STRATEGY DYNAMICS

SESSION 1

COMPLEX SYSTEMS

PGP 2021-23
3rd February 2023
CLD – COVID19
 THE CONCEPT OF A SYSTEM
A system is any group of interacting, interrelated, or interdependent parts that form a
complex and unified whole that has a specific purpose.
Systems have purpose
All parts must be present for a system to carry out its purpose optimally
The order in which the parts are arranged affects the performance of a system
Systems attempt to maintain stability through feedback
Various Types of Systems
Biological Designed

Abstract Social

Human Activity System

 SYSTEMS THINKING
Systems thinking is the ability to see systems holistically by understanding the
properties, forces, patterns and interrelationships that shape the behavior of the
systems which provides options for actions.

OPEN
SYSTEMS

• Examining how
WE CREATE OUR OWN PROBLEMS
DYNAMIC DETAIL
COMPLEXITY • Seeing the COMPLEXITY
BIG PICTURE

• Recognizing that
STRUCTURE INFLUENCES PERFORMANCE
CLOSED
SYSTEMS
 DELUSIONS

The Delusion of Mental Models

The Boiled Frog Delusion

The Delusion of Learning from Experience

The Delusion of Individual Initiative within a System

 System Dynamics

• System Dynamics
• Introduced by Jay Forrester of MIT in 1958
• Grounded in nonlinear dynamics and feedback control.

• According to the theory of system dynamics, the multitude of variables

existing in complex systems become causally related in feedback loops that
themselves interact.

The systemic interrelationships between feedback loops constitute the structure of

the system, and it is this structure that is the prime determinant of system behavior.

• The growth in power of the digital computer was a major inspiration to Forrester at
the time he was developing system dynamics.
 SYSTEMS THINKING TOOLS
Causal Loop Diagrams - a useful way to represent dynamic interrelationships
• Provide a visual representation with which to communicate that understanding
• Make explicit one's understanding of a system structure - capture the mental model
Variables - an element in a situation which may act or be acted upon
• Vary up or down over time (not an event)
• Nouns or noun phrases (not action words)
Links / Arrows - show the relationship and the direction of influence between variables

All systemic-behavior can be described through two basic processes:

R - Reinforcing feedback loop that amplifies change

B - Balancing feedback loop that seeks equilibrium

or they can be denoted by S's and O's - show the way one variable moves or changes in
relation to another
S stands for "same direction” O stands for "opposite direction”
 REINFORCING LOOP

Structure Behavior Over Time

Employee
Supportive
Performance Perf. Behavior
Level
S
S
Unsupportive
Supervisor’s
Behavior
Supportive
Behavior Time
 BALANCING LOOP

Structure Behavior Over Time

Desired S
Discrepancy
Inventory
O
Actual Inventory
100 ++
S Desired Inventory
Actual Inventory 100
Inventory Adjustment
S 100 - -
Time
 Questions these Diagrams help answer

• Which gaps are driving our system when and by how much?

• How accurately do we know what each of the gaps is?

• How are we monitoring the gaps?

• What are the different ways in which we can close the gaps?

• How long does it take for perception to catch up to actual quality?

 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

1. Use nouns when choosing a variable name.

Avoid verbs and action phrases, because the action is conveyed in the loop’s arrows.

For example, “Costs” is better than “Increasing Costs” because a decrease in Increasing
Costs is confusing.

The sign of the arrow (“s” for same or “o” for opposite) indicates whether Costs increase
or decrease relative to the other variable
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

2. Use variables that represent quantities that can vary over time.

It does not make sense to say that “State of Mind” increases or decreases.

A term like “Happiness,” on the other hand, can vary.

 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

3. Whenever possible, choose the more “positive” sense of a variable name.

For example, the concept of “Growth” increasing or decreasing is clearer than an

increase or decrease in “Contraction”
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

4. Think of the possible unintended consequences as well as the expected outcomes

for every course of action included in the diagram.

For example, an increase in “Production Pressure” may increase “Production Output,”

but it may also increase “Stress” and decrease “Quality”
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

5. All balancing loops are goal-seeking processes.

Try to make explicit the goals driving the loop.

