers with profit-and-loss responsibility for particular business units and product lines. Usually, creating a fit between corporate and business strategies is something that corporate managers and business unit managers often negotiate.

Internal consensus must be reached regarding whether and how related activities of the various business units will be co-ordinated. Corporate management has to be convinced that the chosen business-level strategy has an attractive corporate payoff and is willing to provide whatever corporate-level resources are needed for successful strategy implementation. It should be noted that business strategy must be responsive to corporate priorities and match up with both corporate resources and long-term direction. So, there is a two-way traffic between the analysis of corporate and business strategies.

The situation of the single-business enterprise contrasts that of the diversified firms. In single-business or dominant-business enterprises evaluating the strategy of the core business is the centre of corporate headquarters” attention. After this, diversification and other portfolio questions in relation with corporate strategy could be addressed. In this type of a firm, corporate strategy and business strategy analysis are not divorced for the following reasons:

1. Activities outside the core business contribute minimally to the sales and the profits.
2. The questions of where do we go from here hinges on the health and attractiveness of the main business. So in dominant-business companies, corporate strategy takes its clues from the business strategy instead of the reverse.

Whichever kind of approach is adopted, sound strategy analysis starts with a probing of the organisation’s present strategy and business makeup.

 Techniques of Portfolio Evaluation

The major techniques of identifying and evaluating portfolio of business in any organisation are:

1. Boston Consulting Growth (BCG) or growth share matrix.
2. The GE-a-cell directional approach.
3. Hofer author d. little product/market evolution matrix
4. The general electric model.

But by far, the most popular approach is the BCG approach or the growth share matrix.

Growth-Share Matrix for Evaluating DiversifiedPortfolios

The most popular analytical technique for evaluating the overall makeup of a diversified growth of business units involves the use of Boston Consulting Growth (BCG) or growth share matrix. This involves the construction of a business portfolio matrix which is a two-dimensional graphic portfolio of the comparative positions of different businesses.

The revealing variables in this approach have been industry growth rate, market share, long-term industry attractiveness, competitive strength and stage of product or market evaluation.

The use of two-dimensional business portfolio matrix as a tool for corporate strategy evaluation is based on relative simplicity of constructing them as well as the clarity of the overall picture that they produce.

The first business portfolio matrix to receive widespread usage was a four-square grip pioneered by Boston Consulting Group (BCG). The matrix is found using industry growth rate and relative market share as the axes. Each business unit in the corporate portfolio appears as a “bubble” on the four-cell matrix with the size of each “bubble” or circle scaled according to the percent of revenues it represents in the overall corporate portfolio.

The BCG technique arbitrarily place the dividing line between “high” and “low” industry growth rates at around twice the real GND growth rate plus inflation.

Relative Market Share

This is defined as the ratio of a business’s market share to the market share held by the largest rival firm in the industry. The market share is measured in terms of unit volume and not in naira.

Example 1:Assume business A has 15% share of the industry’s total

volume and the share held by the largest rival is 30%, then A”s relative market share is 0.5.

Example 2:If business B has a market-leading share of 40% and its largest rival has a 30% share, then B”s relative market share is 1.33

The implication of BCG relative market share matrix is that only business units will have relative market share values greater than one.

The business units in the portfolio that trails behind the rival firms in the market share will have ratios below 1.0.

The most stringent BCG standard calls for the border between “high” or “low” relative market shares with the grid to be set at 1.0. A ratio of 0.10 indicates that the business has a market share of only 1.10 of the market share of the largest firm in the market while a ratio of 0.80 indicates a market share that is 4/5 or 80% as big as the leading firm”s share. However, locating the dividing line between “high” and “low” at about 0.75 (75%) or 0.8 (80%) is a reasonable compromise.

The advantages of using relative market share include:

(i) It is a better indicator of comparative market strength and competitive position.

(ii) It is more likely a reflection of relative cost based on experience

in producing the product and economy of large-scale production.

Question Marks and Problem Children

Rapid market growth makes such business units to be attractive. They have relatively low market share which raises the doubt on the possibility of the profit potential associated with market growth being realistically captured, hence the question mark designation.

Question mark businesses have financial needs because of their low market share and thinner profit margins. The challenge to the strategic decision maker is to decide whether it is worthwhile to use the corporate money to support the question mark business. ? BCG recommends two options for this group of businesses, namely,

1. Aggressive grow-and-build strategy to capitalise on the high growth opportunity.
2. Divestiture, in event that the grow-and-build strategy constitutes too much of a financial risk.

Therefore, the strategy prescription for managing questions mark/problem children business is to divest those that are weaker and less attractive and groom the attractive ones to become tomorrow”s “stars”.

