Corporate Finance
Feb 21, 2023
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This guide explains what the Ansoff matrix is and how it is used to better understand a company's expansion prospects. Here are some key takeaways about the Ansoff Matrix:
When we're analyzing a business for purposes of investment, it's important to understand the external business environment and the industry the company operates in as well as the company itself.
It's useful to think of this analysis in layers, moving from the external business environment (ie. the country's economy), to the industry the company operates in, down to the company specific analysis we do.
There are some useful frameworks for analyzing the external business environment and the industry as a whole, including: PESTEL Analysis and Porter's Five Forces. Moving beyond this, in this guide we're going to look at the Ansoff Matrix, which is a useful tool for understanding how an individual business operates.
The Ansoff Matrix is a popular tool for assessing an individual company's strategy. It helps stakeholders to visualize the relative attractiveness and the risks between different potential growth strategies.
Ultimately in an M&A deal, buyers of established businesses are looking to justify their investment by viewing the business as an asset that is intrinsically valuable based on the cash flows it produces.
In order to justify paying a large sum of money to acquire a business, buyers need to understand the companies strategy, the industry it operates in, and the internal and external threats and opportunities that justify the investment.
Without this strategic understanding, any attempts at valuation will be too theoretical to be meaningful.
Just as we've used PESTEL analysis and Porter's Five Forces as tools for learning about external business environments and industries, we can use tools to help us analyze a business.
We can use an Ansoff Matrix and SWOT analysis to help us learn more about a specific company.
An Ansoff Matrix helps us look at the role that products and services play in expansion. We look at the reality of selling existing or new products to existing or new markets.
When we're analyzing a business, we're ultimately looking at how companies create relationships with their customers through different types of value propositions.
Here, we want to understand the competitive position the business has in the market place.
Some examples of competitive positions could include: best product, lowest price, best payment terms, offer differentiation, complete versus specific solutions, etc.
Now that we've looked at some examples of competitive positions, let's look at how an Ansoff Matrix can be valuable.
In order for the business to function as an economic entity, it needs to sell something to someone.
The Ansoff Matrix, sometimes called the Product/Expansion Grid looks at the business' strategy from the perspective of how they could sell more "things" to more "buyers".
Below is an infographic of an Ansoff Matrix.
On the axes of the matrix, we see "products" and "markets."
Depending on the type and nature of the business we're evaluating, markets could be defined geographically, demographically, or by the niche they are targeting. Products would be defined by what they are selling.
The Ansoff Matrix gives us four core strategies for expansion.
The first is Market Penetration, where we're selling existing products to existing markets. An example of this strategy could be how wireless phone service providers ruthlessly try to undercut each other on rates or apply various types of promotions for new sign-ups. The goal here is to double down on what's already working.
The second is Market Development, where the strategy is to sell existing products into new markets. As an example, we could look at an Australian supplements business that has decided to start selling their products in North America. The growth play here is to grow the size of the market the business is selling the same products to.
The third strategy is Product Development, where the business looks to sell new products to it's existing market. An example of this could be a business that manufactures and sells men's shaving cream and razors that decides to offer a new line of skin care products to the same existing customer base.
The fourth strategy is Diversification, where the business looks to sell new products to new markets. This strategy could be resultant of a business' core competency. As an example, maybe an aerospace engine manufacturer decides that because they are soo good at creating the steel for their jet engines, they could use that skill to create a new product out of the old method and sell that product to a new market. This strategy is widely considered the riskiest because they need to prove their product and their market at the same time.
At first glance, the Ansoff Matrix is a useful tool for driving organic growth in a business. This tool gives entrepreneurs and management teams a way to consider all of their options and debate the best course of action to take next.
On another note, the Ansoff Matrix is also an excellent framework for considering potential M&A deals. When a business grows to a certain point, growth through acquisition often becomes a better growth strategy than more of the same. Part of this would have to do with how large the market is and the direction management want to grow in. The total addressable market for the business may influence the decisions that management teams make using the Ansoff Matrix as well.
Along the same lines as organic growth, the Ansoff Matrix could also be used to help companies decide what type of business they want to buy. For further reading about how the Ansoff Matrix could be a useful tool in strategic M&A, we'd recommend our guide Types of Mergers & Acquisitions.
For additional reading on the differences between organic growth and growth through M&A, we'd recommend Organic vs. Inorganic Growth.