For example, loop B1 may raise questions as to why increasing “Quality” would
lead to a decrease in “Actions to Improve Quality” By explicitly identifying
“Desired Quality” as the goal in loop B2, we see that the “Gap in Quality” is really
driving improvement actions.
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

6. Distinguishing between perceived and actual states, such as “Perceived Quality”

versus “Actual Quality” is important.

Perceptions often change slower than reality does, and mistaking the perceived
status for current reality can be misleading and create undesirable results.
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

7. If a variable has multiple consequences, start by lumping them into one term while
completing the rest of the loop.

For example, “Coping Strategies” can represent many different ways we respond to
stress (exercise, meditation, alcohol use, etc.)
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

8. Actions almost always have different long-term and short-term consequences.

Draw larger loops as they progress from short-to long-term processes.

Loops B1 show the short-term behavior of using alcohol to combat stress.

Loop R2, however, draws out the long-term consequences of this behavior,
showing that it actually increases stress.
 GUIDELINES FOR DRAWING CAUSAL LOOP DIAGRAMS

9. If a link between two terms requires a lot of explanation to be clear, redefine the
variables or insert an immediate term.

Thus, the relationship between “Demand” and “Quality” may be more obvious when
“Production Pressure” is inserted between them
10. A shortcut to determining whether a loop is balancing or reinforcing is to
count the number of “o’s” in the loop. An odd number of “o’s” indicates a
balancing loop (i.e., an odd number of U-turns keeps you headed in the
opposite direction); an even number or no “o’s” means it is a reinforcing loop.

CAUTION: After labeling the loop, you should always read through it to make sure
the story agrees with your R or B label.
 SD Modeling: Standard approach

• Identify the problem

• Develop a dynamic hypothesis
• Create a basic causal loop diagram
• Convert the causal diagram to a Stock flow diagram
• Write the equations
• Estimate the parameters and initial conditions.
• using statistical methods, expert opinion, market
research data or other relevant sources.
• Simulate the model and analyze results
 STOCKS AND FLOWS
Stocks are a quantity of something. Water in a tank is a good example of a stock. Sometimes stocks
are called reservoirs. All the stocks that are connected with flows will have the same units, that is all
the stocks will be a quantity of water, or an amount of carbon, or the number of people, etc.

Flows connect stocks or source/sinks.

The flow will increase any stock that it
flows into or decrease a stock that it
flows out of.

All the flows that are connected to a

stock will have the units of whatever
the units of the stocks are per time.
 STOCKS AND FLOWS
When we have information that is needed in the model as a constant or we need to make a
calculation, we show that as a "converter/constant".
Information connectors illustrate the flow of information, not material, from other
components to either flows or converters. Information cannot flow to a stock because the
stocks can't do anything with that information. In the simplest form, an information flow simply
notifies an action of the concentration of a stock, the rate of flow, or the value in a
converter/constant.
A source or sink is either has an unlimited, unchanging concentration or a reservoir that is
outside the boundaries of the system that we are studying.
Source Sink

Stock Flow
Information
 IDENTIFYING STOCKS AND FLOWS
THE SNAPSHOT TEST

To identify key stocks in a system, imagine freezing the scene with a snapshot.
Stocks would be those things you could count or measure in the picture, including
psychological states and other intangible variables.
Debt
Borrowing (Rs) Repayment
(Rs / year) (Rs/year)
Product Price
Rate of Price Change (Rs/unit)
(Rs/unit/year)

Expected Customer Orders

(widgets/week)
Change in Expected Order Rate
(widgets/week/week)
 CONDITIONS VERSUS ACTIONS
To change conditions require action(s). One reason to make the distinction between
stocks and flows in building understanding of real world structures is to know how
to improve those conditions we wish to improve.

We usually think of conditions as such static concepts:

• What’s the current level of unemployment?
• How much stress do I feel?
• How many tigers are there in the forest?

Changing conditions require thinking dynamically by focusing on the actions (flows)

that affect these levels.

