Small businesses sometimes start out offering only one product or service. But as businesses grow, they typically expand their product offerings and tap into new markets. Portfolio analysis is a process where managers study the profitability of the various products and services a business offers. It is designed to help optimize the allocation of resources between those products and services. While portfolio analysis can be a useful tool for thinking about how to optimize return on investment, there are both advantages and disadvantages of portfolio analysis.
Defining and Categorizing Products
Portfolio analysis involves separating a company's products and services into different categories that represent its business portfolio. But one of the disadvantages of portfolio management is it is not always easy to define and categorize products. This can lead to subjective decisions about how to categories products and services. For example, the owners of a grocery store might decide that candy and fruit are two of its product categories. If the store sells candied fruit, the owners might have difficulty placing the product in an appropriate category.
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Forecasting via Financials
Portfolio analysis relies upon estimates or forecasts about the future, according to My Accounting Course. Forecasting often involves looking at financial data, such as the sales history of different products, and using that data to extrapolate about the future. For example, if a small grocery store's candy sales have increased 5 percent a year for the past two years, it might forecast that annual sales will continue to increase at a 5 percent rate. Benefits of product portfolio analysis include that forecasting can help managers form expectations about the future. But they can also turn out to be inaccurate, meaning a portfolio analysis does not guarantee optimal return on investment.
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Complex Product Interactions
Portfolio analysis typically focuses on the profit potential of individual products and product categories, which can ignore complex underlying relationships between different types of products, according to Smart Sheet. It is possible for the sales of one product to influence the sales of another, even if they are not in the same product category.
For example, suppose a restaurant loses money on malts because it doesn't charge a high enough price for them, but it makes a lot of profit on burgers. The owners might decide to raise the price of malts. But it might be missing a very important point – that many customers visit the restaurant because its malts are so inexpensive. While they are there, they decide to order a burger as well. Higher malt prices could lead to fewer customers, which would result in lower burger sales and, ultimately, lower profits.
Alternative Investments
Since portfolio analysis focuses on the products and services that a business offers, it ignores possible alternative investments that could be better than investing more in current product offerings. A company might be better off investing in a new technology, for example, than allocating more resources to its current products and services.
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