Parallel Program
DYNAMIC MODELING FOR “PRODUCTS PORTFOLIO”
MANAGEMENT AND NEW PRODUCTS LAUNCHING
Carmine Bianchi Habib Sedehi
Assistant Professor HELP Auditing Informatico
Universita degli Studi di Palermo Via Antonio D’ Achiardi, 31
Facolta di Economia e Commercio 00158 Rome (ITALY)
Istituto di Scienze Economico Aziendali
Viale delle Scienze
90128 Palermo (ITALY)
Abstract
The paper aims to sketch a dynamic model in order to support decisions for the allocation of
financial (i.e. cash flow provided by current sales) and human resources to Marketing and R&D
policies, in order to better manage “product portfolio” and new products launching in an
industrial firm.
The working hypothesis from which the paper stems is to consider that the strategic control for
launching new products and monitoring the path of the old ones along their life-cycles is not only
possible through the use of accounting models, but also through dynamic models.
Both kind of models indeed can be useful in “product portfolio” management; however, each of
them may better satisfy different purposes.
More particularly, accounting models (i.e.: those which are mainly based on General Ledger data)
may better support some cognitive purposes regarding the management of each product
separately without taking in “account” the interrelation influences between new and old products.
On the other hand, the use of dynamic models, which is mainly based on non-accounting data,
may particularly enable to:
- improve management learning of the system (as a whole) to be handled;
- implement a strategic control sub-system of resources allocation to products, drawing more on
mental models, personal experience and intuition of the entrepreneur and of management than on
accounting data;
- improve an inter-functional and inter-divisional approach and so a better understanding of
trade-off among financial, marketing, production, R&D subsystems and though decision on
“product portfolio” management;
- point out the different levers on which management may act and evaluate the different effects
they may produce in the short and in the long term, so to assess the several possible consequences
of managerial decision on product life-cycle;
- better evaluate the medium/long term effects of product discretionary costs (Advertising, R&D,
Education, etc.) on product cash flows.
This may lead to a more integrated monitoring and understanding of the paths that different
products may run along their life-cycle.
The above said working hypotheses will empirically be tested in a medium-sized wine producer
firm.
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Introduction
The major goal of the paper is to define a dynamic modelling approach which might support
decisions concerning the allocation of financial and human resources to Marketing and R&D
policies in order to better manage the "products portfolio" and new products launching in an
industrial firm. The working hypothesis from which the paper stems is to consider that the
strategic control for launching new products and for monitoring those already exist is possible not
only through accounting models but also by using system dynamic methodology. Both kind of
approaches indeed are useful in “product portfolio” management; however, each of them better
satisfy different purposes.
More particularly, accounting models are essentially based on those data which are treated by so
called “transactional” systems (inventory accounting, customers, suppliers, ...) and on information
elicited from firm analytical and general accounting systems.
All accounting models- particularly the traditional strategic marketing ones - have the following
common characteristics:
- micro problem oriented, neglecting the interactions between high level master variables;
- rigid, not oriented to simulation approach;
- analytic, particularly oriented to feed reporting structure systems;
- generic, poorly focused to specific firm needs;
last but not least accounting models are not oriented to support management decisions because
they do not include and so understand firm system structure, which is the core of any high level
decision.
On the other hand, the use of dynamic models, which is mainly based on non-accounting data,
may particularly enable to:
- improve management learning of the system (as a whole);
- improve communication between people, drawing more mental models;
- improve an inter-functional and inter-divisional approach and so a better understanding of
trade-off among financial, marketing, production, R&D subsystems;
- point out the different levers on which management may act and evaluate the different effects
they may produce in the short and in the long term, so to assess the several possible consequences
of managerial decision on product life-cycle;
- better evaluate the medium/long term effects of product discretionary costs (Advertising, R&D,
Education, etc.) on product cash flows;
- make continue updating of the model and so to support firm frequent scenario changing.
After a brief general description of Product Life Cycle(PLC), it will be presented the “state of the
art” of traditional approaches(based mostly on Strategic Management Accounting systems) to
“product portfolio” management, mainly to underline their limits and so to verify how System
Dynamic approach could help the management to better analyze , understand and so decide. The
description of PLC in Italian Wine Sector will introduce the process which the paper will deal
with to put in evidence the strength of Dynamic Modeling for “product portfolio” management in
Casa di Vinicola di Duca di Salaparuta - here and after Corvo (a wine producer firm in Sicily).
