What’s it: A cash cow is a product or business unit with a high market share in a low-growth market. In other words, a product is in a mature market and has a dominant position, perhaps as a market leader.
It is one of four quadrants in the BCG matrix in addition to Star, Question mark, and Dog.
- Star: product with a high market share in the high market growth. The primary strategy is to keep or sustain a market position.
- Question mark: product with a low market share in the high market growth. The primary strategy is to build and increase market position.
- Dog: product with a low market share in the low market growth. The rational options are to stop or divest.
What does a cash cow mean
A high market share means that the company posts high sales. The company might have a strong brand image that allows customers to be loyal and willing to buy products repeatedly.
When the market matures, the company cannot rely on sales growth from new customer demand. At the mature stage, most consumers have used or purchased the product. Hence, the primary source of sales volume is from repeat purchases.
High sales allow companies to achieve significant economies of scale. Thus, average unit costs are relatively low because firms can spread fixed costs over a large number of outputs.
As a result, cash cows tend to have higher profit margins compared to other categories of the BCG matrix. Furthermore, this category is also a significant money earner as it requires a lower investment.
Please remember, the cash cow category does not only apply to products, but also business units.
Investors usually favor cash cows. These categories are more likely to generate continuous dividends thanks to their ability to generate a stable and significant amount of free cash flow.
How the cash cow impacts company strategy
The company must extract cash flow from the cash cows as long as possible. They can use it to support long-term growth, particularly star and question mark categories. It is urgent as the mature stage may end soon and enter the decline stage.
Potential cash sources
The cash cow category generates a lot of cash flow to the company. The company enjoys a higher sales volume (relative to competitors) and, at the same time, incurs relatively little investment.
Companies incur costs such as marketing and promotion are relatively small. I mean, it’s just to maintain market share.
It contrasts with competitors. To seize the top position, they have to spend more. It may be more than the market leader has paid to succeed in capturing market share.
Customers may also be reluctant to switch to competitor’s products because they are satisfied with what they are currently buying. That situation, of course, makes the costs of seizing market positions even higher.
Therefore, we consider the cash cow to have better competitiveness. That, in turn, contributes positively to the company’s profits and cash flow. And, the company can use this cash flow to support the company’s portfolio management strategy. They can use it to fund research and development, develop more effective marketing strategies.
Harvest strategy to support the position of the star category and question mark
The company should make sure to get a sustainable profit and cash flow. To do so, they can develop and launch new products and services in markets that have high and sustainable growth prospects.
If it already has a product portfolio, the company can use the cash flow to support the cash cow and star categories.
Significant investment in the cash cow category will be wasted due to low market growth. The market is going into a downward phase. Hence, investing heavily in the cash cow category is an expensive and unsuccessful strategy.
Indeed, companies still need to invest in cash cows. But, such an investment is relatively small. The strategy for the cash cow category is usually to maintain the current market position.
On the other hand, investment in the star and question mark categories is vital because their positions are unstable. Both are in high growth markets. Competitors can take over and dominate the market.
Stars and question marks are expected to become cash cows sometime in the future. Companies can use cash flow to build question marks into market leaders by increasing market share.
Meanwhile, the star has a dominant position in the market. Hence, the company must at least sustain the current market position until the market reaches a mature stage.
What companies need to pay attention to
Cash cows might remain in the maturity stage for years. Eventually, they will start to decline. At that stage, the company must decide whether to introduce new products or strengthen the star and question mark.
But, sometimes, the mature phase lasts a short time. The market immediately enters a decline stage. And in general, investing in the star and question mark categories is very urgent if:
- The market immediately enters a decline stage.
- The product faces a cheaper and better substitute.
- Unique value propositions quickly become obsolete, for example, due to dynamic technological developments.
The three are usually related. The market usually enters a decline immediately as new substitutes emerge, which use more sophisticated and less expensive technology.
The shorter the maturity phase, the less time the company can extract cash from the cash cow category.
That’s the reason why many tech companies like Facebook acquire other companies. Most of the population uses Facebook. Because of this, the growth prospects for new users are also getting lower.
To support long-term growth, Facebook has finally acquired several products, such as Instagram and Whatsapp. Apart from supporting growth, the company also benefits from synergies.
Back to the cash cow topic.
This category is vulnerable to substitute products that are cheaper and offer better or equivalent benefits. They may adopt more sophisticated technology, allowing them to offer more attractive features. If the new substitute is successful, the cash cow product life cycle will be shorter, reducing its financial returns.
