Product/Market Expansion Matrix

A framework to help executives, senior managers and marketers devise strategies for future growth

Ansoff Matrix

1. Background

THE Ansoff Matrix (referred to by some commentators as the Product/Market Expansion Grid) was developed by a Russian-American mathematician named Igor Ansoff, and first explained in his 1957 Harvard Business Review article entitled Strategies for Diversification.

2. Benefits of the Ansoff Matrix

The Ansoff Matrix is particularly useful for strategic planning because it provides a framework to help executives, senior managers and marketers devise strategies for future growth.

By aiding clear thinking about growth strategy, the Ansoff Matrix can help an organisation avoid key risks such as:

  1. Overlooking available growth strategies;
  2. Misunderstanding the implications of pursuing a particular strategy; or
  3. Selecting an inappropriate strategy given the firm’s diversification objectives.

3. The Ansoff Matrix Explained

The Ansoff Matrix can help a firm devise a product-market growth strategy by focusing on four growth alternatives: Market Penetration, Market Development, Product Development, and Diversification.

Ansoff Matrix

What is a Product-Market Growth Strategy?

A product-market strategy is a description of a firm’s products and target markets. While this may sound straightforward, it can be difficult to clearly delineate a target market since it can be defined very broadly (e.g. the transport market) or very narrowly (e.g. domestic air transport in America for cost-conscious business travellers).

In general, a market should not be defined too broadly (or too narrowly) since a key purpose of market definition is to allow a firm to develop strategy and make decisions.

In his 1957 paper, Ansoff defined a product-market strategy as “a joint statement of a product line and the corresponding set of missions which the products are designed to fulfil.” For example, one of Apple’s product missions might be to provide consumers with easy-to-use digital technology, and another mission might be to provide fashion accessories for Yuppies and young people.

The Four Growth Alternatives

The four alternative growth strategies are:

  1. Market Penetration: a strategy to increase sales without departing from the original product-market strategy. This involves increasing sales to existing customers and finding new customers for existing products.
  2. Market Development: a strategy to sell existing products to new markets (normally with some modifications). Ansoff described this as a strategy “to adapt [the] present product line … to new missions.” For example, Boeing might adapt an existing model of passenger aircraft and sell it for cargo transportation.
  3. Product Development: a strategy to sell new products, with new or altered features, to existing markets. Ansoff described this as a strategy to develop products with “new and different characteristics such as will improve the performance of the [existing] mission.” For example, Boeing might develop a new aircraft design which offers improved fuel economy.
  4. Diversification: a strategy to develop new products for new markets, which can either be related to the current business (e.g. vertical integration or horizontal diversification) or unrelated (e.g. lateral diversification).

Each of the above strategies represents a different path that a firm can take to pursue growth. However, in practice, a firm will often implement more than one strategy at the same time. As Ansoff notes, “a simultaneous pursuit of market penetration, market development, and product development is usually a sign of a progressive, well-run business and may be essential to survival in the face of economic competition.”

4. Selecting a Strategy

Selecting a growth strategy is a three-step process. Firstly, set out all of the available strategies. Secondly, apply qualitative criteria to short list the most favourable few alternatives. And finally, apply a return on investment hurdle to narrow the options still further.

Consider the discussion below for a summary of the issues and various situations in which it may make sense for a firm to select a particular growth strategy.

4.1 Selecting Market Penetration

Market Penetration carries the least implementation risk since a firm is focusing on its existing products and existing markets, and so should be able to leverage its existing resources and capabilities.

Pursuing this strategy is likely to make sense if the firm has a strong competitive advantage, or if the overall size of the market is growing or can be induced to grow.

4.2 Selecting Market Development

Market Development carries more implementation risk than Market Penetration because a firm is expanding into new markets.

Market Development

Companies that have successfully pursued this strategy include Coca-Cola and McDonalds, and it may make sense where:

  • the firm’s core competencies relate to its existing products and it has a strong marketing team;
  • the firm can identify opportunities for market development including chances to reposition the brand, exploit new uses for the product, or expand into new geographical regions; and
  • the firm’s resources are organised to produce particular products and changing the production technology would be costly.

4.3 Selecting Product Development

Product Development carries more implementation risk than Market Penetration because the firm is developing new products.

Companies that have successfully pursued this strategy include 3M, P&G and Unilever, and it may make sense where:

  • the firm understands the needs of its customers, and identifies an opportunity to sell new products to satisfy changing needs;
  • the firm operates in a competitive market where continuous product innovation is necessary to prevent product obsolescence or commoditisation;
  • the firm has large market share and a strong brand;
  • the firm’s products benefit from network effects, and new products can gain a significant edge by being first to market;
  • the firm operates in a market with strong growth potential;
  • the firm identifies opportunities to commercialise new technology; and
  • the firm has a strong R&D team.