You cannot change unemployment without Unemployed Employed

ensuring that the number leaving the gaining employment
Unemployed stock exceeds the number
entering. losing employment
 CONverting CAUSAL LOOP DIAGRAMS TO STOCKS AND FLOWS
Specify the Units of All CLD Variables. Begin by asking yourself the question,
“What are the units of each variable in the diagram?”

Identify and Create the Stocks. Determine which CLD variables are stocks.

Identify and Create the Flows. Once you have identified the stocks, it is easy to identify the flows:
They are the variables that add to or subtract from the stocks

Connect Flows to Stocks and Stocks to Flows (if Necessary). First, connect all flows to the stocks
that they influence. Then, if a stock influences one or more flows, connect the stock to the flows
through an information link.

Add and Link Remaining CLD Variables. Add any CLD variables that you did not identify as stocks
or flows. These “auxiliary” variables are either constants or calculations based on stocks and flows.
Connect the new variables as necessary

Define Stocks and Flows and Check Units. Specify the equations that allow you to calculate the
value of each variable when you know its initial value and the value of the other variables in the diagram.

Create and Link Any Additional Variables. Defining the variables may lead you to discover additional
Variables necessary to complete the conversion process and make the model calculable.
 SYSTEM DYNAMICS MODELING: AN EXAMPLE
We model the marketing resource endowment process of a traditional retailer.
Research Question
How and why does the initial e-commerce resource endowment of a traditional firm
improve or deteriorate the firm’s performance over time?

As the customer base grows, the firm’s revenue increases, expanding the resources
available for marketing and sales activities (i.e., marketing resources endowment).

Marketing resources endowment is used to improve the firm’s marketing capability,

which in turn leads to a net increase in customers by converting potential customers
away from competitors and retaining existing customers (i.e., customer net
increase), which builds the customer base.

Firm growth, reinforced by marketing capability, cannot be sustained due to the finite
size of the market; that is, the limit to growth.
 CLD

Revenue
Marketing + +
Resource
Customer Base
Endowment
+
R1
+
Marketing -
Capability Customer Net B1
+ Increase Competitor's
+
Customer Base
 FIRM BEHAVIOR PATTERN

Firm performance may exhibit exponential growth if the reinforcing loop R1 positively dominates.
Conversely, if loop R1 negatively dominates (i.e., a vicious cycle), the firm may experience
exponential decay.
If loops R1 and B1 are in balance, stable equilibrium behavior may result.
If the reinforcing loop R1 dominates first and then the balancing loop B1 takes over, an S-shape
growth pattern may result (i.e., exponential growth followed by goal-seeking behavior to achieve an
equilibrium state).
 STOCK AND FLOW DIAGRAM

Percentage for
Marketing
Marketing Revenue
Resource
Endowment
Required Marketing Customer Base
Resource per person
Contact Rate

Marketing Customer Net

Marketing Capability Increase Loss Rate
Capability Change
Conversion
Rate
Time to Adjust Competitor's
Marketing Capabilty Customer Base
 Front-end EXTENDED CLD
E-Commerce Resource
Endowment +
+
Front-end
E-Commerce
Capability - Revenue
Marketing + +
Resource
Customer Base
Endowment
+
+
+ Marketing -
Capability Customer Net
+ Increase + Competitor's
Customer Base

Competitor's
response
 Extended model

Front-end Time to Develop

Depreciation Time Total Desired
Front-end E-Commerce Resources
Front-end Percentage of Revenue
Capability Front-end to E-Commerce
Front-end Capability Front-end E-Commerce
Capability Building Resource Endowment
Depreciation
Percentage of E-Commerce
Resource from Marketing Profit
Other Costs
Marketing Revenue
Percentage for Resource
Marketing Endowment
Customer Base
Required Marketing +Market Share
Resource per person
Contact Rate

Marketing Customer Net

Marketing Capability Increase Loss Rate
Capability Change +

Conversion
Rate
Time to Adjust + Competitor's
Marketing Capabilty Customer Base
Competitor's
response
SIMULATION
THANK YOU