June 28, 2002

Thinking Outside the Lines

System dynamics can expand to embrace not just scientific but also analytic business applications

by Edilberto Casado

Analytic applications are today an established part of enterprise strategy. But only an effective use of analytic applications can justify their usually high implementation costs. Now, the power of these tools can be increased, and the resource for this improvement has been with us for quite some time.

System dynamics, a concept developed at the Massachusetts Institute of Technology (MIT) in the mid-1950s, is an important complement to analytic applications when it comes to execution of organizational strategy. Though it's still widely perceived as a scientific tool, there's now a special opportunity to spread its utilization as a business tool. CRM, supply chain management (SCM), and other analytic technologies can noticeably improve their capacities through system dynamics.

An Overview of System Dynamics

Professor Jay W. Forrester of MIT created system dynamics during the mid-1950s. This discipline evolved from prior work in feedback control systems, and progressively its application was extended to fields other than engineering, such as environmental sciences, social sciences, economics, software development, and enterprise management.

System dynamics helps us understand how things change through time, and it's based in the "systems thinking" approach. Systems thinking takes into account internal feedback effects within a system, a concern usually ignored when information from analytic applications is directly used, which can lead us to make "counterintuitive" decisions (a word Forrester used to describe actions we believe right to meet a goal, but that have a null or opposite effect), and it could make us think that such applications are poorly implemented and, consequently, useless.

As a typical example of counterintuitive reasoning and its results, managers may assign more people to a delayed software development project in order to get it back on schedule, even though doing so is proven to introduce more delay. You can find a more detailed list of similar examples for social and economic systems in chapter 1 of Business Dynamics by John Sterman, who also provides an excellent discussion about the phenomenon of "policy resistance."

A Business Strategy Tool

In 1961, Forrester published the first and classical book in the field of system dynamics: Industrial Dynamics. In this book, he emphasizes the expression "enterprise design" when describing the fundamental job of a manager. This expression is equivalent to the oft-used business term "strategy design," the omnipresence of which is one example of how, since Industrial Dynamics was published, system dynamics has increasingly been used as a tool applied to research and analysis of organizational strategy.

State-of-the-art system dynamics applications supply visual and descriptive elements (stocks, flows, connectors, formulas, and so on), which can be used as part of a "strategy modeling language," making explicit the strategy logic and the nature of dynamic effects between strategic actions. This idea for representation has been adopted by the balanced scorecard, a business framework that I'll discuss later.

Analytic Applications in Organizational Strategy

The main role of analytic applications is to support the organizational strategy through continuous monitoring of enterprise performance and market trends, and its implementation must reflect the elements of such a strategy. For example, Ram Reddy wrote in an earlier article about the need for "an actionable CRM strategy, which is a well-defined series of steps or processes for implementing CRM, along with measurable CRM goals and objectives" (see Resources). This same concept is extensible to other technologies such as ERP and SCM, and system dynamics can make "visible" the strategy regarding such implementation. Figure 1 shows an example based on Reddy's article.

The strategy visualization allows us to make better forecasts through simulation. Likewise, with real-world data provided by analytic applications, we can validate the effect of actions underlying the strategy, and make improvements as needed to meet desired goals.

The Balanced Scorecard Opportunity

Though the value of system dynamics as a business tool has been recognized for some time, and we, therefore, might expect that it to be widely applied, it doesn't seem to be. When you search for literature in books, magazines, and the Internet, the first impression you get is that system dynamics is mainly a theoretical and scientific discipline. For example, if you query any Internet search engine with the words "system dynamics," most of the hits will be entries for Web pages about solar dynamics and similar scientific research topics, information about courses, and some educational resources. Only a few of these are about software and consulting firms.

The balanced scorecard, a business framework created by Robert Kaplan and David Norton and formally started in 1992, has quickly gained wide acceptance in many organizations around the world, independently of their size and business sector. In Kaplan and Norton's last book, The Strategy-Focused Organization, they discuss the importance of dynamic simulation as a resource to test the hypotheses underlying an organizational strategy, which they describe using strategy maps (also called cause-and-effect diagrams).

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