Wage Incentive Plans: Objectives, Advantages, Limitations and Types?

Wage Incentive Plans: Objectives, Advantages, Limitations and Types!
Wage incentive refers to performance linked compensation paid to improve motivation and productivity. It is the monetary inducements offered to employees to make them perform beyond the acceptance standards.

According to the National Commission of Labour “wage incentives are extra financial motivation. They are designed to stimulate human effort by rewarding the person over and above the time rated remuneration, for improvements in the present or targeted results”.
Scott defines it as “any formal and announced programme under which the income of an individual, a small group, a plant work force or all the employees of a firm are partially or wholly related to some measure of productivity output”.
Human and Nickerson define it in simple terms as “all the plans that provide extra pay for extra performance in addition to regular wages for a job”.

Objectives of Wage Incentive Schemes:

(i) To use wage incentives as a useful tool for securing a better utilisation of manpower, better productivity scheduling and performance control, and a more effective personnel policy.
(ii) To improve the profit of a firm through a reduction in the unit costs of labour and materials or both.
(iii) To increase a worker’s earning without dragging the firm into a higher wage rate structure regardless of productivity.
(iv) To avoid additional capital investment for the expansions of production capacity.

Principles of a Good Wage and Salary Administration:

a. Simple and easy to understand.
b. Union management agreement.
c. Time standard must be fixed.
d. Reward must be proportional to the effort.
e. Complaints and grievances must be properly attended to.
f. The plans should not change frequently and must be tried out continuously for some length of time.
g. Equity and fairness.
h. Workers must be made to understand the plan.
i. Method study must precede time standard.
j. There must be a min guaranteed payment.

Advantages of Incisive Plans:

Wage incentive plans benefit not only the employees but also the employers.
a. Wage incentive plans provide an opportunity for hardworking and ambitious workers to earn more.
b. It encourages employees to be innovative. They come out with more efficient ways of doing work by overcoming the problems related to productivity and wasteful practice.
c. Incentive plans help to improve discipline and industrial relations. Effective incentive plan helps in minimizing absenteeism, accidents etc.
d. The self motivation on the part of the workers to work hard and improve performance so as to earn monetary rewards will reduce the cost of supervision.
e. The scientific work study undertaken before introducing the incentive plans helps in improving work flow, work methods etc.
f. The employees are encouraged to work as a team with mutual co-operation as their activities is interdepen­dent, and any obstruction on the part of a worker can affect the output and rewards.
g. According to the National Commission on Labour, “wage incentive is the cheapest, quickest and surest means of increasing productivity.”

Limitations:

a. Jealousy and conflicts among workers may arise when some workers earn more than others.
b. Unless strict check and inspections are maintained, quality may come under stake in the enthusiasm among workers to increase productivity.
c. In the absence of a ceiling on incentive earnings, some workers may spoil their health.
d. Strict vigilance becomes necessary to ensure that workers do not disregard safety regulation.
e. The cost and time of clerical work increases in introducing and administrating the incentive plans.
f. Whenever production flow is disrupted due to the fault of management, workers insist on compensation.

Types of Wage Incentive Plans:

Following are the types of wage incentive plans.
They can be diagrammatically represented as below:

1. Straight Piece Rate Plan:

Under the straight piece rate plan workers are paid based on their output. For example, if the piece rate is Rs. 4 per piece of the product, then a worker who turns out 40 pieces/day earns Rs. 160 (Rs. 4 x 40) as his wage for that day. Whereas another employee who produces 32 pieces/ day earns Rs. 128 (Rs. 4 x 32 pieces). Hence a fast worker earns more compared to the slow worker.
Advantages:
i. Motivates the workers to increase their output.
ii. Simple and easy to understand.
iii. improve productivity.
Disadvantages:
i. No guaranteed minimum wage. This makes workers insecure.
ii. Great disparity of earning between slow and fast workers.
iii. Wastage might increase.
iv. Quality of production may suffer as the workers concentrate on quantity.
v. Interpersonal relationship suffers due to jealousy and competition to earn more.
vi. Enforced idleness like electricity failure or machine breakdown, adversely affect earning of workers.

