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Business people meet in the city

The Connector - Spring 2012 Issue

iThink Adds Value to Business Intelligence

Roger Davies Roger Davies

Challenged to find great solutions to complex problems while carefully managing risk, corporate executives are turning to Business Intelligence systems. Designed to coordinate data from all parts of the organization and deliver reports that support decision making, Business Intelligence systems have become business critical technology. There’s just one problem. Business Intelligence systems often fail to deliver the intended decision making value which corporations demand.

“Business Intelligence systems represent huge investments in time and money,” says Roger Davies, Founder and Managing Director of Impact Dynamics, a UK-based consultancy specializing in Value Management. “The technology itself is expensive as are the ETL (extract, transform, load) processes needed to prepare and reconcile huge amounts of financial, sales, customer, manufacturing process, and other data. Data schemas used for timely query and reporting processes require a great deal of redundancy so data stores grow quickly which, in turn, necessitates increased investments in server and storage resources.” Davies reports that, despite all this investment, corporations typically spend about 80% of their effort reconciling data and only 20% on value added analysis and decision-making.

Organizations spend so much time getting the data right that they forget to make sure they're using the right data

“Organizations spend so much time getting the data right that they forget to make sure they’re using the right data,” says Davies. “Even after they’ve implemented changes to business or manufacturing processes, it’s difficult to determine if those changes have added value. They just can’t say if they’ve gotten anything out of their investments.”

Working with partners who are leaders in Business Intelligence, such as Logica, Impact Dynamics helps clients turn Business Intelligence specification, design and implementation processes around in order to ensure that all stakeholders realize value outcomes. This is achieved by building system dynamics models which capture the key issues and problems through ‘stories’ told by the people in the front line who will actually need to make the change.

That sounds complicated but, by focusing on value and performance and adding system dynamics modeling, Impact Dynamics' clients ensure that their Business Intelligence systems focus on the right issues and use only the data that supports focused decision making and precise measurement. “We thought, what if – before you jump into system specification and design – you get key people in a workshop and walk through their stories and translate them into solutions,” explains Davies. The workshop process stretches people to extremes by asking participants, “If you had as much money and authority as you need but no excuses for failure, how would you fix the problems identified in your story and then measure progress and ultimate success?”

As Impact Dynamics and their clients continue to prove, such a workshop is a critical first step in creating a productive Business Intelligence system. “When workshop participants think about critical issues and ways to address them, they, in effect, define objectives to be reflected in, and measured by, their Business Intelligence systems,” says Davies. “We build those objectives and the causal relationships between them into a Strategy Map and Balanced Scorecard and then add dynamic simulation in the form of system dynamics models using iThink from isee systems.

Modules allow work teams to understand each objective and how they relate to achieve intended outcomes

iThink models allow the workshop team to home in on measures that should be included in the Business Intelligence system. As important, the team is able to ignore data that will not add value to making decisions, implementing change, or measuring performance. The models also point out real causal relationships between parts of the system, make that causality transparent, and involve all the right people in the process.”

The Module feature in iThink enables Impact Dynamics to create a separate model for each objective in the Strategy Map as defined in the workshop. “Modules allow work teams to understand each objective and how they relate to achieve intended outcomes. We combine modules to create a complete model that relates to an overall Strategy Map and serves as a specification for the Business Intelligence system,” says Davies. “The models also help us train clients in performance management so that they can continue to measure the effectiveness of their decisions and changes independently.”

Their clients’ continued use of iThink models beyond Business Intelligence implementation was initially somewhat of a surprise to Impact Dynamics consultants. “Even though they have a Business Intelligence system in place, many clients continue to use iThink as a business decision tool,” says Davies. “They use the control panel we’ve created for the model to test out new ideas and identify the most critical leverage points.”

For example, one client, an energy company, used its model to determine the criticality of asset information. “This is a very asset intensive company; they deliver products through equipment that requires data relating the status of the asset and enable targeting of maintenance regimes,” says Davies. “They used their model to determine what level of data would allow them to maintain equipment most cost effectively. They were able to reduce the number of problem reports and increase customer satisfaction. They would not have accomplished that with a spreadsheet. iThink has that kind of analysis for breakfast.”