4.4 Selecting Diversification

Diversification carries the most implementation risk since a firm is simultaneously developing new products and entering new markets, and may be operating entirely outside its circle of competence.

Diversification can enable a firm to achieve three main objectives: growth, stability, and flexibility. And the specific strategies that a firm employs will differ depending on which of these goals the firm is pursuing.

There are three primary kinds of diversification that a firm might undertake:

  1. Vertical Integration: the firm expands its business to different points in the supply chain;
  2. Horizontal Diversification: the firm adds new products that may be unrelated to existing products but are likely to appeal to existing customers. For example, Amazon sells clothes, jewellery and various other products through its online bookstore. Since the new products can be sold through existing distribution channels, Amazon benefits from revenue and cost synergies; and
  3. Lateral Diversification: the firm adds new products that are unrelated to existing products and are likely to appeal to completely different customers. While lateral diversification has little relationship with the firm’s current business, the firm might adopt this strategy in order to:
    • improve profitability by entering a lucrative industry;
    • develop resources and capabilities in a potential new “growth industry”;
    • poach top management or key talent;
    • compensate for technological obsolescence;
    • expand the firm’s revenue base so as to improve its perception in the capital markets and make it easier to borrow money;
    • increase strategic flexibility in an uncertain business environment; or
    • reduce risk by spreading the firm’s activities across multiple products and markets, and thereby decrease its vulnerability to negative Black Swans and unfavourable events like economic downturns, increased competitive rivalry, improved supplier or buyer bargaining power, better-quality substitutes, or reduced barriers to entry.

5. Implementing a Strategy

Consider the suggestions below on how to implement each growth strategy.

5.1 Implementing Market Penetration

Market Penetration involves increasing sales of existing products to existing markets, and could be pursued in the following ways:

  • Increasing advertising to promote the product or reposition the brand;
  • Offering special promotions (e.g. 2 for 1, or Buy One Get One Free);
  • Introducing customer loyalty schemes;
  • Improving the quality or size of the sales force;
  • Modifying the products or product packaging in order to broaden their appeal;
  • Improving the distribution channels in order to reach more customers within existing markets;
  • Targeting a market niche in order to grow sales and build overall market share (this approach makes sense if the firm is small compared to its competitors);
  • Acquiring a competitor (this approach makes sense in mature markets where the size of the overall market is not growing);
  • Changing product pricing; if demand is relatively inelastic, then it might be possible to raise prices without a big drop in sales. Alternatively, prices can be lowered to increase the quantity sold; and
  • Improving operational efficiency so that increased sales can be achieved without a proportional increase in costs (this could be attained through economies of scale and product rationalisation).

5.2 Implementing Market Development

Market Development involves selling existing products to new markets, or new market segments, and could be pursued in the following ways:

  • Marketing products in new locations in order to expand regionally, nationally or internationally;
  • Advertising through different media in order to reach different customers;
  • Utilising new distribution channels to reach new market segments, for example building an online store; and
  • Modifying the pricing policy, products or product packaging in order to appeal to different customer demographics.

5.3 Implementing Product Development 

Product Development involves selling new products to existing markets, and could be pursued in the following ways:

  • Developing new products through R&D;
  • Acquiring a competitor;
  • Forming a joint venture or strategic alliance with a complementary firm;
  • Licensing new technologies;
  • Distributing products manufactured by other firms;
  • Extending an existing product by producing different versions; for example, Apple has recently released the iPhone 5C and 5S;
  • Packaging existing products in new ways; for example, Apple has recently re-released the iPhone 5 in a range of colourful cases and called it the iPhone 5C; and
  • Finding new products that can be sold to existing customers; for example, an online bookstore might develop an e-reader (let’s called it the Kindle) and add a long list of unrelated products to the online bookstore. After all, if customers are willing to buy books on the Internet then they are probably willing to buy other things as well.

5.4 Implementing Diversification

Diversification involves selling new products to new markets, and can be pursued by simultaneously adopting the tactics suggested above for Market Development and Product Development.

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]

Economies of Scope

Economies of scope exist where a firm can produce two products at a lower per unit cost than would be possible if it produced only the one

ECONOMIES OF SCOPE is an idea that was first explored by John Panzar and Robert Willig in an article published in 1977 in the Quarterly Journal of Economics entitled “Economies of Scale in Multi-Output Production”.

1. Relevance

The title of that landmark article may not sound very appealing, but it does make clear that economies of scope and economies of scale are closely related concepts.

Economies of scale is a fairly well known concept relevant to big producers like Intel, Boeing and Toyota.

In contrast, economies of scope is a lesser known concept particularly relevant to small and medium sized enterprises (SMEs) that may not have access to large markets or the ability to produce at scale. SMEs represent the overwhelming majority of global business activity, and are the world’s main source of job creation and economic growth. For example, SMEs currently account for more than 99% of businesses in Europe (Economist Intelligence Unit 2011).