2. Standard Piece Rate with Guaranteed Minimum Wage:

Here the minimum guaranteed wage is fixed on hourly basis. A worker gets the minimum fixed wage/day plus the incentive for the number of pieces produced. To illustrate this, assume that there is 8 hour’s shift the piece rate is Rs 4 and a minimum fixed wage of Rs 16/ hours (Rs 16 x 8 hours = Rs. 128 per day). The standard time/piece is 15 min.
Now, there are two workers A and B. (If worker A produces 25 prices/day then he earns: Rs. 128 (min. guaranteed wage) + Rs. 100 (Rs. 4 x 25 pcs) = Rs. 228/ day
If worker B produces 40 pieces / day then he earns Rs. 128 (min. guaranteed wage) + Rs. 160 (40 pieces x Rs. 4) = Rs. 228/ day)
Advantages:
i. Min. guarantee improves sense of security.
ii. Disparity between slow and faster workers is reduced.
Disadvantages:
i. Demotivate faster worker.
ii. Slow workers get higher piece rate viz Rs. 5.12 (128/ 25).
Differential Piece Rates:
The shortcoming of the above mentioned incentive plans have given way Differential piece rates. The differential piece rates are classified under two heads viz. Individual incentive plans and Group incentive plans.
Individual Incentive Plans:
The different plans here are discussed below:
(a) Halsey Plan:
The features of this plan are:
a. Min. wage is guaranteed.
b. Additional bonus is provided to workers who
Wage and Salary Administration 147 complete the job in less than the “standard time”. Bonus is a certain proportion to the time saved. This proportion is fixed at 50% in this plan.
The total wage is calculated as:
T x R + 50% (S – J) x R
Where J – time taken
R – Rate of wage
S – Standard time
50% – The bonus percentage.
Illustration:
S = 10 hours, J = 8 hours; R = Rs. 5 / Hr; Bonus = 50%
Φ = 8 x 5+(50/100) x (10 – 8) x 5
Φ = Rs. 45.
Advantages:
i. Guaranteed min. wage exists.
ii. Simple and easy.
iii. Dispensed with time consuming and costly process of work study.
iv. Management share a part of bonus on time saved.
Disadvantages:
i. Workers get only half of the benefit of their efficiency.
ii. If the worker’s rush through the job to save time, the quality may suffer.
iii. Workers object management in sharing bonus on time saved.
iv. Sufficient incentive is not provided to fast workers.
(b) Rowan Plan:
This is a modified form of Hasley Plan, developed by James Rowen of England. The Rowan Plan pays more than the Halsey Plan. This is possible if a worker completes the task in half the standard time of the task. If more than 50% time is saved then the bonus he earns decreases.
Therefore, Total wage = J x R + [J x R x (Time saved/std. time)]
Illustration:
S = 10 hours; J = 8 hours; R = Rs. 5 / hrs.
Φ =8 x 5 + [8 x 5+ (2/10)]
Φ = Rs. 48
Advantages:
i. Minimum guaranteed wage exists.
ii. Both the employees and the workers share the benefits of time saved.
iii. The efficient workers get bonus at diminishing rate if they save more than 50% of the standard time. This checks over-speeding.
Disadvantages:
i. Incentive provided for fast worker is not sufficient.
ii. Workers dislike management sharing bonus of time saved.
(c) Gantt plan:
This plan was developed by Henry L. Gantt. Here standard time for every task is fixed through time and motion study. Minimum time wage is guaranteed to all workers.
A worker who fails to complete the task within the standard time receives wages for actual time spent at the specified rate. Workers who achieve or exceed the standard get extra bonus varying between 20% to 50% of the hourly rate for the time allowed for the task.
Illustration:
(S) Suppose the standard time fixed for the job is 8 hours and (T) time rate is Rs. 10 hours and the rate of bonus is 25%, then a worker who completes the job in 10 hours will be paid Rs. 10 x 8 = Rs. 80. On the other hand the worker who completes the job in 6 hours will be paid Rs 100 (Rs. 80 + 25% of Rs. 80).
Advantages:
i. Minimum guarantee exists.
ii. Fast worker is paid bonus at higher rate proportional to their output.
iii. Standard worker is paid 20% bonus.
iv. Part of bonus is shared by the organisation.
Disadvantages:
i. Sharing of bonus by organisation is resentment.
ii. Disunity among the slow and the fast workers.
(d) Bedeaux Plan:
This plan is developed by Charles E. Bedeaux in 1911. Here the minimum time wage is guaranteed to all workers. The workers who complete the job within or more than the standard time are paid at the normal time rate.
Workers who complete the job in less than the standard time are paid bonus, generally 75% of the wage for the time saved and 25% to the foreman.
The wage rate is calculated as:
S x R + 75% of R (S – T)
Illustration:
S = 10 hrs; R = Rs. 5 / hrs; T = 8 hrs.
Then:
Φ = 10 x 5+ 75% (5) x (10-8)
= 50 + (3.75 x 2)
= 50 + 7.50
Φ = Rs. 57.50
Advantages:
i. Min. wage is guaranteed to all the workers.
ii. The foreman is motivated to the productivity as 25% of time saved is paid to him.
iii. This plan is suitable in factories wherein a worker is expected to perform different types of jobs.
Disadvantages:
i. Workers may resent sharing the bonus with foreman.
ii. Workers may find it difficult to understand the complete calculation involved in this method.
(e) Emerson’s Efficiency Plan:
This plan was developed by Harrington Emerson. Here minimum wage is guaranteed. Workers are paid different bonus rates as per their efficiency level. Bonus is given at an increasing percentage beyond the prescribed level of efficiency (usually 66.67%). Efficiency is measured by comparing the actual time taken with the standard time.
Illustration:
S = 10 hrs, T = 8 hrs, R = Rs. 5 / hr.
Bonus = 10% upto 75 % efficiency
20% for 75%- 100%
30% beyond 100%
Φ = (T x R) + (percentage of bonus x T x R)
In this case, the efficiency level in (10/8) x 100 = 125% and,
Bonus at 30% is payable.
Total wage = 8 x 5 + (30/100) (8 x 5)
= 40+12
Rs. 51.
If worker A takes 16 hrs, then his bonus is nil.
If worker B takes 14 hrs, his bonus is (1/10) x 14 x 5.
If worker C takes 10 hrs, his bonus is (2/10) x 10 x 5.
If worker D takes 8 hrs, his bonus is (3/10) x 8 x 5.
Advantages:
i. Guaranteed time wage provides a sense of security to all the workers.
ii. It encourages healthy competition among workers.
iii. Bonus begins at 66.67% efficiency which is within the reach of many workers.
Disadvantages:
i. There is little incentive after 100% efficiency level.
ii. The plan is not very flexible or selective.
iii. Employer may fix the standard time at a low level making it impossible for most of the workers to earn bonus.
Group Incentive Plan:
In some cases like an assembly line production it is not possible to determine the performance of an individual worker as several workers jointly perform a single operation. In such cases it is desirable to introduce a group incentive scheme. Here the bonus is calculated for a group of workers and the total amount is distributed among the group members in proportion to the wage earned by each.
(a) The Scalar Plan:
This is a group plan where the productivity of the entire work force is taken into account. In this plan bonus is paid at the rate of 1 % for every 1% rise in productivity. Workers are not paid the full amount of bonus earned by them in the same month.
A certain percentage is set aside as a “Resource Fund” to take care of fluctuation. At the end of the year, the balance remaining in the “Reserve Fund” is also distributed.
(b) Priest Man Bonus Plan:
Here a committee of workers and management set the standard of performance. A minimum wage is guaranteed to each worker. The group gets bonus when actual output exceeds the standard. The group supervisor also gets a share on the group bonus. This plan promotes team spirit among employees.
Other Forms of Incentives:
Apart from the above mentioned incentive plans; there are also other forms of incentives, especially for the white collared workers. They are briefly discussed below.
Employee Stock Option Plan:
This is popularly known as ESOP. This is a form of incentive where the employees are allotted the company share at a price below the market price. When the company achieve better results, the market price of its shares and the value of the employees’ shareholding rise.
This form of incentive plan is relatively new in India and is becoming popular of late. IT is motivating to the employee, as (it enhances a sense of belongingness to the organisation) shareholders are the owners of the organisation.
Profit Sharing:
Prof. Seager defines profit sharing as “an arrangement by which employees receive a share, fixed in advance of the profits”. Profit sharing usually involves the determination of an organisation profits at the end of the fiscal, year and the distribution of a percentage of the profits to the workers qualified to share in the earnings. The main objectives of profits sharing are to create unity of interest and the spirit of co-operation.
The theory behind profit sharing is that management should feel its workers will fulfill their responsibilities more diligently if they realize that their efforts may result in higher profits which will be returned to the workers through profit sharing.
In India this incentive scheme is not well received by both the management and the workers. Committee appointed by the Govt. of India suggested profit sharing as a method of ensuring industrial peace and a step towards workers’ participation in management and also suggested that 50% of the profit be shared among the workers.
Both the employers and the trade unions rejected this. The trade unions prefer bonus to profits sharing as bonus is payable irrespective of profit or loss under the Bonus Act 1965.
Fringe Benefits:
ILO describes fringe benefits as wages are often augmented by special cash benefits, by the provision of medical and other services or by payment in kind that form part of the cost for expenditure on the goods in services.
In addition workers commonly receive such benefits as holidays with pay low cost meals, low rent housing etc. such additions to the wage proper are sometimes referred to as fringe benefits.
Fringe benefits involve a labour cost for the employer and are not meant directly to improve efficiency. These add to the workers standard of living. Hence benefits may be statutory or voluntary.
They improve motivation and morale of workers by satisfying their needs and develops a sense of belonging and loyalty among workers. They also improve the public image of the organisation.

Difference between performance appraisal and job evaluation?

There are many differences between performance appraisal and job evaluation. Let us discuss them:

1) Performance appraisal is concerned with comparative merit of individuals. While job evaluation analysis the job not take into account the individual abilities of the job holder.

2) It considers the individual abilities while job evaluation considers the requirement of the job in terms of job specification and job description.

3) The purpose of performance appraisal is to take the decisions regarding the pay, transfer, promotion etc. while the purpose of job evaluation is to determine the worth of the job.

4) Performance appraisal rates the man not the job but job evaluation determines the relative worth of the job.

