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Home > Asset Management Checklists > Understanding Portfolio Analysis

Asset Management Checklists

Understanding Portfolio Analysis


Checklist Description

This checklist provides an overview of portfolio analysis and considers when and how the techniques can be used to maximum advantage.

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Definition

Portfolio analysis is a tool which helps managers assess how best to identify opportunities and to allocate resources across a set of products or businesses. The portfolio analysis framework seeks to first identify individual business units’ growth cycle stages. The tool then examines these business units in the context of the overall growth of their respective industries, with a view to optimizing resources and maximizing overall portfolio performance. As an example, the technique seeks to identify resource-hungry units in sectors with the potential for dynamic growth and then shows how highly profitable cash-generative units in more mature industry sectors could be exploited to meet the resource needs of the growing businesses in such a way as to maximize overall portfolio returns. Portfolio analysis can also be used to identify business units or products that have already fulfilled their potential and could therefore be sold to free up resources for more productive investment elsewhere.

Though there are many different portfolio analysis tools, many approaches assess business units on the basis of market share and the growth rate of the industry or sector in which they operate. The technique is founded on the basis that increasing market share should generate higher earnings, while a higher rate of overall market growth typically requires higher levels of investment if the business is to capitalize on the available opportunities. Portfolio analysis also seeks to evaluate the strength of a company’s competitive franchise within an industry or sector, using inputs such as its rate of change of market share, cost base, and product factors such as cost per unit and the strength of its new product pipeline. Using these inputs, portfolio analysis can help to promote success by highlighting areas with the potential to deliver the most attractive future profits, while flagging other areas with limited prospects, thus helping management to steer resources toward areas where they can best be invested.

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Advantages

  • Portfolio analysis simplifies complex situations and provides a valuable overview of the strengths and weaknesses of a company’s mix of businesses and products.

  • The technique is forward-looking and can play an important role in delivering improved returns for stockholders over the medium to long term.

  • Portfolio analysis can help understanding of diversification and identify risks in a company’s portfolio, for example by drawing attention to an overemphasis on particular areas.

  • The technique underlines the need to understand business and product lifecycles and emphasizes the importance of achieving the breakthrough to profitability early, long before an industry or a product begins to mature.

  • The analysis can help to overcome the danger that managers favor their pet projects and industries with extra resources, particularly if some inputs to analysis, such as industry growth projections, can be sourced independently.

  • Portfolio analysis also encourages a view of businesses as collections of diversified cash flows and investments and so shows how corporate strategy integrates with individual business strategy at the business unit level.

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Disadvantages

  • Portfolio analysis relies heavily on estimates of future patterns. Even a slight change in a forecast can significantly impact the results of the analysis.

  • Excessively short-term use of portfolio analysis can lead to frequent and expensive switches of company resources.

  • Acquiring or divesting businesses can be complex and time-consuming. One should take these costs into account before acting on marginal recommendations on portfolio changes.

  • Most businesses are actually “average” but should still be kept. For example, Apple’s laptop business is not growing and the market for laptops isn’t growing, but it is still important to keep it in the firm.

  • Market share is not the same as profitability: firms with low market share can be quite profitable (e.g. mail order catalogs).

  • There may be better places to put your money than in your surplus cash cows (e.g. the open market).

  • Portfolio analysis techniques do not generally consider synergies across businesses or products.

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Action Checklist

  • Before applying portfolio analysis, managers should achieve some understanding of all business units/products and the challenges/opportunities they face.

  • Consider using particular forms of portfolio analysis, such as the Boston Consulting matrix. This places business units into readily understandable categories (cash cow, stars, problem child, dogs) according to factors such as market share and industry growth rate.

  • Use the technique to emphasize the goal of portfolio balance and the need to achieve a “pipeline” of future income streams, rather than relying on the hope of any single blockbuster product resulting from a R&D success.

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Dos and Don’ts

Do

  • Whenever possible, include statistical inputs from external sources to avoid the risk that internal company-specific assumptions may be inaccurate.

  • Be prepared to question and challenge assumptions during the process.

Don’t

  • Don’t rely totally on any one strategic planning technique.

  • Don’t plan for every conceivable eventuality as it is not practical to do this—even the best analysis can come unstuck should a highly improbable “freak” event happen. For example, as a result of the recent credit crunch, a reliance on bank finance to fund future product development costs has been a weakness against the backdrop of tighter credit conditions.

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Further reading

Books:

  • Wheelen, Thomas L., and David J. Hunger. Strategic Management and Business Policy: Concepts and Cases. 11th ed. Upper Saddle River, NJ: Prentice Hall, 2007.
  • Wilson, Richard M. S., and Colin Gilligan. Strategic Marketing Management: Planning, Implementation & Control. 3rd ed. Oxford: Elsevier Butterworth-Heinemann, 2005.

Articles:

  • Eng, Teck-Yong. “Does customer portfolio analysis relate to customer performance? An empirical analysis of alternative strategic perspective.” Journal of Business and Industrial Marketing 19:1 (2004): 49–67. Online at: dx.doi.org/10.1108/08858620410516736
  • Wind, Yoram, and Susan Douglas. “International portfolio analysis and strategy: The challenge of the 80s.” Journal of International Business Studies 12:2 (June 1981): 69–82. Online at: dx.doi.org/10.1057/palgrave.jibs.8490579

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