Building models helps demystify complexity and points out causality. People finally understand how their systems really work. You just can’t do that with a spreadsheet

Using system dynamics to link value and performance management and relate it all to Business Intelligence is a unique approach that Impact Dynamics offers through partners like Logica and other ICT service providers. “Our clients know that their Business Intelligence system is fed with the data that will help them measure outcomes,” says Davies. “By using system dynamics to model new scenarios, they can see those outcomes before spending vast sums of money.”

In order to teach his firm’s approach to Value Management, Davies authored Value Management: Translating Aspirations into Performance. “The book explains why the approach is important for companies investing in Business Intelligence systems,” says Davies. “More importantly, it gives step-by-step instruction on how to use the methodology to build value and measure performance.”

Organizations across many sectors have taken advantage of Impact Dynamics’ approach to Business Intelligence systems using system dynamics. “People tend to think that businesses in different sectors have little in common,” says Davies. “They think ‘How is a bank like an airport?’ But all complex businesses have patterns of cause and effect, called archetypes, that enable them to understand where change is needed, what changes should be made, and how improvement can be measured. Building models helps demystify complexity and points out causality. People finally understand how their systems really work. You just can’t do that with a spreadsheet.”

About Impact Dynamics — Impact Dynamics Limited (IDL) is a niche management consultancy founded in 2002 by Roger Davies. Committed to helping clients realize major shifts in their business and individual performance, Impact Dynamics offers a Value Suite that includes Value Management, Performance Management, and Dynamics Modeling. Available individually or as an integrated whole, each service is delivered through highly collaborative Action Learning consulting which leads to clear outcomes and transfers the skills that clients need to repeat successful change processes using their own people.

Case Study: Equipment Company Restores Financial Stability with Help from iThink

Corey Peck Corey Peck

Nothing inspires an analysis of a business system like a decline in performance. When financial metrics trend downward, businesses typically turn a critical eye toward marketing strategy, pricing, distribution channels, and product quality and positioning. Unfortunately, small changes in the business environment can break underlying operational systems that appear to be working. Diagnosing the impacts of those system breaks on financial performance can be extremely difficult.

Perplexed by its own decline in revenue, Rent-a-Dozer* turned to Lexidyne, LLC, a consultancy that provides insight into the dynamic processes that drive system behavior, and iThink Systems Thinking software to determine the systemic cause of revenue erosion, test remedies, and return the company to profitability.

“Rent-a-Dozer rents out heavy equipment to clients in the construction industry,” explains Corey Peck, Managing Director of Lexidyne, LLC. “The company had enjoyed steady sales volumes for years earning revenue by sending machines to its customers’ construction sites. Clients paid a monthly fee for equipment that was on site and, when equipment broke down, returned it to the Rent-a-Dozer’s maintenance facility for repair and reissue.”

the decision rule was to set a fraction of revenue as the ‘parts budget’ which the facility manager could use to maintain a sufficient inventory,

It was critical to maintain an inventory of parts to facilitate the repair process and ensure that equipment could be returned to customers in a timely manner. The parts required to repair equipment were often expensive and, given the number of machines handled by Rent-a-Dozer, the inventory was extensive.

The company relied on a system for purchasing and stocking replacement parts that was driven by a long-standing policy. “The decision rule was to set a fraction of revenue as the ‘parts budget’ which the facility manager could use to maintain a sufficient inventory,” says Peck. “The system had worked well in the past. Inventory levels were always appropriate, costs were relatively low, and Rent-a-Dozer maintained a fairly constant number of machines at client sites that generated a steady revenue stream.”

Revenue was drifting downward Revenue was drifting downward

The Rent-a-Dozer management team began to notice a disturbing trend, however. Revenue numbers (which had previously been fairly stable, even in the wake of changing economic conditions) were starting to drift downward. The pattern was unmistakable and indicated that the volume of equipment at client sites was declining as well.

“Downward trending revenue lines, especially those that are unexpected, beg for an explanation,” says Peck. “Rent-a-Dozer executives were presented with several theories.” Customers were hinting that the quality of machines was to blame. Maintenance people said that the equipment was being subjected to heavy use and experiencing more rapid wear and tear.

As revenue declined, arguments between the facility manager, sales team, and upper management broke out. The sales team was pressed to demand alternative contracts from customers. Maintenance teams were accused of doing sub-par work or turning over machines that hadn’t been fully repaired. Executives speculated that competitors were encouraging customers to return equipment early and end their contracts.