5) Performance appraisal helps in making decision like transfer or promotion while job evaluation helps in making decisions regarding wage policy.

Concept of performance appraisal?

Performance appraisal means systematic evaluation of the personality and performance of each employee by his supervisor or some other person who is trained in such task. It is the formal procedure to evaluate the contributions of the persons working in the organization and to get the necessary information regarding the employees. Generally it is done by the immediate superior or an independent appraiser. Thus it is a rating technique for comparing the individual employees in the work group, in terms of personal qualities or requirement of their respective job.

Objectives of performance appraisal?

There are mainly two objectives or aims of performance appraisal they are:

1) Administrative objectives

2) Self improvement objectives

1) Administrative objectives: these objectives are further divided into five parts

i) Promotion: it is one of the main aims of performance appraisal. It is beneficial for both the management and the employee to promote the employee to the place where they can show their abilities effectively.

ii) Transfer: in an organization the management has to take the decisions regarding the transfer of the employees which may be due to unsatisfactory performance of the employee or due to the economic conditions of the organization but these actions are suitable if they are based on the performance appraisal of the employees.

iii) Wage and salary administration: the performance appraisal reports helps in the wage and salary administration of the employees.

iv) Training and development: performance appraisal is helpful in finding out the employees who need training to do their job properly while it is also helpful in developing the employees for higher positions.

V) Personnel research: performance appraisal reports help the management in the personnel research and also to find out the reason of their performance.

2) Self improvement: the performance appraisal helps in finding out the abilities of the individual. It helps in human resource development and to prepare oneself for the particular job.

Concept of promotion and promotion policy?

Meaning of promotion:

Promotion means giving higher position to an employee with higher pay, higher status, and more responsibility. The purpose of the promotion is to employ the present employee to a higher post with higher responsibility rather than employing from the outside the organization.

There is the difference between up gradation and promotion. Up gradation means change in the pay of the employee without change in the job while promotion means change in the pay with the change in the job position of the employee.

Promotion policy

 It is the responsibility of the HR department to have an effective promotion policy. It should be in writing and must be understood by all the employees. For the success of the promotion policy the employee assessment should be done regularly and in an objective manner so that the employees must have faith in the promotion policy. Internal staff should be given a fair chance of promotion before filling the post through outside recruitment.

The promotion policy must consider merit, potential and seniority of the employees. The merit of the employee is judged by evaluating the performance of the employee the performance can be judged by regular performance appraisal. Next is the potential of the employee which means whether the employee is capable of doing the job or not. Then comes the seniority, which can be easily calculated by the length of the service of particular employee in the organization. But sometimes senior persons are not promoted in that case management must have suitable reason for it.

Job analysis and its aims?

Job analysis:

Job analysis is a systematic study of job, to know the kind of people to be employed for each job. it is the process of determining the knowledge, ability, attitude and skills required by the workers for successfully performing the job. Human resource planning is concerned with the manpower requirement both in terms of quantity as well as quality. Quantitative aspect means total number of workers required in a particular time period. While the qualitative aspect means the type of people required for doing the job. The process by which qualitative aspect is judged is called job analysis. 

Job description and job specification are the immediate products of job analysis. Job description consists of requirements of job and job specification means qualities demanded from the job holder. Job analysis further help in job evaluation which is concerned with determining the relative worth of various jobs.

Thus the emphasis of job analysis is determining the principal duties of a job, the nature of skill, aptitude required to perform these duties and relation of job to other jobs in the organization.

Aims of job analysis:

The aims of job analysis are to study the processes, simplify the methods, establishing time standards for doing the work, provide information regarding compensation and other benefits and improve the personnel activities like recruitment, selection, training, appraisal etc.

Importance or uses or benefits of job analysis?

Job analysis is an important component of human resource management system. It is the process of determining the type of person required to be employed for doing the job.

The importance or uses or benefits of job analysis are as follows:

1) Human resource planning: job analysis helps in human resource planning as job analysis is a qualitative aspect which means the type of people required for doing the job. it is the job analysis which helps in kind of job, qualification required and what an average person can do on a job in a day. Thus it helps in division of work which is an essential element for the human resource planning.

2) Recruitment and selection: to make an employment programme successful it is necessary to have a complete knowledge of job description (requirement of job) and job specification (requirement of job holder). Both of them help in the effective execution of the employment programme.

3) Placement: job analysis helps in proper placement of the employees as it helps in proper pacing of the employees as per their interest and abilities. Thus, a person is assigned to the job which is best fitted for him.

4) Training and development: the purpose of training and development is to help the employees in gaining the skill required for doing the job. This aim can be achieved successfully if the employees are aware of job description as well as the job specification which means they must be aware of what is expected from them. This helps in making the content of training and development effective.

5) Job evaluation: job evaluation is the process of determining the relative worth of various jobs which means the compensation of job. to calculate the worth of job description helps a lot.

6) Performance appraisal: to check the performance of the employees the actual work done by the employees is compared with the set standards. So here job analysis data can be used to establish the standards for every job.

7) Employee counseling: job analysis helps the employees in making career choices. Employees who are not able to cope with the present job are advised to opt for other job which is less demanding.

8) Job design: job analysis helps in designing as well as redesigning the job.

9) Organizational design: job analysis helps in effective organizational design by making balance between authority and responsibility.

10) Safety and health: job analysis helps in making proper measures to identify the unhealthy environment so corrective measures can be taken to ensure proper safety and avoid unhealthy conditions.

 

Contents of job specification?

Meaning or definition of Job specification:

Job specification is a document which describes the requirement of the job holder. It is the minimum acceptable human qualities which are required to perform the job. Job specification translates the job description into human qualifications and sometimes the level of performance required for successful completion of the job.

Contents of job specification

It generally includes the requirement of job holder which consists the following information:

1) The job grade title.

2) Age limit of the job holder.

3) Educational qualification of the job holder.

4) Mental abilities required by the job holder.

5) Experience of the job holder.

6) Skill required in operating the equipment.

7) Maturity, innovation and dependability of the job holder.

8) Leadership qualities if the job required it.

 

 

 

COMPENSATION MANAGEMENT Q&A

Piece wage system meaning

Under the piece wage method the wages are paid on the basis of the output. They are paid on the basis of the number of units produced by them irrespective of time spent on the job. So the earning of the worker depends upon the speed of the worker so an efficient worker earns higher wages than the inefficient worker.

Wages= number of units produce* rate per unit

This method is also called straight piece rate system

Suppose the worker is paid rs 50 for per unit produced and he made 5 units then he will be paid wages= 5* 50= rs 250.

Applicability of piece wage system:

i) This method is used when job is of repetitive nature.

ii) When production process is simple and does not require personal skill.

iii) When machines used are not costly.

iv) When quantity is important.

v) When physical work is involved.

Advantages of piece wage system:

i) Less supervision; this method does not require more supervision as they are aware that they will be paid more if they work hard.

ii) More quantity: in this case organization gets more of the quantity from the work method.

iii) Economy: here the workers production in per day is more than the other method so the overall production is more which proves to be economical for the organization.

iv) Fair wages: the workers are paid as per the pieces made by them so it penalizes the inefficient workers automatically.

v) Incentive for more production: here the workers get the incentives for more the output they give.