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The "Product Life-Cycle"
Often management ought to face problems concerning the firm "product portfolio" and/or the
selection of Strategic Business Areas(SBA) ! in which to compete.
Some of the most important problems concerning this management area particularly refer to the
evaluation of the:
- most convenient time for a new product (SBA) launching;
- economic and financial consequences;
- different alternatives concerning human and financial resources allocation;
- different policies to pursue, economic and financial opportunities for product growth rate
increase or for prolonging or shortening its maturity stage;
- causal dependencies of financial and economical flows related to different products and possible
levers used to affect their dynamics;
- most balanced "product portfolio" configuration and, particularly, of the ability of the business
system to finance the new products growth through the reinvestment of financial flows provided
by more mature products;
The "Product-Life-Cycle" (PLC) analysis is a key-concept in managing "product-portfolio".
PLC depicts the behavior of each product sales revenues from its introduction on the market
through its obsolescence.
To assert that each product has its own "life-cycle" implies that (Kotler 1986 449):
- it may satisfy only for a limited time span the needs for which it has been conceived;
- the same needs may be felt by consumers for a limited period of time and, so, may cause
products obsolescence, even though they are still in life from a technical point of view;
- product sales evolve over distinct stages, each of them stresses specific management problems;
- each product financial and economical flows are influenced by its particular evolving stage;
- it is necessary to adopt different Marketing, Financial, R&D, Production strategies on behalf of
the particular product evolving stage.
Usually, PLC is defined through four stages (Forrester 1958; Kotler 1984 ,459-462; Levitt 1965;
Patton 1959; Dean 1950; Polli 1969; Buzzell 1966;; Guatri 1972,74-75.; Cox 1967; Ward 1992,
33-36) :
- launching;
- growth;
- maturity;
- decline.
The growth stage is normally characterized by a sharp sales increase, caused by promotion efforts,
sustained in /aunching phase.
During this stage, the firm has normally solved technical, production and commercial. problems;
this implies that product technical and qualitative parameters may become more stable inclining a
more standardized production.
This may lead to important cost savings (scale and experience economies) and so to higher
profits.
On the other hand, in this stage financial flows - even though having a growing dynamics - may
appear still negative. Such behavior may depend on the growing financial needs required by
1 A SBA is made up by one or more Product/Market/Technology combinations that may be considered as a
synthetical profitability area, characterized by an itself economic structure and by particular management needs
(Coda 1990, 50-51).
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current net working capital increases (particularly for account receivable and inventories), caused
by the necessity to adopt commercial policies supporting a demand increase.
In the stage of maturity, sales normally continue to raise with a decreasing rate, as price and
promotion policies tend to lose their impact on the potential market.
Both cash flows and profits are positive. However, cash flows may remain substantially steady, in
virtue of less "aggressive" commercial policies (particularly due to payment delays); on the other
hand, profits may decline, owing to the growing effect of Marketing-mix and, particularly,
advertising costs.
After the maturity stage the PLC may evolve on one of the three following alternatives:
- decline, and the successive product withdrawal or abandonment;
- freezing, i.e.: the continue achievement of a steady state in the demand level and the consequent
termination of product investments due to R&D, Production or Marketing activities;
- renewing, i.e.: a sales increase, due to investments oriented to increase and to improve product
functions (Valdani 1986, 309 ; Franchi 1987, 389)
Particularly, the decline stage takes place when the demand growth rate starts to be negative,
sometimes smoothly, or dramatically; in this stage both cash flows and profits have a decreasing
trend.
To resume the above said considerations, figure 1 shows sales revenues, cash flows and profits of
a "typical" PLC.
force
Figure 1. (from: Hax A. - Majluf N., Strategic Management,Prentice Hall Englewood Cliffs, 1984, pag.250).
The concept of PLC has been critiqued by several scholars. It has been particularly stated that:
- it is not so easy to foresee the PLC stages time length, also because they may differ according to
different products and the market sector. In fact, some products take several years to by-pass the
launching stage, while others are accepted in a short time by the market (Kotler 1986, 471);
- this concept independently refers to all kinds of products, without making any distinction among
different levels of aggregation (e.g.: product classes, brands, or even durable and non-durable
goods) (Polli 1968, 160-161; Porter 1980).