Several remedies were tried and failed; the decline in revenue continued. After months of frustration, Rent-a-Dozer decided to step back and look at their business from a more aggregate, systems perspective. With Lexidyne’s assistance, the Rent-a-Dozer team used iThink, Systems Thinking software from isee systems, to develop a high-level map that allowed them to visualize the structure and relationships inherent in their business model.

The Rent-a-Dozer High-Level Map The Rent-a-Dozer High-Level Map

Even before adding data and simulating the results, the map displayed a simple but potentially devastating reinforcing feedback loop that had gone unnoticed. “It became apparent that any scenario in which machines were returned at a faster rate than they could be repaired caused revenue to fall,” says Peck. “When revenue decreased, there was less money to allocate to purchasing parts. Parts shortages delayed repairs which throttled back the return of machines to the field which, in turn, reduced revenue even more.”

They realized that their decision rule... was creating a vicious cycle that would eventually drive the company out of business

Mental simulation of the feedback loop suggested that the worst was yet to come and a basic iThink simulation concurred. What had appeared to be a simple linear decline in revenue was just the beginning of a nasty trajectory in which revenue would fall at an ever-accelerating rate.

This insight was a turning point for the Rent-a-Dozer team. “They realized that their decision rule which linked parts budgeting and ordering with revenue flow was creating a vicious cycle that would eventually drive the company out of business,” says Peck. “The root cause of the dynamic – the reduction of average time that clients kept the machines on site before they were returned – had to be investigated but the team knew that wasn’t, in and of itself, the problem. Instead, Rent-a-Dozer was inviting instability by continuing to implement a policy that had worked well in the past but was no longer working in the face of changing market conditions. The iThink modeling exercise proved to be an excellent example of one of the central tenants of System Dynamics, the link between the structure of a system and its eventual behavior.”

Revenue projections showed a continual decline Revenue projections showed a continual decline

Armed with new insight, the Rent-a-Dozer team used their basic model to test a number of new decision rules against a wide variety of potential scenarios in order to craft a robust policy for purchasing parts. Equally important, the team gained a more thorough understanding of their business model and saw how some seemingly effective decision rules were actually making a marginally bad financial situation even worse.

About Lexidyne — Lexidyne, LLC specializes in framing, quantifying, and answering specific business questions using the principles of System Dynamics and data analysis. Our facilitated modeling projects offer a unique way for clients to integrate data and institutional knowledge, analyze marketplace dynamics, and quantify the expected impact of strategic decisions.

*Rent-a-Dozer is a fictional name for a real company.

From the Boardroom to the Classroom: Modeling Sales Forecasts to Create Profitable Strategies

Warren Farr Warren Farr

Durability is a great product attribute if you’re a consumer. It’s not so good, at least not over the long term, if you’re a wholesaler of durable goods; products that continue to work for 20 years or more take their owners out of the market. Business success in the durable good market depends on understanding the dynamics of product adoption, replacement and repair in order to position operations for the most profitable revenue streams.

Warren Farr, CEO of Refrigeration Sales Corporation and a guest speaker at both Duke University’s Fuqua School of Business and the University of North Carolina’s Kenan-Flagler Business School, uses an iThink model to guide both his business and MBA students in the creation of profitable strategies for durable goods companies.

In 2000, Refrigeration Sales Corporation (RSC), a wholesaler of heating, ventilating, air conditioning, and refrigeration equipment, parts, and supplies experienced an unusual decline in the growth of air conditioning unit sales. “Since the 1960s, our air-conditioning sales had increased 10% a year on average,” says Warren Farr, CEO of RSC. “With lots of fixed costs typical of a wholesaler, our profits are tied directly to sales volume making sales forecasting critical to business planning and strategy. We needed to understand what was happening in the overall market and what we could do to maintain profitability.”

Farr, who was first introduced to Systems Dynamics at MIT’s Sloan School of Management, created a model based on Bass Diffusion (a model that describes the word of mouth and advertising sales driving product adoption) to forecast US AC industry sales over time. “We talked to our customers who are mechanical contractors that install and maintain air conditioning units, as well as our suppliers. Both groups were somewhat optimistic that the overall market would recover and see a continued upward trend. The system dynamics diffusion model, however, illustrates that no product sales grow forever. Using known industry numbers to tune the model, our model predicted not only a continued slow-down in industry sales, but that AC industry sales would decline by over 20% before reaching a sustainable replacement sales rate.”