With the Euro-zone at the brink of collapse, governments and business leaders may be well advised to revisit basic concepts like ‘economies of scope’.  If properly understood, economies of scope could be used by SMEs to drive profit growth and reduce the risk associated with product failure.

2. Importance

Economies of scope provide firms with two key benefits:

  1. Lower average costs: If a company diversifies its product offering it may be able to lower the average cost of production. For example, McDonalds offers a range of different products (e.g. burgers, fries, sundaes and salads). As a result, it can achieve lower per unit costs by spreading its large overhead costs across a broad range of products. Lower per unit costs allow a company to do one of three things: (1) enjoy higher profit margin on each unit sold; (2) lower the price it charges customers and thereby increase market share; or (3) a combination of 1 and 2.
  2. Diversified revenue streams: By producing multiple products, a firm can diversify its revenue sources, which reduces the risk associated with product failure.

3. Economies of Scope

Economies of scope exist where a firm can produce two products together (joint production) at a lower average per unit cost of production than would be possible if it produced only one of those products (OECD glossary). Economies of scope have been found to exist in a range of industries including banking, publishing, distribution, and telecommunications.

Economies of scope and economies of scale are related concepts. The distinction is that ‘economies of scale’ refers to where the average cost of producing a unit of output decreases as output increases, whereas ‘economies of scope’ refers to where the average cost of producing a unit of output decreases as the number of different products increases.

3.1 Sources of economies of scope

There are 7 potential sources of economies of scope:

  1. Common inputs – Using more of the same inputs will increase bargaining power with suppliers. For example, Kleenex manufactures a range of products which use the same raw materials: tissues, napkins, paper towels, facial tissues, incontinence products and Huggies nappies.
  2. Joint production facilities – Plant and equipment can be more fully utilised. For example, a dairy manufacturer may be able to use its existing dairy production facilities to produce a range of different dairy based products: e.g. milk, butter, cheese and yoghurt.
  3. Shared overhead costs –The cost of certain fixed overhead costs can be shared across products. For example, McDonalds can produce hamburgers, French fries and salads at a lower average cost than it would cost to produce any of these goods separately. Each product shares overhead costs such as food storage, preparation facilities, restaurant space, toilets, car parks and play equipment.
  4. Marketing – The cost of advertising can be shared across products. For example, Proctor & Gamble produces hundreds of products from Gillette razors to Old Spice aftershave, and can therefore afford to hire expensive graphic designers and marketing experts and spread that cost across a broad range of products.
  5. Sales – Selling products is easier when salesmen can provide customers with a range of value options, as well as upsell and cross promote … “Would you like fries with that?”
  6. Distribution – Shipping a range of products is more efficient than shipping a single product. For example, Amazon sells an extremely broad range of products. As a result, it can negotiate favourable deals with freight companies.
  7. Diversified revenue streams – A firm that sells multiple products will have lower revenue risk because it is less dependent on any one product to sustain sales. More stable cash flows are attractive for three reasons. Firstly, they can be used to negotiate more favourable credit terms with banks. Secondly, a strong cash position can also be used to extend credit to customers and thereby increase sales. Thirdly, more stable cash flows can allow a firm to be more innovative with new product launches because the failure of any one product will have less impact on total revenues.

4. Diseconomies of scope

A firm that offers too many products may actually incur an increase in average per unit costs when it offers additional products. Reasons for diseconomies of scope may include:

  1. diluted competitive focus;
  2. lack of management expertise;
  3. higher raw material costs due to bottlenecks or shortages; or
  4. increased overhead costs.

Warren Buffett on long term value investing

BACK IN 1998, Warren Buffett gave an inspirational talk to a group of MBA students at the University of Florida, College of Business. In the speech, Buffett gives his perspective on investing, in which he outlines the need to understand the underlying economics of the businesses that you invest in, and the need to stick to disciplined principles of business evaluation without being swayed by passing investment fads.

Here are 15 of the most interesting and insightful points made by Buffett in his speech about successful long term investing, as follows:

1. Return on equity is key

Return on equity is fundamental. In general, there is no point to investing, just because of the availability of cheap financing, if a business has a low return on equity. It’s hard to earn much as an investor when the business you’re in doesn’t earn very much money. Buffett elaborates that when he started out as an investor he would sometimes purchase very ordinary stocks at prices way below the value of working capital. This is what Buffett calls the ‘Cigar Butt’ approach to investing. You look around for a cigar butt (i.e. really cheap company), you find one that is old and soggy. You get one free puff out of it, and then you throw it away and try to find another one. If you’re looking for a free puff then this approach to investing works, but these are very low return businesses. By investing in a wonderful business with a high return on equity then, even if you initially pay a little too much, you’ll do well if you stay in for a long time.