 Disadvantages of piece wage system:

i).wastage: as the workers are more concerned with production this results into wastage of the material as well as of the machinery.

ii) Low quality: the workers are concerned about producing more and more rather than the quality of the product.

iii) Health hazard: some workers are in habit of making more pieces irrespective of the effect of this on their health.

iv) Inefficient workers: they are not paid properly because the payment is as per the pieces made by them.

v) Difficulty in rate fixation: it is very difficult to fix the per piece rate for paying the workers.

Difference between time wage and piece wage system?

In last articles I have discussed the time wage system and piece wage system, let us today discuss the difference between the two:

1) Security: Time wage systems provide a security to the workers as they are assured of their wages. While wages in piece wage system varies from month to month.

2) Wastage: wastage of time is high in time wage system and in piece wage system wastage of raw material, machines is high.

3) Supervision: supervision is required so that there will be no wastage in time wage system but in piece wage system no supervision is required.

4) Quality: quality of the product is good in time wage system as compared to piece wage system.

5) Determination of wages: wages are determined on the basis of time spent in time wage system while in piece wage system wages are determined on the basis of number of pieces produced.

6) Support from trade union: trade union support to time wage system and oppose piece wage system due to lack of assurance of minimum wages.

7) Cost of maintenance: cost of maintenance is less because machines are properly handled while in piece wage system maintenance cost of machines is more.

Methods of wage payment?

Wage payment concept is not only important for the employees but also for the employers as they are interesting in paying fewer wages. But paying low wages are not economical as they can prove to be costly for the employer. Employer is morally responsible to pay fair wages to his employees.

There are generally two methods of wage payment

i)                    time wage system

ii)                   piece wage system

Time wage system: in this method worker is paid for the amount of time he has spent on the job. The period of time may be an hour, a day, a week, a month and the wages depend upon the period of time. Here wages are paid for the amount of time spent not on the basis of output. Thus, it is a non variable method of wage payment.

Wages= number of hours worked* rate per hour

Suppose the worker is paid rs 10 per hour and he worked for 15 hours so his wages will be 15* 10 = rs 150

Applicability of time wage system:

i) This method is used when it is difficult to fix standard time for the job.

ii) When production process is complicated and requires high degree of skill.

iii) When machines used are costly.

iv) When quality of work is important.

v) When mental work is involved.

Advantages of time wage system:

i) Simple method: this method is very simple as it is easy to calculate the time spent on the job.

ii) Better quality: when the quality of the product is more important in that case it is better to use this method rather than piece wage system because in that worker are in hurry of making more and more pieces.

iii) Less wastage: under this method workers are not in hurry so there is less wastage of material as well as of machinery.

iv) Equal wages: all the workers are paid as per the time spent by them not on the basis of production. So there is the equality of wages between them.

v) Secure feeling: this method gives the feeling of security to the workers as they will be paid irrespective of what ever is the production.

 Disadvantages of time wage system:

i) Slow work: under this method the workers slows down their work as there is no pressure of making required amount of pieces.

ii) Supervision: this method requires a lot of supervision to ensure better productivity.

iii) Fixed wages: if the workers make more production in that case also they are paid fixed wages as per the time spent by them in the job.

Compensation and its types?

Concept of compensation:

Compensation is a wide range of financial and non financial rewards to employees for their services rendered to the organization. It is paid in form of wages, salary, other benefits such as vacations, maternity leave, medical facilities etc. compensation helps in motivating the employees and reduce labor turnover.

Types of compensation:

1) Base compensation

2) Supplementary compensation

Base compensation: it involves monetary benefit to the employees in the form of wages and salaries. It is giving the remuneration to the workers for doing the work. Wages are generally given to the workers based on hourly, daily, weekly or monthly basis. But salary is the compensation given to the office employees. Wages may be based on the number of units produced i.e. piece wage system or the time wage system i.e. the time spent on the job. But salary is always based on the time spent on the job. When it is difficult to judge the production of the company then the compensation is paid in form of salary.

Supplementary compensation: now days the organizations use supplementary compensation over and above the base compensation. It helps in satisfying the employees as well as retaining them for long time. It can be given in form of various services like housing, medical, educational facility. Supplementary compensation is also called fringe benefit as well as hidden payroll. The basic purpose of fringe benefit is to maintain efficient human resources in the organization and to motivate the employees.

These are the two main types of compensation.

Supplementary compensation is again divided into following types:

1) Protection against hazards: supplementary compensation helps in protecting against the hazards of illness, injury, old age, death, permanent disability.

2) Employee services: some big organizations provide housing, low-cost loan, food, medical, and day care centre for children, educational facilities to their employees for their services.

3) Payment for time not worked: the employees are also paid for the time they are not working like wash up time, lunch period, vacations, holidays, sick leave etc.

4) Legal payments: payment under this category involves unemployment; layoff compensation, old age benefits etc.

7 factors affecting compensation?

Factors affecting wages or compensation or determinants of wages or compensation:

1) Productivity of workers: to get the best results from the employees and to increase the productivity compensation has to be productivity based.

2) Ability to pay: it depends upon the employer’s ability to pay wages to the workers. This depends upon the profitability of the firm. If the firm is marginal and can’t afford to pay higher than the competitors then the employees will go to other firms while if the company is successful then they can easily pay their employees as they wish.

3) Government: government has also fixed the rules for protecting the interest of the employees. The organizations are liable to pay as per the government instructions. Wages can not be fixed below the level prescribed by the government.

4) Labor union: labor union also helps in paying better wages to the workers. Higher wages have to be paid by the firm to its workers under the pressure of the trade unions.

5) Cost of living: wages depends upon the cost of living if it is high wages will also hike.

6) Demand and supply of labor: it is one of the important factors affecting wages. If the demand of labor is more they will be paid high wages otherwise vice versa. If the supply of the employees is more than they will be paid less and vice versa.

7) Prevailing wage rate: wages also depends upon the prevailing wage rate as the organizations have to pay accordingly to keep the employees with them.

 

 

 

 

GE-McKinsey nine-box matrix(strategic Management)?

GE-McKinsey nine-box matrix

is a strategy tool that offers a systematic approach for the multi business corporation to prioritize its investments among its business units.

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GE-McKinsey

is a framework that evaluates business portfolio, provides further strategic implications and helps to prioritize the investment needed for each business unit (BU).

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Understanding the tool

In the business world, much like anywhere else, the problem of resource scarcity is affecting the decisions the companies make. With limited resources, but many opportunities of using them, the businesses need to choose how to use their cash best. The fight for investments takes place in every level of the company: between teams, functional departments, divisions or business units. The question of where and how much to invest is an ever going headache for those who allocate the resources.
How does this affect the diversified businesses? Multi business companies manage complex business portfolios, often, with as much as 50, 60 or 100 products and services. The products or business units differ in what they do, how well they perform or in their future prospects. This makes it very hard to make a decision in which products the company should invest. At least, it was hard until the BCG matrix and its improved version GE-McKinsey matrix came to help. These tools solved the problem by comparing the business units and assigning them to the groups that are worth investing in or the groups that should be harvested or divested.
In 1970s, General Electric was managing a huge and complex portfolio of unrelated products and was unsatisfied about the returns from its investments in the products. At the time, companies usually relied on projections of future cash flows, future market growth or some other future projections to make investment decisions, which was an unreliable method to allocate the resources. Therefore, GE consulted the McKinsey & Company and as a result the nine-box framework was designed. The nine-box matrix plots the BUs on its 9 cells that indicate whether the company should invest in a product, harvest/divest it or do a further research on the product and invest in it if there’re still some resources left. The BUs are evaluated on two axes: industry attractiveness and a competitive strength of a unit.

