THE BOSTON CONSULTING GROUP
UNIVERSITÀ DI GENOVA
Corso di Laurea in Ingegneria Gestionale
31 Gennaio 2003
Experience curve e la matrice BCG
PORTFOLIO MATRIX IS A TOOL ORIGINALLY DEVELOPED
TO ASSESS CASH FLOWS BALANCE WITHIN A FIRM
Business portfolio of group xxx, B ITL 1996
Market 10%
growth
OTC
drugs
Star
Wines
Industrial
machines
5%
Question
mark
RX drugs
Wholesaling
Consumer
Products
Packed meat
cash
cash
absorbed
absorbed
Seeds
Business controllati
Cash cow
Business in JV
Dog
Fatt. 100 Mdi
1%
10
1
0.1
cash
cash
generated
generated
0.01 Relative
market share
Why
Why growth
growth is
is aa proxy
proxy for
for cash
cash absorbed?
absorbed?
Why
Why market
market share
share is
is aa proxy
proxy for
for cash
cash generated?
generated?
•• What
What impacts
impacts cost,
cost, in
in particular?
particular?
UniGenova-January2003
-2-
SCALE, EXPERIENCE, COMPLEXITY, AND UTILIZATION
HAVE DISTINCT COST EFFECTS
Scale
•
•
Relates unit cost or price to production volume
Generally applies to machines or facilities of different sizes at a point in time
Experience
•
Relates unit cost or price to cumulative production
•
Best to think in terms of entire industry experience over long periods
•
Arises for a variety of economic reasons
•
Is used a lot less frequently than you may think
Complexity
•
Relates unit cost to some measure of complexity
•
Either
- over time
- over different facilities at a point in time
Utilization
•
Relates unit cost or profitability to utilization as a percentage of capacity
•
Applies to different volumes or output from given facilities over time
UniGenova-January2003
-3-
SOMETIMES UNIT COSTS HAVE A “CONSTANT ELASTICITY”
y
log y
x
log x
Which
Which examples
examples follow
follow this
this behaviour?
behaviour?
•• Under
Under which
which circumstances?
circumstances?
UniGenova-January2003
-4-
A SIMPLE EXAMPLE: ECONOMIES OF SCALE
Unit Cost decreases as Volume Increases
In a cost structure, “scale economics” exist when an increase in volume requires
less than a proportional increase in cost
•
If so, then unit cost falls as volume increases
Rather than a rare exception, this is actually the norm and is caused by the fixed
part of cost structure
Fixed Cost
•
As Unit Cost =
+ Variable Cost, you can use the FL/VC ratio to
Volume
predict whether scale exist
We need to define a way to measure the decrease of unit cost related to volume
increase
•
BCG uses the “slope” concept
Slope
Slope is
is defined
defined as
as the
the decrease
decrease of
of unit
unit cost
cost
(in
(in %
% terms)
terms) for
for aa doubling
doubling of
of volumes
volumes
UniGenova-January2003
-5-
BCG slope
BCG SLOPE IS DEFINED AS THE NEW UNIT COST
AT EVERY DOUBLING OF THE VOLUME
log
Unit Cost
LogUC2 - logUC1
b=
logV2 - logV1
log
(old cost)
log
(slope* old cost)
log slope
b=
log2
log
(old volume)
log
(2* old volume)
log Volume
slope= 2 b
log (unit cos t) = a + b · log (Volume)
UniGenova-January2003
-7-
DIFFERENT COST SLOPES (LOG-LOG)
YIELD DIFFERENT BCG SLOPES
Slope of
log V, log UC
Log UC
BCG
Slope
b=
0
s = 100%
b=
-.152
s = 90%
b=
-.322
s = 80%
b=
-.515
s = 70%
b=
-.737
s = 60%
b=
-1
s = 50%
b<
-1
s < 50%
b>
0
s > 100%
Interpretation
log V
UniGenova-January2003
-8-
TWO WAYS TO CALCULATE ECONOMIES OF SCALE (BCG SLOPE)
Starting from observed data point
Easy way: Derive S from doubling V
(1) Find approximate doubling of V to 2V (not
log V, log 2V!)
