Project Appraisal

Swagat Kishore Mishra

Department of Economics
WILP: Project Appraisal
Lecture 2
Email: [email protected]
Tel. 0832-2580207 (O) 08879506995 (M)

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Course No. ETZC414 Project Appraisal

Outline

Introduction: Strategy and Resource Allocation

Corporate Capital
Allocation of Corporate Capital
Portfolio Planning Matrices

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Introduction

i.
ii.
iii.
iv.
v.
vi.

Strategy and Resource Allocation

Capital is scarce
Managing the resource allocation is not simple
Investment options (Corporate RA Strategy)
Replacement and modernization
Capacity expansion
Vertical integration
Concentric diversification
Conglomerate diversification
Divestment

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 Developing a strategic direction, supported by

the necessary reallocation of resources and
coordinated business unit plans, and designing a
sustainable strategy development process.
Companies face a multitude of challenges when
designing and executing corporate strategies.
Many fail to distinguish a strategic review from
the annual budgeting process, or lack adequate
processes for strategic planning.
Is there a set of core capabilities and tools that
can help clients strengthen their strategies at the
enterprise level?
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Portfolio Strategy & Resource

Allocation
Many companies manage their portfolios through
the annual review of a single over-arching
budget.
But such an approach can turn portfolio
management into simply a series of budgeting
exercises, hiding the true range of strategic
options that a company has and obscuring
individual initiatives and their risks.
Companies can make high-level corrections this
way, but cannot create a truly balanced portfolio.
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 Senior managers today face an extremely dynamic

environment that requires vigilant scrutiny and nimble
management practices. Senior strategy executives, in
particular, have pointed to the need to better manage
uncertainty in strategy development through flexible and
adaptive strategic management practices.
This requires on-going dialogue on strategic issues, as well as
the ability to execute a new strategic plan. Highly effective
organizations have few barriers to reallocating resources and
implementing their corporate strategies.
However, most organizations struggle to implement their
plans, with one year's budget allocation being, by far, the
largest predictor of the next year's allocation.

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 Strategic portfolio management requires

companies to generate growth through
investment in existing businesses, developing or
acquiring new businesses, and exiting
unprofitable ones.
Doing so effectively requires taking a
comprehensive approach to resource allocation.
The firm helps clients define an optimal portfolio
mix by looking closely at their current mix of
assets, their capabilities, and their aspirations in
light of the evolving marketplace.
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Strategic Management & Planning

A critical part of enhancing the planning process
is improving overall strategic decision-making
capabilities. Left unchecked, subconscious biases
such as excessive optimism, groupthink, and loss
aversion will undermine strategic decisionmaking.
Behavioral strategy provides a perspective on
and a way to mitigate the impact ofthe biases
that are often inherent in clients decision-making
processes.
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Portfolio Planning Tools

They assist in strategic planning and resource
allocation
Two types:
i.
ii.

BCG Product Portfolio Matrix

General Electric Spotlight Matrix

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i. BCG Product Portfolio Matrix

A Perspective titled "The Product Portfolio" introduces the
growth-share matrix. This framework categorizes products
within a company's portfolio as stars, cash cows, dogs, or
question marks according to growth rate, market share, and
positive or negative cash flow.
By using positive cash flows a company can capitalize on
growth opportunities.

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 To be successful, a company should have a

portfolio of products with different growth
rates and different market shares.
The portfolio composition is a function of
the balance between cash flows.

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i. General Electric Spotlight Matrix

The GE/McKinsey Matrix is a nine-cell (3 by 3) matrix used to
perform business portfolio analysis as a step in the strategic
planning process.
The GE/McKinsey Matrix identifies the optimum business
portfolio as one that fits perfectly to the company's strengths
and helps to exploit the most attractive industry sectors or
markets.
Thus, the objective of the analysis is to position each SBU on
the chart depending on the SBU's Strength and the
Attractiveness of the Industry Sector or Market on which it is
focused.
Each axis is divided into Low, Medium and High, giving the
nine-cell matrix as depicted in next slide.
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SBUs are portrayed as a circle plotted on the GE/McKinsey Matrix, where the size of the
circle represents a factor such as Market Size. The GE/McKinsey Matrix differs from other
tools, like the Boston Consulting Group Matrix, in that multiple factors are used to define
Industry Attractiveness and Business Unit Strength.
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 Each factor can be given a different weighting in

calculating the overall attractiveness of a particular
industry.
Typically:
Industry Attractiveness = Attractiveness Factor 1 Value by
Factor 1 weighting + Attractiveness Factor 2 Value by Factor 2
weighting, etc.
Business Unit Strength = Strength Factor 1 Value by Factor 1
weighting + Strength Factor 2 Value by Factor 2 weighting,
etc.
This template allows the user to define up to 10 SBUs to be plotted. Up to
10 different factors can be used to define Industry Attractiveness, Typical
factors would be Market Size, Market Growth Rate, Industry Profitability,
Competitive Rivalry, etc.
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Types of Portfolio Analysis

