Economics has diversity of
applications across streams. The applications range from management to business
studies to national economies to politics to societies to history among others.
Economics by its very nature has direct applications in the field of business
theory. Many business theories, concepts, models, principles or whatever they
might be have their origin in the domain of economics. The past posts have
discussed such examples from the field of management theory that can be traced
to economic roots. One such application that would be discussed in the current
post would be the Boston Consulting Group (BCG) Matrix. Sometime back, there
was a discussion on the application of BCG matrix in the context of sports
popularity and innovation. The current post however would seek to locate BCG matrix
in the context of economic theories and models.
As is well known to students of
management, BCG matrix finds its application in product portfolio management. The
products in the firm’s repertoire are mapped to two dimensions. The first is
the market growth while the second dimension is the market share. There are
four possibilities that arise out of the interaction between the two. The first
is the question marks which refers to the products which have uncertain
outcomes. They have low market share but have the potential for high market
growth. The second are the stars which as the name suggests not only command
significant market shares but also have high market growth rates. The third
quadrant are those which have high market share but having reached a sort of
saturation, they have low market growth. These are known as cash cows and often
are the bread and butter of the firm at the present. The fourth have low market
growth and low market share and generally on the way to obsolescence. These products
on the way to turn obsolete are called as dogs.
Each of these quadrants have their
origins in economic modelling. They can be linked to certain economic theories.
In the production analysis, economics relies on returns to scale and economies
of scale. While some text books might seem to see each other as synonyms, they
are not. They are different. They might be present in the same situation but
does not imply they are the same. Returns to scale are linked to the elasticity
of output with respect to the inputs. They measure the sensitivity of the
output with respect to the changes in inputs. On the other hand, economies of
scale are linked to average costs and output. They examine the sensitivity of
the output with respect to the change in average costs of production. Thus there
exists a difference between the two. The BCG matrix can be explained through a
resort to returns to scale and economies of scale.
Question marks are those which are
exhibiting increasing returns to scale but do not exhibit economies of scale. As
the inputs increase, the output increases more than proportional to the change
in input thus resulting in increasing returns to scale. On the contrary as the
output increases, the average costs of production drop down thus exhibiting
economies of scale. In the initial stages, the increase in output would be
relatively lower thus witnessing lower possibility of economies of scale. Yet at
this stage, even small changes in inputs result in more than proportional
increase in output thus causing increasing returns to scale. Stars are the
classic examples where one observes both increasing returns to scale as also economies
of scale. Given the increasing market growth, it is evident that the output is
increasing more than proportional to the changes in input. At the same time, as
the output has increased the average costs of production are declining. The
declining average costs of production are indicative of the economies of scale
in progress. Thus stars have both boosters if one might call it and thus are
the key part in the product portfolio of the firm. Thus there is no wonder why
the firms would like each of their product to be stars.
The cash cows already have passed
the point of significant high degree of economies of scale. Yet, given the
output level, small increase in output too would bring down the average costs
of production but not by much. The economies of scale would now have given way
to constant economies of scale. The scale might not be the starting point for
cash cows as even then there is a significant scope for the firms to leverage
economies of scale. Yet the firms have already passed the stage of increasing
returns to scale and are manifesting the constant returns to scale. The increase
in output is leading to a similar response from the output. As the cash cows
would perhaps mature, there would be marked decline in leveraging economies of
scale and returns to scale. In a slow but steady manner, in absence of any
external intervention or correctional measure, the returns to scale would start
to diminish. The same would be observed with respect to scale as the firm
begins to experience the diseconomies. Diseconomies are the outcome wherein the
firm’s average costs increase with respect to increase in output. Decreasing
returns are the case in point wherein the firm’s output is less than
proportional in terms of its response to changes in input. The situation where
both diseconomies of scale as also the decreasing returns to scale sets is
referred to as dogs.
For dogs to be converted back into
question marks or stars, there needs to be an external intervention or an
exogenous shock. Else it would be game over for these products. They have
enjoyed their prime and perhaps it is time for the firms to move on beyond
caring for emotions. Thus as one observes, the BCG matrix can be easily mapped
to the concepts in economics. It can be mapped through the two parameters of
economies of scale and returns to scale. The journey of the firm or the product
through the path of returns to scale and economies of scale are resembling of
the behavior along BCG matrix.
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