- PLC may impose a deterministic approach to strategy management decisions, that should be
characterized by a dynamic point of view, being that a firm is not, by its very nature, a static
system.
For example, due to a product sales reduction, the management could be tempted to believe that a
stage of decline is coming next, while it may be a matter of contingent market fluctuations, or of a
demand decrease caused by management and/or competitors decisions, independently on product
attitude to satisfy consumer needs.
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The decline stage will be unavoidable if, due to the demand reduction, top management decide to
reduce funds for that product, in favor of new product investments.
It should be worth while, however, to examine different alternatives for demand stimulation
changing, for example, client mix or different marketing levers, or again product positioning
(Dhalla 1976).
"Product portfolio" models as a traditional tool to manage product mix.
All traditional "product portfolio" models have as a common denominator some general features
that is worth while to underline.
Tn fact, information which could be elicited from them are as follows:
- normative, instead of descriptive,
- partial, instead of systemic;
- static, instead of dynamic,
- exploring of an existing state of the system, instead of anticipating of different possible
scenarios (Ansoff 1984, 99);
- unbalanced, as they refer only to some variables as, for example, sales, revenues, cash flows,
market share, ROI (Return On Investments), ROE (Return on Equity), instead of being well
balanced both referring to key variables and to the Jevers through which it is possible to affect
product portfolio performance;
- deterministic, instead of stochastic;
- oriented to the planning staff, instead of to the line product management too,
- oriented to a cognitive, instead of a behavioral, and/or political decision making process
(Ansoff 1984, 100-101).
Traditional "product portfolio" models are, still today, main tools - also in Italian firms - on which
strategic management accounting is based in order to support top management policies.
Such models, as well as those concerning management/responsibility accounting, may be defined
as accounting models, as they draw mainly their data from a common base:
- Transactional Systems (e.g.: data on inventory, account receivable/payable, cash, ...),
- General Ledger;
- Budgeting System.
"Product portfolio" models are usually based on inter-relationships between market growth rate
and market share for each product and/or SBA.
The model early (60's) proposed by Boston Consulting Group (BCG), represents a fundamental
milestone for the ones further sketched by others.
Some of the most referenced among them are as follows:
- General Electric-McKinsey & C. model, using an industry attractiveness-business strength
matrix (beginning 70's) (Hax 1991, 183-194);
- Arthur D. Little, Inc. model, using a product maturity-business competitive position matrix
(1974) (Arthur D. Little 1974 1979 and 1980);
- an alternative BCG model, using a Size of Competitive Advantage-Ways to Compete matrix
(beginning 80's) (Hax 1991, 206-207; Mc Namee 1985, 132-134);
- Marakon Associates model, using a Profitability matrix, crossing business investment growth
and Return On Equity (ROE) (beginning 80's) (Marakon Associates 1980);
Referring to the literature on this subjects, quoted in the bibliography of this paper, it is worth
while hereby to refer only to the BCG model.
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System Dynamics '95 — Volume II
The essence of the BCG approach is to represent the firm as a portfolio of different businesses,
each one offering a stand alone contribution to the growth of company revenues. The firm is so
viewed as a multi entity of largely independent units whose strategic guidelines are to be
distinctively addressed (Hax 1984).
The matrix which is specifically represented by four-quadrant grid indicates in the x axis Relative
Market Share (the strength of the firm in the SBA) and the y axis Market Growth Rate (the
attractiveness of the market for the SBA). A breaking point, defined by the company, separates
high-growth from low-growth business (figure 2).
Market Growth Rate
30%
Star Question Mark
10%
Cash Cow Dog
- 10% Relative Market Share
10 1 0
Fig. 2 - The growth share portfolio matrix
Once each product is positioned in the grid, the market man with statistics in mind associates a %
which defines the contribution of the product in company earrings on sales. In fact, each product
is represented on the matrix as a circle, whose diameter is proportional to its contribution.
Depending in which quadrant the product is positioned, through BCG approach it has a distinct
characteristic (Morton; 1987) with regard to company cash-flow (figure 3).
So, just to conclude rapidly, this brief BCG description, the approach suggests, for each product a
set of steps to undertake so to have best “feedback” from the market, taking in to account the
cash transfer, from those products that are highly profitable but have a limited potential for
growth, to those that offer attractive opportunities for future revenues.
