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Increasingly organizations implement process improvement efforts aimed at increasing revenue and/or decreasing cost. While some efforts lead to success (Honeywell, Seagate e.g. Huber and Launsby, 2002), others lead to failure. For instance, Home Depot implemented Six Sigma and their American Customer Satisfaction Index ranking dropped from a top spot to the bottom of their industry. Initially profitability soared at Home Depot, but then their stock price plummeted. Home Depot was able to cut costs with Six Sigma, but the energy and emphasis placed on these efforts at cost containment ultimately lead them to lose focus on the customer (thus threatening their underlying revenue stream). Our research investigates how organization approach decisions to direct their improvement efforts toward either revenue improvement or cost reduction. We examine this by considering the perspectives that individual managers have regarding the operational and performance dynamics that follow these changes at their firms. Our study leverages a multi-stage survey and interview protocol approach, uniquely leveraging system dynamics simulation as a critical component of the interview process. The surveys provide a foundation for assessing the broad of perceptions held by managers, while the interview provides an iterative mechanism for critical analysis, model calibration and case development. As a result we are able to triangulate areas where certain fateful perceptions regarding organizational dynamics in the face of change and resource tradeoffs exists, as well as areas where more in depth consideration tends to provide clarifying adjustments to managerial perceptions regarding those dynamics.
Citation preview
04/13/2023
Profit Gaps and Short-Term Heuristics: Systems Dynamics Understanding as a Reinforcement of Operations Strategy
Professor Paulo Goncalves, University of Lugano (Switzerland)
Rick Hardcopf, PhD Student, University of MN
Professor Kevin Linderman, University of MN
Professor Elliot Bendoly, Emory University
04/13/2023
Agenda
> Research Motivation> Case Studies> Research Objectives> Literature – Behavior Under Pressure> Managerial Views> Research Method and Approach> Preliminary Findings> Conclusion
04/13/2023
Research Motivation
> National Science Foundation grant3M – behavior, feedback and delaysCorning – innovation
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A Profitability Gap Leads to Pressure…
DesiredProfits
Profit Gap+
ActualProfits
-
+-
TotalRevenues
TotalCosts
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… to Improve Customer Satisfaction…
DesiredProfits
Profit Gap+
Effort Allocated toCustomer Satisfaction
CustomerSatisfaction
Focus
B1
ActualProfits
Pressure to ImproveCustomer Satisfaction
-
+-
+
+
+
TotalRevenues
TotalCosts
CustomerSatisfaction
MarketShare+
+
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… and Pressure to Cut Costs.
DesiredProfits
Profit Gap
Effort Allocated toCost Cutting
+
Effort Allocated toCustomer Satisfaction
CustomerSatisfaction
Focus
B1
ActualProfits
Pressure toCut Costs
Pressure to ImproveCustomer Satisfaction
+
+
-
+-
+
+
+
Cost CuttingFocus
B2
TotalRevenues
TotalCosts
-
CustomerSatisfaction
MarketShare+
+
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Cost Focus Reduces Effort Allocated to Customer Satisfaction …
DesiredProfits
Profit Gap
Effort Allocated toCost Cutting
+
Effort Allocated toCustomer Satisfaction
CustomerSatisfaction
Focus
B1
ActualProfits
Pressure toCut Costs
Pressure to ImproveCustomer Satisfaction
+
+
-
+-
+
+-
+
Cost CuttingFocus
B2
Costs Cuts Overmarket Share
R1 TotalRevenues
TotalCosts
-
CustomerSatisfaction
MarketShare+
+
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… and Generates More Effort to Cut Costs.