Calculate b, then determine UC
(1) Convert V, UC to log V, log UC
(2) Determine slope b (of log V, log UC)
(2) Calculate S
•
S =
UC2
(at 2V)
UC1
(at V)
For multiple data points, regress:
log UC = a + b• log V
•
For 2 data points, calculate slope:
b=
(3) If necessary derive b (not often)
b =
log S
log V2 – log V1
(3) Derive S from b, using:
S = 2b
log 2
Easy method for quick estimate
UniGenova-January2003
log UC2 – log UC1
Only method with regression
-9-
TWO WAYS TO PREDICT UNIT COST IMPACT FROM SCALE
Starting from BCG slope and starting / ending volumes
Easy way: Predict UC2 from doubling V
(1) If V doubled, predicted UC2 is simple:
Calculate b, then determine UC
(1) Derive b from S, using
log S
UC2 = S • UC1
b =
log 2
(2) Plug in b, old V1, UC1, new V2 (logs!)
into slope equation;
b =
log UC2 – log UC1
log V2 – log V1
and solve for new log UC2
(3) Translate log UC2 out of log
UniGenova-January2003
(
b
(
UC2 = UC1 •
V2
V1
-10-
Exercise
Exercise
AN APPLICATION OF SCALE ANALYSIS
Problem:
You are reviewing the 3-year business plan of a Telco operator
They are aiming at move from a target of 120 000 customer for
next year, to 900 000 the year after and reach a total of 1.8m in
the third
The Marketing director, asked to project customer acquisition
costs over the entire period, expects them to half
The Sales director thinks he is crazy
UniGenova-January2003
-11-
Exercise
Exercise
ECONOMIES OF SCALE SIGNIFICANTLY REDUCE
ACQUISITION AND RECURRING COSTS
Example: acquisition costs for a Telco operator, €/client
87
Marketing
32
“Slope” (%)
Overall activity cost slope is … %
80
This information can support
Incentives
4
90
?
?
?
?
Sales and
distribution
?
42
?
90
Clients (‘000)
UniGenova-January2003
10
116
70
X8
?
928
• Estimate of cost position for
competitors at different scale,
given the cost of factors
• Simulation of impact of
managerial options
?
Activation
• Projection of future evolution
of cost, given expected
volumes
?
X2
- i.e. increase/reduce fixed
vs variable selling cost
?
1 856
-12-
WARNING: WHEN LOOKING FOR SCALE, LOOK THE RIGHT WAY
Find the meaningful scale relation
Illustration: tissue manufacturing
Cost
per ton
($/t)
P6
•
P1
•
P3
•
Cost
per ton
($/t)
P6
•
P1•
P2
•
P3
•
P2
•
P4
•
P5
•
Plant size
000 tonn/ year
No
No economies
economies of
of scale
scale ??
•P4
P5
•
Machine size
000 ton/ year
Sure,
Sure, but
but only
only by
by machine
machine size
size
Px : plant x
UniGenova-January2003
-13-
DOES SIGNIFICANT SCALE EXIST?
Process
Process
High
High fixed
fixed Cost
Cost
!
! steep
steep slope
slope (60-70%)
(60-70%)
High
High variable
variable cost
cost
!
