Growth and portfolio theory

All about the growth and portfolio theory

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In the 1970s size, growth, and portfolio theory have been the focus of much of strategic management. The PIMS study was a long term study, started in the 1960s and lasted for 19 years, that attempted to analyze the Profit Impact of Marketing Strategies (PIMS), particularly the effect of market share. Started at General Electric, moved to Harvard in the early 1970s, and then moved to the Strategic Planning Institute in the late 1970s, it is now a major reference containing decades of information on the relationship between profitability and strategy. Their initial conclusion was unambiguous: The greater a company's market share, the greater will be their rate of profit. The high market share provides volume and economies of scale. It is considered an excellent source of experience and learning curve advantages. The combined effect is increased profits. The studies conclusions continue to be drawn on by academics and companies today: "PIMS provides compelling quantitative evidence as to which business strategies work and don't work" - Tom Peters.

There was also research that indicated that an outstanding profit can be earned from a low market share strategy. Schumacher (1973), Woo and Cooper (1982), Levenson (1984), and later Traverso (2002) showed how smaller niche players obtained very high returns.

By the early 1980s the paradoxical conclusion was that high market share and low market share companies were often very profitable while most of the companies in between were not. This was the origin of the term called the “Hole in the middle” problem. This anomaly would be explained by Michael Porter in the 1980s.

The management of diversified organizations required new techniques and new ways of thinking. Alfred Sloan at General Motors was the first CEO to address the problem of a multi-divisional company. GM was decentralized into semi-autonomous “strategic business units” (SBU's), but with centralized support functions.

Portfolio theory was one of the most valuable concepts in the strategic management of multi-divisional companies. In the previous decade Harry Markowitz and other financial theorists developed the theory of portfolio analysis. It was deducted that a broad portfolio of financial assets could reduce specific risk. In the 1970s marketers extended the theory to product portfolio decisions and managerial strategists extended it to operating division portfolios. Each of a company’s operating divisions was being dealt with as an element in the corporate portfolio. Each operating division (also called strategic business units) was treated as a semi-independent profit center with its own revenues, costs, objectives, and strategies. To analyze the relationships between elements in a portfolio, several techniques were developed. B.C.G. Analysis, for example, was developed by the Boston Consulting Group in the early 1970s. This theory was the origin of the wonderful image of a CEO sitting on a stool milking a cash cow.

 

Article Tags: Portfolio Theory, Market Share

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