2. Ownership of a stock is partownership of a business

Ownership of a stock is part ownership of a business.  With that in mind, the investors should not pay attention to the day to day stock fluctuations.

3. Invest in businesses that you understand

As Buffer jokes, this significantly narrows down the number of companies that he has to look at. You need to look for a simple business which is easy to understand, and which has honest and able management. Buffett says that this lets him understand where a company is going to be in ten years time. If he can’t see where the company will be in ten years, he won’t buy it. Buffett says that “investing is putting out money now, to be sure of getting more money back later at an appropriate rate. To do that you need to understand the business.” Buffett says that he wouldn’t invest money in a new internet business because he doesn’t understand that business and couldn’t say where it would be in ten years time. In his early years he would conduct extensive industry research. For example, by asking every CEO in an industry “if you could buy the stock of one other company in the industry, which one would it be and why?”

4. Invest within your circle of competence

The nice thing about investing is you don’t need to learn anything very new. Buffett says that he learnt about Wrigley’s chewing gum 40 years ago, and still understands that industry today. As a result, you will develop a pool of knowledge about different industries that builds up over time. Interestingly, Buffett says that most of his deals get completed in a matter of hours. If you don’t know enough about a business instantly, you won’t know enough in a month or two.

5. Invest based on solid reasoning

If someone told you about a company at a cocktail party or the charts look good, that’s not good enough. Paying a little too much for a wonderful business, you’ll do well if you stay in for a long time. You buy a lousy business for a good price; you stay in for a long time you’ll get a lousy result. If you’re right about the business, you’ll make a lot of money.

6. Invest for the long term

Buffett recommends buying businesses that you would be happy to own forever. It may happen that you have to sell for one reason or another, but you should, at the time you buy, want to be buying a company that you’ll own forever.

7. Strong businesses need a durable competitive advantage

A strong business needs a durable competitive advantage. Buffett says that although he wants to understand the businesses he goes into, he doesn’t want a business that is easy. You want a business with a moat around it with a duke defending the castle. That moat might be low cost operations, quality of products, service, patents, real estate location, or share of mind (Buffett explains that thirty years ago, Kodak’s moat was as wide as Coke’s moat. Kodak had share of mind, forget about share of market. They had something in everybody’s mind that said, “Kodak is the best”).

8. Feel strongly about the products

You want a business that has products that are not price dependant. Disney and Coca-Cola have developed a favourable impression in the mind of consumers that allows these companies to charge more for their products and sell more of them than other companies in the same industry.

9. Don’t borrow money that you don’t need

Buffett says that he never borrows money. He loves his job and was doing the same thing when he had $10,000 and when making $1,000 was a big deal. He recommends taking a job that if you were independently wealthy you would take. “If you think you’re going to be a lot happier if you have 2X instead of X, then you’re probably making a mistake.”

10. You only have to get rich once

Risking what you have and need to get what you don’t have and don’t need is foolish. Buffett gives the example of Long Term Capital Management. This hedge fund was run by smart people, with extensive experience and with their own money invested. To make money they didn’t have and didn’t need, they risked money they did have and did need. Buffett says, “if you risk something that is important to you for something that is unimportant to you, that decision just doesn’t make sense.”

11. Be patient, think carefully and avoid over stimulation

Buffett says that, in his opinion, the best way to think about investments is to sit in a room and just think. The problem with being in a market environment is that you get the feeling that you have to do something everyday, you get over stimulated. You want to be away from any environment that stimulates activity. Get one good idea a year, and ride it to its full potential.

12. Professional investors should not diversify

Buffett believes that if you are not a professional investor, which is ninety nine percent of people, then you should extensively diversify your investments and not trade. However, once you decide that you are going to bring an intensity to the game and start evaluating businesses and bring the effort, intensity and time involved to get that job done, then Buffett believes that diversification is a terrible mistake. In his opinion, if you really know businesses then you shouldn’t own more than 6 of them. “Very few people have got rich on their seventh best idea.”

13. Business size is not the important consideration

When investing, business size is not the important consideration. Small, medium and large cap stocks can all represent good investment opportunities. It doesn’t matter about the size of the business; it’s the certainty of the returns that counts. The relevant questions are:

  1. Can we understand the business?
  2. Do we like the people running it?
  3. Does it sell for a price that is attractive?

14. Only worry about what is important and knowable

Anything that is unimportant or unknowable, you should forget about it. Buffett outlines that market predictions do not affect his investment decisions. “I have no idea where the market is going to go.”

15. Make investment mistakes

Buffett says that the mistakes that he has actively made have been far less costly than his mistakes of omission. He reflected that the times where he understood a business, saw an opportunity and sat on his hands and did nothing have cost him tens of billions of dollars.