Growth Share Matrix (Boston Consulting Group)

Industry Attractiveness/Business Position Matrix (General
Electric)

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Market Growth Rate

The Boston Consulting Groups GrowthShare Matrix

20%18%16%14%12%10%8%6%4%2%0

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Stars

Question marks

?2

Dogs

Cash cows

1
8

6
10x 4x 2x 1.5x 1x

.5x .4x .3x .2x .1x

Relative Market Share

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Star Strategies
Leader expanding industry
Generates large profits
Requires substantial
investments to sustain
growth
Farthest down on
experience curve relative to
competition
Increase sales e.g. new
markets, new channels of
distribution
Increase market share
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Problem Child or ?
Low market share in
expanding industry
Needs substantial cash to
improve its position
Slow progress on
experience curve
Increase sales (limit to niche
or increase market share
(limit to niche)
Leave market

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Cash Cow
Leader in mature or declining
industry
Can generate funds for other
SBUs
Maintain market share e.g.
ensure quality, build customer
loyalty, develop substitute brands
Maximize Cash Flow e.g. increase
usage rate, rate of replacement,
modify expense structure, raise
prices

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Dogs
Low market share in a
mature or declining industry
Slow progress on
experience curve
Cost disadvantages and few
growth opportunities
Harvest or Divest
Concentrate on niches
requiring limited effort

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Strategy Implications BCG

Star Leader in Expanding Industry
BUILD - Continue to increase market share if necessary at
expense of short-term earnings

Problem Child Low market share in Expanding

Industry
HARVEST if weak, BUILD if strong.
Assess chances of dominating segment. If good, go after
share. If bad, redefine business or withdraw.

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Strategy Implications BCG

Cash Cow Leader in mature or declining industry
HOLD - Maintain share and cost leadership until further
investment becomes marginal
Maximize cash flow

Dogs Low market share in a mature or declining

industry
DIVEST Plan an orderly withdrawal so as to maximize cash
flow or concentrate on niches that require limited effort

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Assumptions of Growth /Share Matrix

High market share generates cash revenues ?
High Market growth uses more cash resources ?

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Issues with Growth/Share Matrix

Market growth is not the only factor related to
cash usage.
Market growth is not necessarily related to cash
usage.
Market share is not necessarily related cash
generation.
Multiple factors lead to profitability.
Cash is not the only factor in evaluating a
portfolio.

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Issues With Growth/Share Matrix

Limited to industries where experience curve
is relevant
Appropriate for volume industries
Overlooks perils of growth
Measurement problems
Product-market definition problems
Difficult to implement strategies
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SPACE Approach
Strategic Position and Action Evaluation Matrix
SPACE Analysis is a systematic appraisal of four key
issues that balance the external and internal factors
that should determine the general theme of the
strategy:
External
i.
ii.

Industry Attractiveness
Environmental Stability

Internal
i.
ii.

Competitive Advantage
Financial Strength

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 By combining ratings on each dimension on one SPACE

matrix diagram, the framework guides the strategic agenda.
The dimensions are combined in a way that seems strange
at first but makes sense because two sets of factors are
assessed as strengths (financial strength and industry
strength) and rated positive while the other two
(competitive advantage and environmental stability) are
assessed as potential weaknesses and rated negatively.

The logic is that financial strength is needed to compensate

for environmental instability. The more difficult the future
environment is thought to be, the more important it is to
have strong financials.

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 Financial Strength is scored 6

great to 1 poor in the SPACE
Analysis Matrix
Competitive advantage is scored 1 (minus 1) great to 6 (minus 6)
poor
Industry attractiveness is scored 6
great and 1 poor in the SPACE
analysis matrix
Environmental stability is scored
1 (minus 1) great to 6 (minus 6)
poor
This diagram shows that the firm is in a very favorable position and is able to
take an aggressive growth strategy. It is operating in an attractive and stable
industry and has major competitive advantages backed up by significant
financial strength.
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Key Words

Resource allocation framework

Resource allocation strategies
Portfolio planning tools
Strategic planning and Capital budgeting

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THANK
YOU
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