DesiredProfits
Profit Gap
Effort Allocated toCost Cutting
+
Effort Allocated toCustomer Satisfaction
CustomerSatisfaction
Focus
B1
Cost Cuts OverCustomer
Satisfaction
B3
ActualProfits
Pressure toCut Costs
Pressure to ImproveCustomer Satisfaction
+
+
-
+-
+
+-
-
+
Cost CuttingFocus
B2
Costs Cuts Overmarket Share
R1 TotalRevenues
TotalCosts
-
CustomerSatisfaction
MarketShare+
+
04/13/2023
Systems Dynamics Models
> System Dynamics is used to understand the dynamic behavior of complex systems over time
> Uses feedback loops, stocks and flows, and non-linearities to model complex system behavior
> An ideal approach to model complex, managerial resource allocation decisions over time
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DesiredProfitsGap in
Profits+Effort Allocated
to CustomerSatisfaction
ProcessQualityInvestment in
Quality
ActualProfits
TotalEffort
Effort Allocatedto Cost Cutting
Change inAllocation
Time to ChangeAllocation
Initial EffortAllocated to Cost
Cutting
Base Allocation forImprovement
IndicatedProcess Quality
Time to Investin Quality
MinimumProcess Quality
IndicatedAllocation toCost Cutting
MaximumProcess Quality
StepInput
StepHeight
StepTime
MinimumAlocation toCost Cutting
UnitCosts
Initial UnitCosts
Effect of CostCutting Effort
on CostsTable for Effect ofCost Cutting Effort
on Costs
Initial ProcessQuality
Demand
IndustryDemand
MarketShare
CompanyAttractiveness
CompetitorAttractiveness
Effect ofQuality onDemand
Quality Elasticityof Demand
UnitPrice
Initial DolarMargin Actual
DolarMargin
PriceElasticity
of DemandEffect ofPrice onDemand
Initial UnitPrice
Fraction CostReduction toCustomers
Ratio CostCutting EffortFraction of Effort
to CustomerSatisfaction
Fraction of Effortto Cost Cutting
DesiredDolar Margin
DesiredDemand
Desired EffortAllocated to Cost
Cutting
Desired UnitCosts
<Initial UnitPrice>
Desired CostRatio
<Initial UnitCosts>
<Initial EffortAllocated to Cost
Cutting>
<Table for Effect ofCost Cutting Effort on
Costs>
DesiredMarketShare
Desired CompanyAttractiveness
DesiredProcessQuality
<Actual DolarMargin>
<Total Effort>
<DesiredProcess Quality>
Model Overview: A little more complicated
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Research Question(s)
> Current Research Question(s) – How do organizational leaders account for the various complex repercussions of actions designed to resolve profit gap pressures? Are they naturally biased towards short-term resolutions
of a particular kind when coping with these pressures? If short-term heuristics are favored, are there typical
holes in managerial understanding of system-wide impacts that are likely contributing to the use of such heuristics?
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Proposition
> In an effort to resolve profit gaps, managers often over-emphasize cost reduction at the expense of customer satisfaction, and product innovation - and long-term performanceRegardless of an awareness of the profit benefits from
customer satisfaction and product innovation efforts, manager still show a bias cost cutting
System Dynamics complexity and gaps in managerial understanding contribute to biases toward cost cutting
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Literature – Over-Emphasis on Cost
> Biases toward cost cutting Attribution errors – misdiagnose profit reductions as a need to control costs
(Onifade et al. 1997, Silver et al. 1995, Johnston & Kim 1994, Staw & Ross 1978; Repenning and Sterman 2002)
Locus of control (internal vs. external) – people focus improvement efforts on areas in which they have greater control, i.e. internal (Stewart & Chase 1999, Ho & Vera-Munoz 2001)
> Behavior under pressure Under Pressure, individuals tend to rely more on (are biased towards) heuristics that
emphasize, sometime insufficient, subsets of reality (tends to favor the short-term; Bendoly et al. 2010 (Bodies of Knowledge), Bendoly 2013 (Revenue Mgmt)).
> System Dynamics Understanding (SDU) SDU appears crucial in developing solutions to complex problems that span time.
Mental models that do not effectively account for the dynamics of constraints, stocks and flows, feedback loops, etc., are associated with lower performance in complex multi-functional multi-period decision settings (Bendoly 2014 forthcoming).
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Research Method and Approach
> Target Audience – Senior decision makers> Survey 1 – Identify strategic resource allocations loops, and
their prevalence, within a firm (validate the model) Qualitative data are recognized as the main source of information
to develop system dynamics models (Forrester 1992)> Survey 2 – Identify firm specific strategy, industry context,
improvement lead-times, and elasticity’s (parameterize the model)
> Semi-structured (dis-confirmatory) interview –Understand how mental decision models correlate to “disconnects” identified Qualitative data and judgments are much more used by managers
in the development of strategy and decision-making processes (Wolstenholme 1999)
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Preliminary Findings
> Survey #1 (78 responses so far) Individuals were presented with depictions of system dynamics models and
asked to rate their belief regarding the relevance of each causal arc in the diagrams
Respondents represent a range of industries (Baxter, Cox, General Mills, Georgia-Pacific, International Paper, Philips Electronics, SubTrust, etc.).
> Finding #1: There exist general beliefs that profit gaps naturally give rise to cost cutting pressures (both at the respondent’s own firm, and at others)
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Preliminary FindingsFinding #1 addendum: DESPITE general beliefs that a strong causal chain ties efforts at innovation and increased customer satisfaction to profit gains (more so than cost cutting, given the potential for market share impacts).
* Biases to cost cutting aren’t stemming from a general lack of awareness of chains of events, but perhaps from a lack of understanding of their nuances in the presence of timing effects.
