Ansoff matrix: choose your growth direction and weigh the risk

When a firm wants to grow, the first instinct is to push harder: more sales calls, more advertising, a sharper price. Sometimes that works. More often the real question is a different one: with which products, in which markets? The Ansoff matrix is the simplest tool for that question, and it still holds up because the question has not changed.

The question matters more than effort. McKinsey's research found that 80 percent of the variance in revenue growth is explained by choices about where to compete (source: McKinsey, January 2011). Igor Ansoff gave managers a grid for those choices in Strategies for Diversification (Harvard Business Review, September 1957). It sorts growth options by two questions, existing or new products and existing or new markets, which gives four growth directions, each with its own risk.

What is the Ansoff matrix?

Why the risk rises

The further you move from what you know, the more you have to learn at once. In market penetration you know both product and customer. In product development or market development one of the two is new. In diversification both are, and the skills, channels and reputation behind your current business help least. "New" is a matter of degree, though. A neighbouring country with similar buyers is closer than another continent, and a variant of an existing product is closer than a new technology.

How to work out options for each growth direction

The matrix sorts options; it does not create them. Generate ideas with your SWOT analysis and TOWS matrix, place each one in a cell and work through the questions below.

Market penetration

Can you win share, or get existing customers to buy more often or more per order? Look at loyalty, cross-selling and pricing before you buy growth with discounts, because a price cut needs more extra volume than most people expect.

Firmfocus calculation; price cut and contribution margin as a percentage of the old price.

Market development

Does the product fit the new group as it is, or does it need adapting? Who already serves this market, and how will you reach the buyers: your own sales team, distributors or online? Exporting adds rules, currencies and payment terms that a domestic firm has not yet dealt with.

Product development

Which job do your current customers want done that you do not yet do for them? Start from that job rather than from what your technology can do; see value proposition and jobs to be done. Watch for cannibalisation: a new product that mainly replaces an existing one adds cost, not growth.

Diversification

Which of your capabilities carry over, and are they rare and hard to copy? Core competences and VRIO help you judge. Related diversification builds on existing skills or channels; unrelated diversification relies mostly on capital and management. Ask how the new business fits your portfolio and who pays for its loss-making start-up years, the question behind the BCG matrix.

A growth direction is not yet a strategy. You still have to decide how you will win in that direction, and Porter's generic strategies help with that.

Build, partner or buy?

The further a direction lies from your core, the more a partner or acquisition can shorten the learning curve, and the heavier the integration risk weighs. The trade-offs are in acquisitions and alliances.

Spreading growth over time: three horizons

McKinsey's three horizons model (McKinsey Quarterly, December 2009) divides growth by maturity. Horizon one is the core business that brings in most profit and cash today. Horizon two holds emerging businesses that should earn substantial profits in the coming years. Horizon three holds options for later: research, pilots and small stakes in new ventures. The model's warning is that the urgency of the core easily crowds out the other two, so all three need managing at the same time.

Steve Blank argued in Harvard Business Review (February 2019) that the timing no longer holds: digital products can be rolled out fast, so incumbents cannot assume that breakthrough ideas take years to mature. Use the horizons to classify growth, not as a timetable.

How do you divide the money? Bansi Nagji and Geoff Tuff found that outperforming firms allocate about 70% of innovation resources to core offerings, 20% to adjacent efforts and 10% to transformational initiatives (source: Harvard Business Review, May 2012). They stress that the right balance differs by industry and company. Read core roughly as market penetration, adjacent as product or market development and transformational as diversification, and you have a starting point for the budget talk.

Worked example: a maker of commercial ovens

A family-owned maker of ovens for craft and industrial bakeries employs 90 people and sells in its home market and two neighbouring countries. Revenue is €24,000,000 in a mature market. The owners want revenue up by half in five years, to €36,000,000. The management team worked out one option per direction.

The team then estimated the extra revenue each option could add by year five and, as honestly as it could, the chance that each one delivers.

Fictitious Firmfocus example. Expected extra revenue = extra revenue in year five x chance of success; the chances are the team's own estimates. The logic works in any currency.

On paper the four options add €18,000,000, well above the target. Weighted by their chances they add €8,700,000, taking revenue to €32,700,000: growth of about 36%, not 50%. That gap is the most useful outcome of the exercise. The owners either accept a lower target or add options, for example buying a regional service company to speed up the first horizon.

They choose a mix: service contracts as the base, the software through a partnership, the chains first in the home market, and a small dryer pilot with two industrial bakery customers that want to dry their own production waste. Each horizon gets its own owner and budget. Of an annual growth budget of €2,000,000, €1,400,000 goes to horizon one, €400,000 to horizon two and €200,000 to horizon three.

Small business vs larger organisation

Pitfalls with the Ansoff matrix

• Calling everything market penetration: a new customer group is market development, with its own risks.
• Diversifying to escape a weak core: the problems of the core usually travel with you.
• Ignoring cannibalisation: count only the revenue that does not replace existing sales.
• Only low-risk options: they feel safe, but in a mature market they rarely deliver the growth you need.

The Ansoff matrix tells you where to grow; the BCG matrix shows which units can fund it, and acquisitions and alliances covers growth through others. All models for this decision are in strategic choices, part of the strategy overview.