The Directional Policy Matrix (or GE-McKinsey Matrix) illustrates which segments the Host Company should actively pursue, and which segments should be divested. Development of the multivariate Directional Policy Matrix came about through recognition of the potential limitations of using only one single variable within the BCG Matrix. It was considered that a number of additional factors should also be utilised to develop a more representative analysis of the business.
The matrix shows the relative position of each segment using ‘Relative Competitive Strength’ as the (horizontal) X-Axis and ‘Relative Segment Attractiveness’ as the (vertical) Y-Axis. The diameter of each pie is proportional to the Volume or Revenue accruing to each Segment, and the solid slice of each ‘pie’ represents the share of the market enjoyed by the Host Company.
The company should invest in Product / Market opportunities that appear to the top left of the matrix. The rationale is that the company should invest in segments that are both attractive and in which it has established some measure of competitive advantage. Product / Market opportunities appearing in the bottom right of the matrix are both unattractive to the host company and in which it is competitively weak. At best, these are candidates for cash management; at worst candidates for divestment. Product / Market opportunities appearing 'in between' these extremes pose more of a problem, and the host company has to make a strategic decision whether to 'redouble its efforts' in the hopes of achieving market leadership, manage them for cash, or cut its losses and divest.
In this article, we look at 1) what is the GE McKinsey Matrix, 2) understanding the matrix, 3) applying the matrix to your business, and 4) some examples.
WHAT IS THE GE MCKINSEY MATRIX?
The GE McKinsey matrix is a nine-box matrix which is used as a strategy tool. It helps multi-business corporations evaluate business portfolios and prioritize investments among different business units in a systematic manner.
This technique is used in brand marketing and product management. The analysis helps companies decide what products need to be added to a product portfolio as well as what other opportunities should continue to receive investments. Though similar to the BCG matrix, the GE version is a lot more complex. The analysis begins as a two-dimensional portfolio matrix but the dimensions are multifactorial with nine industry attractiveness measures and twelve business strength measures.
The business world is becoming increasingly focused on its investment decisions as resources become more and more scarce. Each decision needs to be the best use of investments and aim to bring in the most return on this investment. For diversified businesses, the fight for resource allocation becomes even more complex because multiple products, brands and portfolios need to be managed. This matrix helps companies make these decisions in a more systematic and informed manner.
UNDERSTANDING THE MATRIX
The matrix is a 3×3 grid. The Y-axis measures market attractiveness while the x-axis measures the business strength. The scale is high, medium and low. A few key steps are necessary to create this matrix.
- List the entire range of products created or sold by a particular strategic business unit.
- Identify the factors that make a specific market attractive.
- Evaluate the strategic business unit’s position in the market.
- Calculate the business strength and market attractiveness.
- Determine the strategic business unit’s category: High, Medium or low.
1) Market Attractiveness
This dimension helps determine the attractiveness of the market by analyzing the benefits a company is likely to get by entering and competing within the market. A number of factors are studied within this analysis. These include the size of the market, its rate of growth, profit potential, and the nature, size and weaknesses of the competition within the industry. Some factors used to determine market attractiveness include:
2) Business/Competitive Strength
The other main dimension that makes up this grid is the competitive or business strength of the company itself. An assessment along this dimension helps understand whether a company has the required competence to compete in a particular market. This can be determined by internal factors such as assets, market share and development of this market share, brand position and loyalty, creativity, and handling of market changes and fluctuations. This can also be determined by external factors such as environmental concerns, government regulations and laws, energy consumption etc. Some factors that can determine this business/competitive strength include:
- Total market share
- Market share growth compared to competitors
- Strength of the brand
- Company profitability
- Customer loyalty
- Value chain
- Product differentiation
3) Measurement and Plotting
After identifying and rating the factors that are needed to determine both dimensions, these factors are given a magnitude and a calculation is made. This calculation is:
Factor1 rating x Factor1 magnitude + Factor2 rating x Factor2 magnitude + …..FactorN rating x FactorN magnitude
The strategic business unit is taken as a circle when plotting on the graph. Its size is determined by the size of the market. A pie chart within the circle shows the brands or products within that unit and an arrow outside it shows where the unit is expected to be in the future.
4) Investment Strategies
Once the chart is plotted, investment strategies can be created based on which box within the matrix the strategic business unit appears in. The three options are:
- Grow – Business units that fall within this category attract investment by the corporation because they are in a position to bring high returns in the future. Investments include those in research and development, acquisitions, advertisement and brand expansion as well as an expansion in production capacity.
- Selectivity – These business units are in a more ambiguous position and it is unclear whether they will grow in the future or become stagnant. Investments in this category may happen after money has already been put into ‘grow’ units and if there is a strategic purpose for these units.
- Harvest – Units in this category may be poor performers and in less attractive industries and markets. Investment will be put into these if they generate revenues to equal this investment. If this does not happen, then these units may be liquidated.
Developed in the early 1970s, this matrix was the work of management thinkers at Mckinsey. The matrix was developed out of a need by emerging multi-business companies to manage various business units profitably. This matrix is the forerunner of many other portfolio models including the MACS and the portfolio of initiatives. Despite increasing complexity in assessing industry attractiveness and business strength, many companies still refer to the nice box matrix or one of its descendants to make the right business decisions.
As with any tool, there are some limitations to keep in mind. For the Mckinsey matrix, these limitations include:
- The industry attractiveness and business unit strength can only be accurately determined by a consultant or a very experienced person.
- The entire exercise can be costly to conduct for a company
- Potential synergies and dynamics between 2 or more business units are not taken into account.
- The weight given to different factors can be very subjective as there is no set of rules to determine this.