Industry Attractiveness

Industry attractiveness indicates how hard or easy it will be for a company to compete in the market and earn profits. The more profitable the industry is the more attractive it becomes. When evaluating the industry attractiveness, analysts should look how an industry will change in the long run rather than in the near future, because the investments needed for the product usually require long lasting commitment.
Industry attractiveness consists of many factors that collectively determine the competition level in it. There’s no definite list of which factors should be included to determine industry attractiveness, but the following are the most common: ^[1]

• Long run growth rate
• Industry size
• Industry profitability: entry barriers, exit barriers, supplier power, buyer power, threat of substitutes and available complements (use Porter’s Five Forces analysis to determine this)
• Industry structure (use Structure-Conduct-Performance framework to determine this)
• Product life cycle changes
• Changes in demand
• Trend of prices
• Macro environment factors (use PEST or PESTEL for this)
• Seasonality
• Availability of labor
• Market segmentation

Competitive strength of a business unit or a product

Along the X axis, the matrix measures how strong, in terms of competition, a particular business unit is against its rivals. In other words, managers try to determine whether a business unit has a sustainable competitive advantage (or at least temporary competitive advantage) or not. If the company has a sustainable competitive advantage, the next question is: “For how long it will be sustained?”
The following factors determine the competitive strength of a business unit:

• Total market share
• Market share growth compared to rivals
• Brand strength (use brand value for this)
• Profitability of the company
• Customer loyalty
• VRIO resources or capabilities (use VRIO framework to determine this)
• Your business unit strength in meeting industry’s critical success factors (use Competitive Profile Matrix to determine this)
• Strength of a value chain (use Value Chain Analysis and Benchmarking to determine this)
• Level of product differentiation
• Production flexibility

Advantages

• Helps to prioritize the limited resources in order to achieve the best returns.
• Managers become more aware of how their products or business units perform.
• It’s more sophisticated business portfolio framework than the BCG matrix.
• Identifies the strategic steps the company needs to make to improve the performance of its business portfolio.

Disadvantages

• Requires a consultant or a highly experienced person to determine industry’s attractiveness and business unit strength as accurately as possible.
• It is costly to conduct.
• It doesn’t take into account the synergies that could exist between two or more business units.

Difference between GE McKinsey and BCG matrices

GE McKinsey matrix is a very similar portfolio evaluation framework to BCG matrix. Both matrices are used to analyze company’s product or business unit portfolio and facilitate the investment decisions.
The main differences:

• Visual difference. BCG is only a four cell matrix, while GE McKinsey is a nine cell matrix. Nine cells provide better visual portrait of where business units stand in the matrix. It also separates the invest/grow cells from harvest/divest cells that are much closer to each other in the BCG matrix and may confuse others of what investment decisions to make.
• Comprehensiveness. The reason why the GE McKinsey framework was developed is that BCG portfolio tool wasn’t sophisticated enough for the guys from General Electric. In BCG matrix, competitive strength of a business unit is equal to relative market share, which assumes that the larger the market share a business has the better it is positioned to compete in the market. This is true, but it’s too simplistic to assume that it’s the only factor affecting the competition in the market. The same is with industry attractiveness that is measured only as the market growth rate in BCG. It comes to no surprise that GE with its complex business portfolio needed something more comprehensive than that.

Using the tool

There are no established processes or models that managers could use when performing the analysis. Therefore, we designed the following steps to facilitate the process:

Step 1. Determine industry attractiveness of each business unit

• Make a list of factors. The first thing you’ll need to do is to identify, which factors to include when measuring industry attractiveness. We’ve provided the list of the most common factors, but you should include the factors that are the most appropriate to your industries.
• Assign weights. Weights indicate how important a factor is to industry’s attractiveness. A number from 0.01 (not important) to 1.0 (very important) should be assigned to each factor. The sum of all weights should equal to 1.0.
• Rate the factors. The next thing you need to do is to rate each factor for each of your product or business unit. Choose the values between ‘1-5’ or ‘1-10’, where ‘1’ indicates the low industry attractiveness and ‘5’ or ‘10’ high industry attractiveness.
• Calculate the total scores. Total score is the sum of all weighted scores for each business unit. Weighted scores are calculated by multiplying weights and ratings. Total scores allow comparing industry attractiveness for each business unit.

Industry Attractiveness (1/2)

		Business Unit 1		Business Unit 2
Factor	Weight	Rating	Weighted Score	Rating	Weighted Score
Industry growth rate	0.25	3	0.75	4	1
Industry size	0.22	3	0.66	3	0.66
Industry profitability	0.18	5	0.90	1	0.18
Industry structure	0.17	4	0.68	4	0.68
Trend of prices	0.09	3	0.27	3	0.27
Market segmentation	0.09	1	0.09	3	0.27
Total score	1.00	-	3.35	-	3.06

Industry Attractiveness (2/2)

		Business Unit 3		Business Unit 4
Factor	Weight	Rating	Weighted Score	Rating	Weighted Score
Industry growth rate	0.25	3	0.75	2	0.50
Industry size	0.22	2	0.44	5	1.10
Industry profitability	0.18	1	0.18	5	0.90
Industry structure	0.17	2	0.34	4	0.68
Trend of prices	0.09	2	0.18	3	0.27
Market segmentation	0.09	2	0.18	3	0.27
Total score	1.00	-	2.07	-	3.72

This is a tough task and one that usually requires involving a consultant who is an expert of the industries in question. The consultant will help you to determine the weights and to rate them properly so the analysis is as accurate as possible.

Step 2. Determine the competitive strength of each business unit

‘Step 2’ is the same as ‘Step 1’ only this time, instead of industry attractiveness, the competitive strength of a business unit is evaluated.

• Make a list of factors. Choose the competitive strength factors from our list or add your own factors.
• Assign weights. Weights indicate how important a factor is in achieving sustainable competitive advantage. A number from 0.01 (not important) to 1.0 (very important) should be assigned to each factor. The sum of all weights should equal to 1.0.
• Rate the factors. Rate each factor for each of your product or business unit. Choose the values between ‘1-5’ or ‘1-10’, where ‘1’ indicates the weak strength and ‘5’ or ‘10’ powerful strength.
• Calculate the total scores. See ‘Step 1’.