! flat
flat slope
slope (90-95%)
(90-95%)
Manufacturing
Manufacturing
Truck
Truck production
production line
line
Hermes
Hermes tie
tie production
production
Marketing
Marketing
Television
Television advertising
advertising
campaign
campaign
Discount
Discount coupon
coupon
Sales
Sales
Trading
Trading on-line
on-line
Phone
Phone sales
sales of
of books
books
Think
Think carefully
carefully about
about the
the product,
product, customer
customer and
and process
process
UniGenova-January2003
-14-
SCALE EXAMPLES
Paper
Paper machine
machine labor
labor
Advertising
Advertising costs
costs
Man-hours/
ton
58% Scale (S)
Advertising/ 0.05
sales
0.04
60% Scale (S)
0.03
1.0
0.8
0.02
0.6
0.4
0.2
0.01
40 60
100
200
400
800
Machine capacity (TPD)
As expected -large machines suggest
high fixed costs
UniGenova-January2003
8
16
24
32
Sales (US$M)
Suspiciously steep
-15-
HOWEVER, THINK BEYOND THE DATA
First Cut of Data Would Show Wide Dispersion
Automotive Component Suppliers
Salaried and 10.0
Indirect Employees/
Sales ($M)
5.0
3.0
100
2.0
70
1.0
30
0.5
2
5
10
20
50
100
200
Plant Sales/Product Family ($M)
Traditional Approach
Cost-based Management Approach
Time-based Management Approach
Source: BCG Analysis
UniGenova-January2003
-16-
DIFFERENT VOLUME LEVELS CAN JUSTIFY
SUPERIOR TECHNOLOGIES
Conventional Lathes by Mechanical Design
Machining
Cost/Piece
Manual Universal
Machine
Manual
Copy Lathe
Manual
Chucker
Automatic
Single Spindle
Automatic
Multispindle
Lot Size
UniGenova-January2003
-17-
NOT ONLY SCALE HAS AN IMPACT
ON COSTS: EXPERIENCE CURVE (I)
Learning restricted within companies
Direct Costs Per Megawatt Steam Turbine Generators 1946-1963
Direct Cost/
MW
380
Allis-Chalmers
340
300
General Electric
Westinghouse
260
5
UniGenova-January2003
15
50
Firm Cumulative
Megawatts (M)
-18-
NOT ONLY SCALE HAS AN IMPACT
ON COSTS: EXPERIENCE CURVE (II)
Learning is shared by entire industry
Crushed and Broken Limestone Prices
Price/Ton
($ Constant)
80% Slope
2.50
1938
2.00
1945
Price
Price data
data can
can be
be plotted
plotted
against
against different
different
experience
experience bases:
bases:
•• The
The industry’s
industry’s
1929
1952
1.50
1971
1.5
2
3
4
5
6
7
8
10
•• The
The technology’s
technology’s
•• The
The company’s
company’s
•• The
The leader’s
leader’s
•• The
The fastest
fastest growing
growing
competitor’s
competitor’s
•• Etc.
Etc.
Industry Accumulated Experience
(B Tons)
UniGenova-January2003
-19-
COMPLEXITY COSTS ARISE FROM PROBLEMS
AND COSTS INVOLVED IN COORDINATING MANY ACTIVITIES
Complexity gives rise to unit costs that increase with the scope of activity
• Scope in manufacturing: parts, models, product lines, etc. . . .
• Scope in administration: businesses, countries, etc. . . .