HOW TO APPLY THE MATRIX TO YOUR BUSINESS
Practical Use Tips
Despite the complexity, a few key steps can be followed to apply this matrix to a business.
Step 1: Determine Industry Attractiveness of Different Business Units
Industry attractiveness can be determined by the following steps:
- Compile a list of factors – The first step is to identify and compile a list of relevant factors which help determine industry attractiveness. There are some common factors across industries but the company should include those factors that are most appropriate for the business.
- Assign Weights – Once the factors have been listed down, it is necessary to give them weights. These weights determine the importance of the factor to the determination of industry attractiveness. The weight could be from 0.01 (not important) to 1.0 (very important). The total of all the weights should be equal to one and all chosen factors should be assigned a weight.
- Rate the Factors – Once weighted, the factors are now rated for each product or business unit. Values can be between 1-5 or between 1-10. 1 is an indicator or low industry attractiveness while the higher value signifies higher industry attractiveness.
- Calculate Final Scores – With the weights and ratings in hand, a total score can now be determined. This is achieved by multiplying the weight of each factor by the rating of each factor. These are added up to achieve one figure for each business unit and these total score can then be used to compare industry attractiveness.
Because there is no rule for assigning weights and ratings, companies will usually need to hire a consultant or an industry expert to help ensure that an accurate analysis is conducted.
Step 2: Determine the Competitive Strength of each Business Unit
With the industry attractiveness out of the way, this step takes a look at the competitive strength for each business in much the same manner as step 1.
- Compile a list of factors – As before, you can choose from a list of common determinants of competitive strength but should try to make these as relevant to the particular business as possible.
- Assign weights – The chosen factors are then assigned weightage according to their importance in helping the company achieve sustainable competitive advantage. As before, the weights can be between 0.01 to 1.0 with the total equal to 1.
- Rate Factors – Once the weights have been assigned, the rating for each factor needs to be determined for each product or business unit. These ratings can be between 1-5 or 1-10. 1 is the weakest while 5 or 10 will be strongest ratings.
- Calculate Total Score – Multiple the weight of each factor with the rating for each of the business units and add up to achieve a total score.
Step 3: Plot the business units on a matrix
With all the scores needed in hand, the business units can now be plotted in the matrix. Each unit is denoted by a circle with the size of the circle representing the same proportion as the business revenue that the unit brings in for the company.
Step 4: Analysis of Information
Based on the position of each business unit in the matrix, there are three actions a company can take for each unit. These actions are to invest/grow, selectivity/earnings and harvest/divest. Each unit falls within a certain set of boxes and this position determines the action to be taken.
- Invest/Grow – These are the units that will gain the most investment as they promise the greatest future returns. Because of their growth potential, these units will also require large amounts of investment to allow them to grow or maintain their share in a growing industry.
- Selectivity/Earnings – Investment is put into these business units if there is some to spare after giving it to those units in the grow category. These are uncertain businesses and it cannot be stated with any clarity if they will continue as is, grow in the future or decline. If the unit is in an important and bigger market, then it may be worthwhile to invest further to keep a step in the door.
- Harvest/Divest – These are units in an unattractive industry with no sustainable competitive advantage. They are not able to achieve any advantage and perform under expectations. If the company has surplus cash, then there can be investment in those units who manage to make enough cash to break even and there is some strategic advantage to keeping them around. If this is not the case, then the units should be divested and liquidated.
Step 5: Identify future direction of each unit
The matrix itself only helps a company determine the current state of the industry and competitive strength with no indication of the future and where things may be headed. With the help of an industry analyst, the company may be able to determine the potential direction the future will take. Will the industry grow more or less attractive or will it stay the same? Will the competitive strength grow or reduce. With this information, the steps to be taken may be altered significantly if the potential in any area is expected to improve or reduce.
Within the matrix, an arrow is added to each circle, showing its future direction.
Step 6: Prioritize Investments
The final step in the matrix analysis is to decide the wheres and hows of the investment decisions for the company in practice. Some questions that may need to be answered in addition to the matrix analysis include:
- Are some units really worth the investment?
- How much should be invested in each unit?
- Which area within a unit should get more investment than others? For example, should the funds go to research and development, marketing, value chain development or customer development)
GE and the Matrix Development
This matrix was created by McKinsey consulting company for GE. In the 1970s, General Electric Company was an umbrella corporation managing a wide array of complex and unrelated products. There was a dissatisfaction from the returns on investment from many of the products. The method for investment decisions was based on various projections such as future cash flows, market growth etc. There projections remained unreliable and inaccurate.
GE brought McKinsey & Co on board and the 9 box matrix was designed.
A 2013 assessment of Apple according to this matrix reveals an interesting picture. Apple Inc has a variety of business units each operating in a different market. Business units include desktop computers, laptops, tablets, portable music devices, smartphones, watches and smartphones. An analysis of the different units in light of the GE McKinsey matrix can help assess what units the company is likely to invest in, develop selectively, or divest.
The market attractiveness access was determined easily by the researcher using information about external factors such as current market size, market growth rate, barriers to entry and state of technological development.
The business unit strength section is harder to determine because it used factors internal to the company including customer loyalty, access to resources, strength of the management etc. this information was gathered from secondary sources for the sake of this assessment.
The matrix shows that Apple remains moderately or very strong in each of its units and is competing in many attractive and fast growing sectors such as tablets and smartphones. These units are unlikely to be divested and instead will be fed from the revenues of cash cows such as personal computers and iPods. There are significant barriers to entry in these high-tech markets with high investment required to gather the required expertise and technology, despite Apple’s dominance, the best areas to compete with Apple remain the newer and faster growing markets of tablets and smartphones.