Stars

The “stars” are the businesses with high relative market share position in high growth markets. They offer both excellent profit and excellent growth opportunities. The business enterprises depend on them to boost overall performance of the total portfolio.

Stars require large cash investments to support expansion of production facilities and working capital needs. They often tend to generate their own large internal cash flows because of low-cost advantage resulting from economies of scale and production experience.

According to BCG, some stars are virtually self-sustaining in terms of cash flow and make little demand on the corporate purse. Yong stars however, require substantial investment capital beyond what they can generate on their own and may thus be cash hogs.

Cash Cows

These are businesses with a high relative market share in a low-growth market. Their position tends to yield substantial cash surplus over and above what is needed for reinvestment and growth in the business. “Many of today”s cash cows are yesterday”s stars” is a popular phrase in strategic management. From the growth standpoint, cash cows are less attractive but they are very valuable because they can be “milking” for their cash to pay corporate dividends and corporate overhead.

They provide the cash for financing new acquisitions and the funds for investing in young stars and problem children that are groomed as the next round of stars. It means that the “cash cows provide the naira to „feed” the cash hogs”. Usually, strong cash cows are not harvested but are maintained in a health status to sustain long-term cash flow. Weak cash cows may be designated as prime candidates for harvesting and eventual divestiture if their industry becomes unattractive.

Dogs

Dogs are businesses with low growth and low relative market share in the BCG matrix. This is because of their weak competitive position resulting perhaps, from high cost, low-quality products and less effective marketing. They also have low profit potential that often accompanies slow growth or impending market decline. Dogs are unable to generate attractive cash flows on a long-term basis; sometimes they do not produce enough cash to fund a hold-and-maintain strategy.

The BCG prescription is that dogs be harvested, divested or liquidated depending on the alternative that yields the most attractive amount of cash for redeploying to other businesses or to new acquisitions.

The implication ofBCG matrixfor the corporate strategy it draws attention to the cash flow and investment characteristics of various types of businesses in order to optimise the long-term strategic position and performance of the corporate portfolio. The weaker and less attractive question mark businesses not worthy of financial investment necessary to fund a long-term grow-and-build strategy are portfolio liabilities.

The BCG Growth-Share Business Portfolio Matrix

 RELATIVE MARKET SHARE POSITION

Dogs are retained only as long as they can contribute positive cash flow and not tie up assets and resources that could be more profitably redeployed.

There are two disaster sequences in the BCG scheme: when a star’s position in the matrix erodes over time to that of a problem child then it falls to become a dog and when a cash cow loses a market leadership to the point where it becomes a hog on the decline.

Other strategic mistakes include over investing in a safe cash cow; underinvesting in a question mark so that instead of moving into the “star” category, it tumbles into a dog; and short gunning resources thinly over many question marks rather than concentrating them in the best question mark to boost their chances of becoming “stars” not harvested but are maintained in a healthy status to sustain long-term cash flow.

Shortcomings of BCG portfolio evaluation

There are many shortcomings that are associated with BCG portfolio evaluation. These observed weaknesses of BCG created the obvious need for more probing techniques of business strategy evaluation. Other approaches include General Electric Motor (GE) approach and the life cycle matrix approaches, which take care of some of BCG”s weaknesses.

The Need for Other Techniques of Strategy Evaluation

There is need for other techniques of strategy evaluation. This need arises out of the observable weaknesses or shortcomings of BCG growth share matrix.

The Lifecycle Matrix

Evaluating Corporate Strategy by Using More Probing Factors

1. The BCG 4-cell matrix is based on high-low classification. This hides the fact that there are “average” growth rates to be market leaders may be getting stronger while others are getting weaker. A few one-time starts or cash cows have ended up in bankruptcy. Hence, the characteristics to assess are the trend in a firm”s relative market share, i.e., is it gaining ground or losing ground and why? This particular weakness of BCG can be corrected by indicating each business”s present and future position in the matrix.
2. Bell and Hammnd (1979) particularly argue that BCG matrix is not a reliable indicator relative to investment opportunity across business units. They state that investing in a star is not necessarily more attractive than investing in a lucrative cash cow.b. The matrix results are silent over when a question mark business is a potential winner or being likely loser. The matrix also says nothing about a shrewd investment becoming a string dog, star or cash cow.c. The connection between relative market share and profitability is not as light as the experience curve effect implies. d. The importance of cumulative production experience in lowering unit cost varies from industry to industry e. A thorough assessment of the relative long-term attractiveness of business units in the business portfolio requires an examination of more than just marketing growth and relative share variables. f. Being a market leader in a slow-growth industry is not a sure guarantee of cash status because

(i) the investment requirements of a hold-and-maintain strategy, given the impact of information on the cost of replacing worn-out facilities and equipment, can soak up much, if not all, of the available internal cash flow, and

(ii) as the market matures, competitive forces often stiffen, and ensure a vigorous battle for volume and market share, can shrink profit margins and surplus cash flows.