Since the US economy was also in decline, it was tempting to point at external causes. The declines we forecast were attributable solely to a dynamic in durable goods markets

The downward sales forecast raised two big questions – what would cause an industry sales decline and what should RSC do to preserve profits? Since the US economy was also in decline and new housing starts were slowing, it was tempting to point at external causes. “The economy and housing starts certainly impact the sales of air conditioning units,” says Farr, “but our model didn’t include those two factors. The declines we forecast were attributable solely to a dynamic in durable goods markets.”

Sales of new products follow a basic bell curve. Sales of new units increase as the product is adopted and then decrease as the market becomes saturated. Replacement sales add revenue as products break or get traded out for newer models. The level of replacement sales is a function of the size of the installed base and the useful life of the product. A large installed base and short product lifespan result in high rates of replacement sales.

“The air conditioning market has experienced 10% year to year growth since the 1960s so the installed base is large and the market is thought to be saturated,” says Farr. “Air conditioning units are also very durable. They work well for 15 to 20 years or longer in the northern US. Replacement units don’t sell at a rate that makes up for the decline in new unit (adoption) sales. Our dynamic modeling showed that, even in a good economy with healthy housing starts, the US AC industry wouldn’t deliver the constant, steady increases in sales opportunities that had defined the previous four decades. This was a particularly interesting result because growth in the US AC industry had slowed, but showed no sign of decline.”

With their future clearly modeled, RSC decided that it had to take action sooner rather than later to ensure profitability. “We made some moves that would have been counterintuitive if we hadn’t seen the market contraction coming,” says Farr. “Having extra warehouse space enables a wholesaler to grow their business by stocking, and then moving, more products. We decided to reduce warehouse space in order to decrease costs while maintaining an appropriate inventory. We also reduced staff which is an unusual move for a wholesaler in our market. It’s difficult to find and recruit people who have the requisite experience and technical knowledge. Our best sales people are trained in-house and, unless you understand that the market opportunity is shrinking, it seems shortsighted to let them go.”

Without the model and the cost-cutting steps we took, things would have been really rough. We would have lost money. That didn’t happen.

Now, ten years after RSC first used a dynamic model to forecast sales, Farr reports that the company remains healthy and profitable. “We took painful steps to prepare for a significant market contraction while times were still good,” says Farr. “Without the model and the cost-cutting steps we took, things would have been really rough. We would have lost money. That didn’t happen. By pre-emptively cutting cost, RSC was positioned to grow in territory and product lines when the US AC industry decline began. Despite an industry decline of over 30%, RSC was able to grow revenues and maintain profitability. As a result we have developed confidence in our dynamic modeling efforts. We’ve continued to build and use it as a proactive planning tool.”

The model has also become a teaching tool at The Fuqua School of Business and the University of North Carolina’s Kenan-Flagler Business School where Farr speaks about business strategy. “We use the model to present two important themes to business students,” says Farr. “First, system dynamics is a tool that brings true value to business strategy. It’s an under-represented voice providing insights that aren’t easily found using other methods or intuition. Second, even if students don’t want to create models, thinking in stocks and flows gives them an atomic language for describing systems that is really powerful.”

Farr points out that the insight into an industry’s control of its own destiny is an important lesson. “Because exogenous conditions like the general economy do impact markets and businesses, it’s easy to blame them for poor performance and decide that nothing can be done about it,” says Farr. “The RSC experience teaches students to seek and carefully describe important causal mechanisms and then determine how to modify the business policies they can control. Students learn the value of taking responsibility for business systems. And, because the model is actually used inside a functioning business, they see how system dynamics can be used to the advantage of an owner-operator or executive.”

MBA students trained in system dynamics bring real value to the businesses they join

While Farr is experienced in a variety of systems modeling tools, he uses iThink in the classroom. “The storytelling feature allows me to unfurl the model and walk the students through it in a way that helps them understand the market and RSC more quickly,” says Farr. “In a dynamic interlinked model, I can reveal one step at a time and keep students focused on what is important. It’s a great tool for an instructor.”

System dynamics is finding its way into more and more business schools and strategy classes. “Professors from other schools familiar with the RSC case study are seeing how system dynamics and tools like iThink will improve their strategy curriculum,” says Farr. “The RSC experience, and the role that modeling plays in other notable companies like Harley-Davidson, shows that MBA students trained in system dynamics bring real value to the businesses they join.

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