Synthetically it can be affirmed;
- selective offensive strategies of “Question Marks” products;
- offensive strategies for all products in “Star” area;
- defensive strategies for “Cash Cows”;
- divest or harvest strategies for Dog productions.
Morton, Léffler an Wiedmann in their paper show that BCG approach can lead to erroneous
strategic choice by ignoring important feedback between the firm, its competitors and the general
economic environment.
This means that, according to the BCG approach, a balanced portfolio has to include products
simultaneously in three (Question Mark, Stars and Cash Cow) different quadrants. Even though a
portfolio containing products only in the bottom-left quadrant might be considered more
interesting in a short term perspective, on a financial point of view, it will be not so in a medium-
long term, as "cash cow" products sales will decline and no "question mark" or "star" products
will be raised to a "cash cow" class.
Parallel Program
Concluding remarks on traditional portfolio models.
Further revisions and new formulations of portfolio models, after BCG, integrated and improved
the foundations of the original concepts.
Stars
Scenario
Highly attractive products, which have
strong competitive position in a rapidly
growing market.
Interpretation
Products generate large amounts of cash
but at the same time require a significant
inflow of cash resources to hold the
competitive position in the growing market.
Action
Hold the position of products and invest.
Question Marks
Scenario
Products which appear to be very attractive
because of the high market growth rate, but
have a low market share.
Interpretation
Large cash needed to stimulate market.
Action
Most favorable products must be selected
and sufficient funds should be invested to
Products with extremely high competitive
strength in a declining market, generate
more cash than they can wisely reinvest
into “Question Marks” and “Stars”
Interpretation
The resource allocation process has to be
centralized at a higher managerial level,
otherwise the management of a product
will tend to reinvest in its own domain,
suboptimizing the use of its resources.
Action
The large positive cash should be used to
support the development of other
businesses (“Question Marks” and partly
“Stars”).
achieve a leading position.
Cash Cows Dogs
Scenario Scenario
Products are “great losers”: unattractive
and weak.
Interpretation
Cash generated by products at most is
needed for maintaining their operations.
Action
If there is no specific reason, the logical
strategy to follow would be harvesting or
divesting
Fig. 3 Characteristics of the different product positions
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The higher level of sophistication of such models has, on the other hand, weakened one of the
major advantages of the traditional portfolio approach, which are particularly highlighted through
synthesis and immediate graphic exposition of results.
In fact, most of methodologies adopted today are characterized by a too rigid and mechanistic
approach.
This implies that if these models are simply used as "stand-alone", may be poorly efficient and
unfocused to business real information needs, particularly in those contexts where it is not
available neither a Strategic Management/Responsibility Accounting, nor a divisional organization
structure.
Both in these last cases and, however, when the firm operates in a turbulent and complex
environment, it is worth while to adopt dynamic models - or, at least, to put them together with
traditional portfolio methodologies - so to support management through a systemic and flexible
approach in understanding problems structure and market processes.
According to this view, traditional approaches may be useful in identifying key-variables relating
to the relevant processes. However, these variables should be connected one another, usually
according to non-linear relations, and possibly with other "input" variables, that could identify
management system levers or environmental external constraints.
The Product Life-Cycle in the Italian wine sector.
The Italian wine sector, particularly in the last years, has been characterized by structural demand
changes, due to decreasing consumption.
There are, at least, three main market segments (GPF & Associati 1994-95, 15):
1) heavy consumers, to which mostly correspond declining or mature products;
2) medium consumers, to which mostly correspond growing or already developed products;
3) light consumers, to which mostly correspond products in the launching stage or in transit from
launching to development stage.
The first segment - even though most important from the consumption point of view - is
nowadays decreasing. To this segment belong those less evolved socio-cultural classes (GPF &
Associati 1994-95), who mostly drink wine during main meals and prefer "every day" red wines.
Wine consumption in Italy are today less and less related to daily habits (GPF & Associati 1994-
95, 14) and more and more to important gastronomic and specific situations.
More evolved consumers, during daily meals, prefer either beer or new wine brands than in the
past.
In conclusion, medium e light consumers segments are both increasing in respect of the first
segment.
Medium consumers prefer light wines, both red and white, while light consumers prefer
particularly sparkling and young wines.
In the early stage of the PLC it is possible to allocate "ad hoc" wines, either fantasy or well
known signed brands, or even those labeled by the name of the species of wine.
In the growing stage it is possible to find young and low alcoholic strength wines.
