Relative market share was used because it was seen to be an indicator of the product’s ability to generate cash; this axis correlates with the experience curve. Market growth forms the other axis, correlating with the stages of the life cycle and was used as an indicator of the products cash requirements. This matrix has meaningful implications for the company especially in respect of cash flow.
Firstly a firm with a relative market share of greater than 1.0 will move along the experience curve at a faster rate than its competitors and therefore gain a long-term cost advantage.
Secondly studies have suggested that long-term profitability is related to market share (PIMS)In the earlier sixties, a large number of industries were surveyed in terms of their costs and the cumulative production outputs that they achieved. It was found that there was a relationship between cost reduction and cumulative output. Dramatic cost reductions were observed (up to 15%) every time overall output doubled. I.e. more experience lowers unit costs.
These effects can be seen at an industry level as well as at a company level. At the company level, the market leader will have produced more product that any other company and will therefore have a cost advantage over the competitors. At industry level costs are reduced as the industry produces more and every company will benefit from the knowledge that is circulated within the industry.
The Boston Consulting Group considers the experience effect to be a demonstration of the way in which a company conducts its whole business.
In the BCG matrix, the experience curve effect requires that market share is increased to be able to drive down costs in the long run and that a company with a dominant market share will inevitably have a cost advantage over competitor companies because they have the biggest volume. Market share is correlated with experience. High market share means high experience and lower costs, implying high margins and profitability. It implies improved cash flows whereas a lower market share implies the unavailability of cash and profits.
It is easier to gain market share in a high growth market where competitor activity is usually lower
High growth markets are usually less price competitive as it is here that demand exceeds supply
Market growth is often used as an indicator of the stage in the business/product life where positive growth indicates a growing or mature market and a negative growth indicates a declining market. The stages of the life cycle play a role in decision-making and the matrix is a quick method of showing where the business/products stand in their life cycle. Growth therefore also indicates attractiveness