Competitive Strength (1/2)

		Business Unit 1		Business Unit 2
Factor	Weight	Rating	Weighted Score	Rating	Weighted Score
Market share	0.22	2	0.44	2	0.44
Relative growth rate	0.18	3	0.48	2	0.38
Company’s profitability	0.14	3	0.42	1	0.14
Brand value	0.10	1	0.10	2	0.20
VRIO resources	0.20	1	0.20	4	0.80
CPM Score	0.16	2	0.32	5	0.80
Total score	1.00	-	1.96	-	2.74

Competitive Strength (2/2)

		Business Unit 3		Business Unit 4
Factor	Weight	Rating	Weighted Score	Rating	Weighted Score
Market share	0.22	4	0.88	4	0.88
Relative growth rate	0.18	4	0.64	2	0.36
Company’s profitability	0.14	3	0.42	3	0.42
Brand value	0.10	3	0.30	3	0.30
VRIO resources	0.20	4	0.80	4	0.80
CPM Score	0.16	5	0.80	5	0.80
Total score	1.00	-	3.92	-	3.56

Step 3. Plot the business units on a matrix

With all the evaluations and scores in place, we can plot the business units on the matrix. Each business unit is represented as a circle. The size of the circle should correspond to the proportion of the business revenue generated by that business unit. For example, ‘Business unit 1’ generates 20% revenue and ‘Business unit 2’ generates 40% revenue for the company. The size of a circle for ‘Business unit 1’ will be half the size of a circle for ‘Business unit 2’.

Step 4. Analyze the information

There are different investment implications you should follow, depending on which boxes your business units have been plotted. There are 3 groups of boxes: investment/grow, selectivity/earnings and harvest/divest boxes. Each group of boxes indicates what you should do with your investments.

Investment implications

Box	Invest/Grow	Selectivity/Earnings	Harvest/Divest
Invest or not?	Definitely invest	Invest if there’s money left and the situation of business unit could be improved	Invest just enough to keep the business unit operating or divest

Invest/Grow box. Companies should invest into the business units that fall into these boxes as they promise the highest returns in the future. These business units will require a lot of cash because they’ll be operating in growing industries and will have to maintain or grow their market share. It is essential to provide as much resources as possible for BUs so there would be no constraints for them to grow. The investments should be provided for R&D, advertising, acquisitions and to increase the production capacity to meet the demand in the future.
Selectivity/Earnings box. You should invest into these BUs only if you have the money left over the investments in invest/grow business units group and if you believe that BUs will generate cash in the future. These business units are often considered last as there’s a lot of uncertainty with them. The general rule should be to invest in business units which operate in huge markets and there are not many dominant players in the market, so the investments would help to easily win larger market share.
Harvest/Divest box. The business units that are operating in unattractive industries, don’t have sustainable competitive advantages or are incapable of achieving it and are performing relatively poorly fall into harvest/divest boxes. What should companies do with these business units?
First, if the business unit generates surplus cash, companies should treat them the same as the business units that fall into ‘cash cows’ box in the BCG matrix. This means that the companies should invest into these business units just enough to keep them operating and collect all the cash generated by it. In other words, it’s worth to invest into such business as long as investments into it doesn’t exceed the cash generated from it.
Second, the business units that only make losses should be divested. If that’s impossible and there’s no way to turn the losses into profits, the company should liquidate the business unit.

Step 5. Identify the future direction of each business unit

The GE McKinsey matrix only provides the current picture of industry attractiveness and the competitive strength of a business unit and doesn’t consider how they may change in the future. Further analysis may reveal that investments into some of the business units can considerably improve their competitive positions or that the industry may experience major growth in the future. This affects the decisions we make about our investments into one or another business unit.
For example, our previous evaluations show that the ‘Business Unit 1’ belongs to invest/grow box, but further analysis of an industry reveals that it’s going to shrink substantially in the near future. Therefore, in the near future, the business unit will be in harvest/divest group rather than invest/grow box. Would you still invest as much in ‘Business Unit 1’ as you would have invested initially? The answer is no and the matrix should take that into consideration.
How to do that? Well, the company should consult with the industry analysts to determine whether the industry attractiveness will grow, stay the same or decrease in the future. You should also discuss with your managers whether your business unit competitive strength will likely increase or decrease in the near future. When all the information is collected you should include it to your existing matrix, by adding the arrows to the circles. The arrows should point to the future position of a business unit.
The following table shows how industry attractiveness and business unit competitive strength will change in 2 years.

	Business Unit 1	Business Unit 2	Business Unit 3	Business Unit 4
Industry attractiveness	Decrease	Stay the same	Stay the same	Increase
Business unit competitive strength	Decrease	Increase	Increase	Decrease

Step 6. Prioritize your investments

The last step is to decide where and how to invest the company’s money. While the matrix makes it easier by evaluating the business units and identifying the best ones to invest in, it still doesn’t answer some very important questions:

• Is it really worth investing into some business units?
• How much exactly to invest in?
• Where to invest into business units (more to R&D, marketing, value chain?) to improve their performance?

Doing the GE McKinsey matrix and answering all the questions takes time, effort and money, but it’s still one of the most important product portfolio management tools that significantly facilitate investment decisions.

Internal Factor Evaluation (IFE) Matrix(strategic management)?

Internal Factor Evaluation (IFE) Matrix

is a strategy tool used to evaluate firm’s internal environment and to reveal its strengths as well as weaknesses.

^[1]

External Factor Evaluation (EFE) Matrix

is a strategy tool used to examine company’s external environment and to identify the available opportunities and threats.

Understanding the tool

The internal and external factor evaluation matrices have been introduced by Fred R. David in his book ‘Strategic Management’^[1] (at least I found them there and couldn’t trace their origins anywhere else). According to the author, both tools are used to summarize the information gained from company’s external and internal environment analyses. The summarized information is evaluated and used for further purposes, such as, to build SWOT analysis or IE matrix. Even though, the tools are quite simplistic, they do the best job possible in identifying and evaluating the key affecting factors. Both tools are nearly identical so we’ll only show an example of an EFE matrix right now.

External Factor Evaluation Matrix

Key External Factors	Weight	Rating	Weighted Score
Opportunities
1. New trade agreement that lifts the ban of imported food is signed with a neighboring country.	0.11	3	0.33
2. Signing a contract with a new supplier.	0.09	1	0.09
3. Processed food market growing by 15% next year in our largest market.	0.24	2	0.48
4. Incorporating a new company in neighboring country, where the tax rate is decreasing by 3% next year.	0.10	1	0.10
Threats
5. The contract with the main customer expires in 2 months.	0.17	4	0.68
6. Extreme cases of natural disasters occurring next year.	0.03	2	0.06
7. New law, requiring decreasing the amount of sugar in the food by 20%, could be passed next year.	0.14	3	0.42
8. Competitors opening 3 new stores in the town.	0.12	2	0.24
Total	1.00	-	2.40

Key External and Internal Factors

EFE Matrix. When using the EFE matrix we identify the key external opportunities and threats that are affecting or might affect a company. Where do we get these factors from? Simply by analysing the external environment with the tools like PEST analysis, Porter’s Five Forces or Competitive Profile Matrix.
IFE Matrix. Strengths and weaknesses are used as the key internal factors in the evaluation. When looking for the strengths, ask what do you do better or have more valuable than your competitors have? In case of the weaknesses, ask which areas of your company you could improve and at least catch up with your competitors?
The general rule is to identify 10-20 key external factors and additional 10-20 key internal factors, but you should identify as many factors as possible.

Weights

Each key factor should be assigned a weight ranging from 0.0 (low importance) to 1.0 (high importance). The number indicates how important the factor is if a company wants to succeed in an industry. If there were no weights assigned, all the factors would be equally important, which is an impossible scenario in the real world. The sum of all the weights must equal 1.0. Separate factors should not be given too much emphasis (assigning a weight of 0.30 or more) because the success in an industry is rarely determined by one or few factors.