Consequent to these shortcomings, an alternative approach that avoids some of the shortcomings of the BCGs growth can be sought with the help from the consulting firm of McKinley and company. The GE effort is a 9-cell portfolio matrix based on the two dimensions of long-term product market attractiveness and business strength/ competitive position.

In the GE 9-cell matrix, as shown in Fig. 10 the area of the circles is proportional to the size of the industry, and the pie slices within the circles reflect the business market share.

The vertical axis represents each industry”s long-term attractiveness.

This is defined as a composite weighting of market growth rate, market size, historical and projected industry profitability, market structure and competitive intensity, economies of scale, seasonality and cyclical influences, technological and capital requirement, emerging threats and opportunities, and social environmental and regulatory influences.

In this procedure, each industry is assigned attractive importance and each business is rated on each factor, using a 1 to 5 rating scale. A weighted composite rating is thus obtained.

Example:

Thus, each business is rated using this approach to arrive at a measure of business strength and competitive position. The competitive values for long-term product market attractiveness and business/competitive position are then used to plot each business’s position in the matrix.

The Corporate Strategy Implication

(1) The vertical lines consisting of three cells at the upper left indicate that long-term industry attractiveness and business strength/competitive position are favourable. The businesses in these zones are given a high priority in terms of fund allocation.

(2) The second zone, i.e., the un-shaded zone, comprising these three cells which usually carry medium investment allocation. The strategy to be adopted here is hold-and maintain.

(3) The third zone, i.e. the horizontal lines, is composed of the 3 cells in the lower right corner of the matrix.

The strategy prescription here is typically harvest or divest. However, in every exceptional case, such a business can be rebuilt or repositioned using a turn around approach.

The 9-cell GE approach has some merits. It is a 3-cell GE approach which is as follows:

1. It allows for intermediate ranking between high and low, and between strong and weak.
2. It considers much wider varieties of strategically relevant variables.
3. It emphasis channeling of corporate resources to those businesses that combine medium-to-high product-market attractiveness with average-to-strong business strength or competitive position. The fact is that the greatest probability of competitive advantage and superior performance lies in these combinations.

In order to identify a developing winner type of business, Hofer (1978) has developed a 15-cell matrix in which business is plotted in terms of stage of industry evolution and competitive position. This is supposed to be an improvement over the 9-cell GE approach. Just as in the previous approaches the cycles represent the sizes of the industries involved and the pie wedges denote the business market share.

In the Table above, A would appear to be a developing winner and C would be a potential loser, E is an established winner, F is a cash cow and G is a loser or a dog.

The strength of the lifecycle matrix is the story it tells about the distribution of the firm”s business across the stages of the industry evolution.

It should be noted that each of the matrix types has its pros and cons.

Thus, there is no need to vehemently insist on the choice of the matrix to use.

The business unit competition position

The most important thing is to have a good analytical accuracy and completeness in describing the firm”s current portfolio position just for the purpose of knowing how to manage the portfolio as a whole and get the best performance from the allocation of the corporate resources.

The construction of business portfolio matrices has been identified as the step in evaluating diversified forms of current strategic situations. This is because of the insight and clarity they provide about the overall character of a firm”s business build up. However, business portfolio analysis does not constitute the whole corporate strategy evaluation process. A business portfolio matrix offers a snapshot comparison of different business units and some general prescriptions for the direction of the business strategy.

But this is too simple a framework on which to base long-term direction setting, make strategic decisions and allocate huge corporate resources. In light of this, more probing into the status and prospects of each business unit in the portfolio is needed to guide corporate strategydecisions. The needed probing required has been well explained by Hofer and Schendel (1978). The steps involved include these.

1. Construct a summary profile of the industry environment and competitive environment of each business unit.
2. Appraise each business unit”s strength and competitive position in its industry; understand how each business unit ranks against its rivals and the key factor for competitive success. This affords corporate managers a basis for judging the business unit”s chances for real success in its industry.

1. Identify and compare the specific external opportunities threats and strategic issues peculiar to each business unit”s situation.
2. Determine the total amount of corporate financial support needed to fund each unit”s business strategy and what corporate skills and resources could be deployed to boast the competitive strength of the various business units.
3. Compare the relative attractiveness of different businesses in the corporate portfolio. This includes industry attractiveness/business strength and a look at how the different business units compare on various historical and projected performance measures such as sales profit margins and return on investment.
4. Check the overall portfolio to ascertain that the mix of the businesses are all well balanced, i.e. there are not too many losers or question marks, not too mature business that can slow down corporate growth. But there should be enough cash producers to support the stars and develop winners, too few dependable profit performances as suggested by Thompson and Strickland (1987).