• Complexity often works against scale
Example: the cost of connecting every two people in a communication network with
a dedicated connection at $1 per connection
Number
of People (~)
2
5
10
50
100
UniGenova-January2003
Number of Connections
[(N)(N-1)/2]
1
10
45
1,225
4,950
Cost/Person ($)
0.5
2
4.5
24.5
49.5
-20-
COMPLEXITY ARISES IN INDUSTRY DUE TO MANY FACTORS
Plant makes so many products that machines spend substantial time
changing over between products
Salesmen sell too many products to master any one of them properly
Multiproduct plant has high administrative costs of coordination and tracking
UniGenova-January2003
-21-
COMPLEXITY EXAMPLES
Machine
Machine Manufacturing
Manufacturing
Other
Other Manufacturing
Manufacturing
8 Factories
Indirect Cost 30
(% of Total
Cost)
20
Indirect Cost
(% of Total 50
Cost)
30
20
10
10
139%
5
5
10
20
40
# of Product Families Produced
4 5 6
8 10
15 20 30 40 50
# of Models
Source: BCG Interviews and Analysis
UniGenova-January2003
-22-
UTILIZATION IS ANOTHER FACTOR IMPACTING COSTS
Health
Health Care
Care Services
Services
Printing
Printing Presses
Presses
Daily
Procedures/
Professional
Cost/ 140
Procedure
($) 100
5
80
Fully 78
Loaded 77
Cost
($/1,000 76
32s)
New Technology
75
60
10
74
73
40
15
20
Standard Gravure
72
71
20
70
16
69
12
68
0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00
2
3
4 5
20
Number of Professionals/Office
Aggressive Gravure
Note: Assumes 2,000,000 Run Length
Utilization
Utilization is
is important
important when
when
•• Capital
intensity
is
high
Capital intensity is high
•• Energy
Energy consumption
consumption is
is major
major part
part of
of costs
costs
•• Startup
costs
are
high
Startup costs are high
•• Labor
Labor force
force is
is not
not flexible
flexible
Different
Different from
from scale
scale
•• Frequently
Frequently the
the two
two phenomena
phenomena interact
interact
UniGenova-January2003
-23-
SO ... WHAT DO YOU THINK ABOUT THIS PORTFOLIO?
Business portfolio of group xxx, B ITL 1996
Market 10%
growth
OTC
drugs
Star
Wines
Industrial
machines
5%
Question
mark
RX drugs
Wholesaling
Consumer
Products
Packed meat
cash
cash
absorbed
absorbed
Seeds
Business controllati
Cash cow
Dog
Business in JV
Fatt. 100 Mdi
1%
10
1
0.1
cash
cash
generated
generated
UniGenova-January2003
0.01 Relative
market share
-24-
... AND THIS ONE?
Business portfolio of group yyy (1999, B €)
Market growth, 25%
avg last three
years, (%)
20%
Insurances 3,1
15%
Trucks 7,4
10%
Automation 1,3
cash
cash
absorbed
absorbed
5%
Engines 1,4
Foundry 1,7
Tractors* 9,4
0%
10,0
Automotive 24,1
Components 4,1
0,1 Relative
market share
1,0
-5%
€ 1 B sales
cash
cash
generated
generated
UniGenova-January2003
Intercompany share
-25-
An excercise
Exercise
Exercise
A SOUND COST ANALYSIS IS THE BASE
FOR STRATEGIC DECISIONS
Problem:
Sirio, a 1 bn € grocery retailer, with strongholds in 2 of the 8
regions of the country is overlooking 3 options for acquisition
•
Andromeda, a same-sized national retailer
•
Berenice, a 500m € local retailer competing in same
regions
•
Cassiopea, a 500m € local retailer competing in
bordering regions
Which option would provide the highest competitive advantage
from an operating cost perspective ?
UniGenova-January2003
-27-
Exercise
Exercise
A SOUND COST ANALYSIS STARTS WITH THE COST STRUCTURE
Example: cost structure of a grocery retailer, average figures
Key driver
COGS
75%
Logistics
5%
POS labour
12%
Advertising
2%
Central Staff
4%
OP. Margin
2%
UniGenova-January2003
Scope
Slope
-28-
SCALE AND COMPLEXITY TYPICALLY
WORK AGAINST EACH OTHER
Measured in the same way
Overhead
cost/unit
Combined impact= f (v, p)
Complexity impact = f (p)
Scale impact = f (v)
1
10
100
1,000
Volume
Managing
Managing complexity
complexity reduces
reduces cost
cost
UniGenova-January2003
-29-
COST MIGHT BEHAVE LIKE WAVES
Examples: specialty retail chain, simulation on cost model
Cost
(as % of sales) 96%
92%
88%
84%
80%
0
5
10
15
20
25
Number of
stores
Source: BCG client case
UniGenova-January2003
-30-