Weights have the same meaning in both matrices.

In our first example, the most significant factors are ‘Processed food market growing by 15% next year in our largest market.’ (0.24 points), ‘The contract with the main customer expires in 2 months.’ (0.17 points) and ‘New law, requiring decreasing the amount of sugar in the food by 20%, could be passed next year.’ (0.14 points).

Ratings

The meaning of ratings is different in each matrix, so we’ll explain them separately.
EFE Matrix. The ratings in external matrix refer to how effectively company’s current strategy responds to the opportunities and threats. The numbers range from 4 to 1, where 4 means a superior response, 3 – above average response, 2 – average response and 1 – poor response. Ratings, as well as weights, are assigned subjectively to each factor. In our example, we can see that the company’s response to the opportunities is rather poor, because only one opportunity has received a rating of 3, while the rest have received the rating of 1. The company is better prepared to meet the threats, especially the first threat.
IFE Matrix. The ratings in internal matrix refer to how strong or weak each factor is in a firm. The numbers range from 4 to 1, where 4 means a major strength, 3 – minor strength, 2 – minor weakness and 1 – major weakness. Strengths can only receive ratings 3 & 4, weaknesses – 2 & 1. The process of assigning ratings in IFE matrix can be done easier using benchmarking tool.

Weighted Scores & Total Weighted Score

The score is the result of weight multiplied by rating. Each key factor must receive a score. Total weighted score is simply the sum of all individual weighted scores. The firm can receive the same total score from 1 to 4 in both matrices. The total score of 2.5 is an average score. In external evaluation a low total score indicates that company’s strategies aren’t well designed to meet the opportunities and defend against threats. In internal evaluation a low score indicates that the company is weak against its competitors.
In our example, the company has received total score 2.40, which indicates that company’s strategies are neither effective nor ineffective in exploiting opportunities or defending against threats. The company should improve its strategy and focus more on how take advantage of the opportunities.

Benefits

Both matrices have the following benefits:

• Easy to understand. The input factors have a clear meaning to everyone inside or outside the company. There’s no confusion over the terms used or the implications of the matrices.
• Easy to use. The matrices do not require extensive expertise, many personnel or lots of time to build.
• Focuses on the key internal and external factors. Unlike some other analyses (e.g. value chain analysis, which identifies all the activities in the company’s value chain, despite their importance), the IFE and EFE only highlight the key factors that are affecting a company or its strategy.
• Multi-purpose. The tools can be used to build SWOT analysis, IE matrix, GE-McKinsey matrix or for benchmarking.

Limitations

• Easily replaced. IFE and EFE matrices can be replaced almost completely by PEST analysis, SWOT analysis, competitive profile matrix and partly some other analysis.
• Doesn’t directly help in strategy formation. Both analyses only identify and evaluate the factors but do not help the company directly in determining the next strategic move or the best strategy. Other strategy tools have to be used for that.
• Too broad factors. SWOT matrix has the same limitation and it means that some factors that are not specific enough can be confused with each other. Some strengths can be weaknesses as well, e.g. brand reputation, which can be a strong and valuable brand reputation or a poor brand reputation. The same situation is with opportunities and threats. Therefore, each factor has to be as specific as possible to avoid confusion over where the factor should be assigned.

Using the tool

Step 1. Identify the key external/internal factors

EFE matrix. Do the PEST analysis first. The information from the PEST analysis reveals which factors currently affect or may affect the company in the future. At this point, the factors can be either opportunities or threats and your next task is to sort them into one or the other category. Try to look at which factors could benefit the company and which ones would harm it.
You should also analyze your competitors’ actions and their strategies. This way you would know what competitors are doing right and what their strategies lack.
IFE matrix. In case you have done a SWOT analysis already, you can gather some of the factors from there. The SWOT analysis will usually have no more than 10 strengths and weaknesses, so you’ll have to do additional analysis to identify more key internal factors for the matrix.
Look again into the company’s resources, capabilities, organizational structure, culture, functional areas and value chain analysis and recognize the strong and weak points of the organization.

Step 2. Assign the weights and ratings

Weights and ratings are assigned subjectively. Therefore, it is a more difficult process than identifying the key factors. We assign weights based on industry analysts’ opinions. Find out what the analysts say about the industry’s success factors and then use their opinion or analysis to assign the appropriate weights. The same process is with ratings. Although, this time you or the members of your group will have to decide what ratings should be assigned. Ratings from 1-4 can be assigned to each opportunity and threat, but only the ratings from 1-2 can be assigned to each weakness and 3-4 to each strength.

Step 3. Use the results

IFE or EFE matrices have little value on their own. You should do both analyses and combine their results to discuss new strategies or for further analysis. They are especially useful when building advanced SWOT analysis, SWOT matrix for strategies or IE matrix.

Examples

We provide only the general examples of both matrices.

EFE Matrix Example

Key External Factors	Weight	Rating	Weighted Score
Opportunities
1. New immigration laws abolish the restrictions for immigrants to live and work freely in the country.	0.02	1	0.02
2. A government increases budget spending for our products.	0.17	4	0.68
3. New product market, worth $1 billion a year, could be introduced for the consumers.	0.05	4	0.20
4. Consumers are 20 % more likely to by the products that share the same ecosystem.	0.12	4	0.48
5. We have patented the technology that increases the quality of our products and lowers the amount of the materials needed to produce it.	0.03	3	0.09
6. Our largest competitor is selling their subsidiary in TV market.	0.14	2	0.28
Threats
7. Tax rates will increase by 10% for the polluting companies.	0.06	2	0.12
8. Due to the fast economic growth credit availability will tighten.	0.04	4	0.16
9. Credit rates are growing by 5%.	0.02	2	0.04
10. Natural disasters disrupt our suppliers’ or our operations.	0.08	3	0.24
11. Rivalry in the market is intensifying.	0.12	4	0.48
12. Competitor is pursuing horizontal integration strategy.	0.10	3	0.30
13. Inflation has increased to 6%.	0.05	2	0.10
Total	1.00	-	3.19

IFE Matrix Example

Key Internal Factors	Weight	Rating	Weighted Score
Strengths
1. Diversified income (5 different brands earning more than $4 billion each)	0.10	4	0.40
2. Brand reputation valued at $35 billion	0.08	3	0.24
3. Strong patents portfolio (13,000 patents)	0.07	4	0.28
4. Excellent employee management	0.02	3	0.06
5. Competency in mergers and acquisitions	0.06	3	0.18
6. Extensive distribution channels	0.11	4	0.44
7. Strong product ecosystem	0.08	4	0.32
Weaknesses
8. High debt level ($3 billion)	0.10	1	0.10
9. Over-dependence on sales from U.S.	0.13	2	0.26
10. Too low net profit margin	0.07	2	0.14
11. Competition based on prices	0.09	2	0.18
12. Rigid (bureaucratic) organizational culture impeding fast introduction of new products	0.04	1	0.04
13. Negative publicity	0.05	2	0.10
Total	1.00	-	2.74

BCG growth-share matrix(Strategic Management)?