Auto-consumption and Direct supply wines are identified in the maturity stage. Sparkling and
"DOC" fine wines are positioned in the renewing stage.
Declining wines are those with a high alcoholic strength and daily and low-price wines ( figure 4).
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Direct Supply day Wines
@ Light Wines
@ Young Wines Wines
@ Well known signed brand Wines
Fig. 4 - Today Italian Wine Life Cycle Position
Dynamic modeling to support "product portfolio" management in an Italian wine
producer firm: Casa Vinicola Duca di Salaparuta (Corvo).
"Product portfolio" analysis in Corvo.
Today Corvo "product portfolio" is made up of 13 products, two of them are going to be
launched, that may be grouped in 5 SBA:
1) Classica, containing Corvo Bianco, Corvo Rosso, Corvo Rosato and Corvo Glicine wines;
2) Elegante, containing Colomba Platino and Terre d'Agala wines;
3) Riserve, containing Bianca di Valguarnera and Duca Enrico wines;
4) Specialita, containing Ala, Riserva Brut and Corvo Novello wines;
5) Giovane, containing Portale Bianco and Portale Rosso wines.
The above said products are devided in two categories, according to their positive or negative
sales trends:
a) positives: Corvo Rosso, Corvo Rosato, Corvo Glicine, Colomba Platino, Corvo Novello, Ala;
b) negatives: Corvo Bianco, Terre d'Agala, Duca Enrico, Bianca di Valguarnera, Riserva Brut.
Figure 5 shows all products position along their life-cycle curve.
After an initial analysis of the "product portfolio", it has been used the BCG methodology to
identify the different policies to be pursued for each kind of wine (figure 6).
More particularly, it is possible to observe that:
- Ala is evolving towards star class;
- Brut and Terre d'Agala that impose a decision oriented to renewing or to abandonment,
considering that a decline stage is next;
- Bianca di Valguarnera and Duca Enrico, for which it is necessary to understand if (and when)
they will possibly evolve to star class or will permanently remain in the question mark class.
Colomba Platino, Corvo Glicine and Corvo Novello, being in the star class, are holding a good
market position. They are good cash generators, but they require high investment support as their
market segment is continuously growing.
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System Dynamics '95 — Volume II
@Rosato @Rosso *
N. of bottles 4 *@Bianco
i @Colomba *
* 4 i*
Novell : ; *
* : i 4
@Glicine | : : *
* i E i *
@Ala : ; *
* : i : *
* *
Portale
Fig. 5 - Wine position of CORVO products Life-Cycle
Classica SBA products - except for Corvo Glicine - are in the cash cow class. Particularly Corvo
Rosato seems to be recently evolved to this class, after having been a star product. Corvo Rosso
seems to be in a more advanced stage, while Corvo Bianco is the nearest to dog class.
Portale Bianco and Portale Rosso are new brands in a launching stage in a growing market
segment, so they are positioned in question mark class.
AD ic Model for Corvo "Product Portfolio" Management.
The major goal of the model, which is still in progress, is to support management in verifying
which actions to adopt in launching the two new brands/products Portale Bianco and Portale
Rosso (presently positioned in Question Mark class), mainly taking in to account the financial
constraints given by cash flows generated by cash cow products.
The master variables identified, by now, in order to simulate different scenarios are as follows:
A) Business factors
- product, i.e.: quality, packaging, sales delay,...;
- price, i.e.: mark-up, discount ranges
- promotion, i.e.: advertising, agents sales incentives, fairs participation, conventions,...;
- physical distribution (or place), i.e.: delivery delay, stock level.,...;
B) Supply-chain factors
- competitors, i.e.: gentlemen's agreements, joint ventures, mutual product exchanges...
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- distributors, i.e.: agreements with trade, restaurants, small drugstores...
- suppliers,:
© Glicine : « Brut
H Ala
STAR Novello QUESTION MARK
® Colomba : oTerre
« Duca . Bianca
® Rosato
@ Rosso ;
CASH COW : DOG
e Bianco
eS)
Fig. 6 - BCG matrix of CORVO Product Portfolio
Moreover, there are other Environmental factors, i.e.. EEC constraints, Regional Government
tules, etc, that will not be considered in this first version of the model.
Both because of space limit imposed and present state of work , the model, “hopefully” with some
operative results will be indicated during the presentation.
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