Friday, February 12, 2010

Looking at BCG's (In)Famous 2x2 Matrix with HHI

Today, we were talking about BCG's 2x2 Matrix (shown above) in our marketing class and our professor proposed to specifically define market share using a benchmark of the industry leader (or if the company was the market leader, the second place leader) as the line between High and Low Market Share. He acknowledged the primary shortcoming that using this definition, there can only be (by definition) one cash cow in the industry. He then introduced the idea of Coke and Pepsi with 52% and 48% relative marketshare (a slight exaggeration to prove a point) where they are both cash cows generating regular cash flows, but failing the definition: Pepsi would then be "dropped" as a project because of poor systematic definition. Or even if you use a given number (say x%) it doesn't account for the number of firms or size of firms.

In thinking about this, I also started to think about how we might be able to use the Herfindahl-Hirschman Index (HHI)to help correct for this problem. The current problem in the above standard proposed model is the definition of "market share" doesn't include competitiveness of the market (or lack thereof) when defining a cash cow. However, by definition the HHI looks at both the market share of the leaders as well as the effect on competitiveness from their relative size to each other.

Having said that, I would change "Market Share" in the horizontal axis to "Competitive Market Share" or mathematically:

Competitive Market Share = Competitive Market Capture / HHI

Competitive Market Capture = [% Market Share * 100]^2

Using this formula, we can tell that in the extremes, it works. For instance in a monopoly, Competitive Market Capture = HHI, so Competitive Market Share = 1.0 or 100%

In "perfect" competition (infinite number of firms with infinitesimal or marginal / trivial /zero market share), Competitive Market Capture = 0, Competitive Market Share = 0.0 or 0%.(Actually, to try to use "layman's" calculus terms, the Competitive Market Capture would be by definition a "smaller" zero than the HHI).

Also, because of the effect of squaring the market share (as is the case in HHI) we account for the effect of size in terms of competitiveness.
Having said that, the finance perspective is different then the marketing perspective. The only thing that really matters: Positive NPV.

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