BCG matrix

(or growth-share matrix) is a corporate planning tool, which is used to portray firm’s brand portfolio or SBUs on a quadrant along relative market share axis (horizontal axis) and speed of market growth (vertical axis) axis.

Growth-share matrix

is a business tool, which uses relative market share and industry growth rate factors to evaluate the potential of business brand portfolio and suggest further investment strategies.

Understanding the tool

BCG matrix is a framework created by Boston Consulting Group to evaluate the strategic position of the business brand portfolio and its potential. It classifies business portfolio into four categories based on industry attractiveness (growth rate of that industry) and competitive position (relative market share). These two dimensions reveal likely profitability of the business portfolio in terms of cash needed to support that unit and cash generated by it. The general purpose of the analysis is to help understand, which brands the firm should invest in and which ones should be divested.
Relative market share. One of the dimensions used to evaluate business portfolio is relative market share. Higher corporate’s market share results in higher cash returns. This is because a firm that produces more, benefits from higher economies of scale and experience curve, which results in higher profits. Nonetheless, it is worth to note that some firms may experience the same benefits with lower production outputs and lower market share.

Market growth rate. High market growth rate means higher earnings and sometimes profits but it also consumes lots of cash, which is used as investment to stimulate further growth. Therefore, business units that operate in rapid growth industries are cash users and are worth investing in only when they are expected to grow or maintain market share in the future.
There are four quadrants into which firms brands are classified:
Dogs. Dogs hold low market share compared to competitors and operate in a slowly growing market. In general, they are not worth investing in because they generate low or negative cash returns. But this is not always the truth. Some dogs may be profitable for long period of time, they may provide synergies for other brands or SBUs or simple act as a defense to counter competitors moves. Therefore, it is always important to perform deeper analysis of each brand or SBU to make sure they are not worth investing in or have to be divested.
Strategic choices: Retrenchment, divestiture, liquidation
Cash cows. Cash cows are the most profitable brands and should be “milked” to provide as much cash as possible. The cash gained from “cows” should be invested into stars to support their further growth. According to growth-share matrix, corporates should not invest into cash cows to induce growth but only to support them so they can maintain their current market share. Again, this is not always the truth. Cash cows are usually large corporations or SBUs that are capable of innovating new products or processes, which may become new stars. If there would be no support for cash cows, they would not be capable of such innovations.
Strategic choices: Product development, diversification, divestiture, retrenchment
Stars. Stars operate in high growth industries and maintain high market share. Stars are both cash generators and cash users. They are the primary units in which the company should invest its money, because stars are expected to become cash cows and generate positive cash flows. Yet, not all stars become cash flows. This is especially true in rapidly changing industries, where new innovative products can soon be outcompeted by new technological advancements, so a star instead of becoming a cash cow, becomes a dog.
Strategic choices: Vertical integration, horizontal integration, market penetration, market development, product development
Question marks. Question marks are the brands that require much closer consideration. They hold low market share in fast growing markets consuming large amount of cash and incurring losses. It has potential to gain market share and become a star, which would later become cash cow. Question marks do not always succeed and even after large amount of investments they struggle to gain market share and eventually become dogs. Therefore, they require very close consideration to decide if they are worth investing in or not.
Strategic choices: Market penetration, market development, product development, divestiture

BCG matrix quadrants are simplified versions of the reality and cannot be applied blindly. They can help as general investment guidelines but should not change strategic thinking. Business should rely on management judgement, business unit strengths and weaknesses and external environment factors to make more reasonable investment decisions.

Advantages and disadvantages

Benefits of the matrix:

• Easy to perform;
• Helps to understand the strategic positions of business portfolio;
• It’s a good starting point for further more thorough analysis.

Growth-share analysis has been heavily criticized for its oversimplification and lack of useful application. Following are the main limitations of the analysis:

• Business can only be classified to four quadrants. It can be confusing to classify an SBU that falls right in the middle.
• It does not define what ‘market’ is. Businesses can be classified as cash cows, while they are actually dogs, or vice versa.
• Does not include other external factors that may change the situation completely.
• Market share and industry growth are not the only factors of profitability. Besides, high market share does not necessarily mean high profits.
• It denies that synergies between different units exist. Dogs can be as important as cash cows to businesses if it helps to achieve competitive advantage for the rest of the company.

Using the tool

Although BCG analysis has lost its importance due to many limitations, it can still be a useful tool if performed by following these steps:

• Step 1. Choose the unit
• Step 2. Define the market
• Step 3. Calculate relative market share
• Step 4. Find out market growth rate
• Step 5. Draw the circles on a matrix

Step 1. Choose the unit. BCG matrix can be used to analyze SBUs, separate brands, products or a firm as a unit itself. Which unit will be chosen will have an impact on the whole analysis. Therefore, it is essential to define the unit for which you’ll do the analysis.
Step 2. Define the market. Defining the market is one of the most important things to do in this analysis. This is because incorrectly defined market may lead to poor classification. For example, if we would do the analysis for the Daimler’s Mercedes-Benz car brand in the passenger vehicle market it would end up as a dog (it holds less than 20% relative market share), but it would be a cash cow in the luxury car market. It is important to clearly define the market to better understand firm’s portfolio position.
Step 3. Calculate relative market share. Relative market share can be calculated in terms of revenues or market share. It is calculated by dividing your own brand’s market share (revenues) by the market share (or revenues) of your largest competitor in that industry. For example, if your competitor’s market share in refrigerator’s industry was 25% and your firm’s brand market share was 10% in the same year, your relative market share would be only 0.4. Relative market share is given on x-axis. It’s top left corner is set at 1, midpoint at 0.5 and top right corner at 0 (see the example below for this).
Step 4. Find out market growth rate. The industry growth rate can be found in industry reports, which are usually available online for free. It can also be calculated by looking at average revenue growth of the leading industry firms. Market growth rate is measured in percentage terms. The midpoint of the y-axis is usually set at 10% growth rate, but this can vary. Some industries grow for years but at average rate of 1 or 2% per year. Therefore, when doing the analysis you should find out what growth rate is seen as significant (midpoint) to separate cash cows from stars and question marks from dogs.
Step 5. Draw the circles on a matrix. After calculating all the measures, you should be able to plot your brands on the matrix. You should do this by drawing a circle for each brand. The size of the circle should correspond to the proportion of business revenue generated by that brand.

Examples

Corporate ‘A’ BCG matrix

Brand	Revenues	% of corporate revenues	Largest rival’s market share	Your brand’s market share	Relative market share	Market growth rate
Brand 1	$500,000	54%	25%	25%	1	3%
Brand 2	$350,000	38%	30%	5%	0.17	12%
Brand 3	$50,000	6%	45%	30%	0.67	13%
Brand 4	$20,000	2%	10%	1%	0.1	15%

This example was created to show how to deal with a relative market share higher than 100% and with negative market growth.

Corporate ‘B’ BCG matrix

Brand	Revenues	% of corporate revenues	Largest rival’s market share	Your brand’s market share	Relative market share	Market growth rate
Brand 1	$500,000	55%	15%	60%	1	3%
Brand 2	$350,000	31%	30%	5%	0.17	-15%
Brand 3	$50,000	10%	45%	30%	0.67	-4%
Brand 4	$20,000	4%	10%	1%	0.1	8%