Figures and Tables excerpted from

Business Dynamics:
Systems Thinking and Modeling for a Complex World
Chapter 3

John D. Sterman
Massachusetts Institute of Technology
Sloan School of Management

Figures and Tables excerpted from

BUSINESS DYNAMICS: SYSTEMS THINKING AND MODELING FOR A COMPLEX WORLD
John D. Sterman

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Business Dynamics
 The modeling process is iterative.

1. Problem Articulation
(Boundary Selection)

5. Policy
2. Dynamic
Formulation
Hypothesis
& Evaluation

4. Testing 3. Formulation

Figure 3-1 Results of any step can yield insights that lead to revisions in any
earlier step (indicated by the links in the center of the diagram).

Business Dynamics
 Problem Articulation (Boundary Selection)

Theme selection: What is the problem? Why is it a problem?

Key variables: What are the key variables and concepts we must
consider?

Time horizon: How far in the future should we consider? How far
back in the past lie the roots of the problem?

Dynamic problem definition (reference modes): What is the

historical behavior of the key concepts and variables? What might
their behavior be in the future?

Business Dynamics
 The Modeler’s Dilemma

That’s another thing we’ve learned from your nation,” said Mein
Herr, “map making. But we’ve carried it much further than you. What
do you consider the largest map that would really be useful?”

“About six inches to the mile.”

“Only about six inches!” exclaimed Mein Herr. “We very soon got to
six yards to the mile. Then we tried a hundred yards to the mile. And
then came the grandest idea of all! We actually made a map of the
country on a scale of a mile to the mile!”

“Have you used it much?” I inquired.

“It has never been spread out yet,” said Mein Herr. “The farmers
objected: they said it would cover the whole country, and shut out the
sunlight! So now we use the country itself, as its own map, and I assure
you it does nearly as well.”

Lewis Carroll (1893) – Sylvie and Bruno Concluded

Michael L. Deaton
 Modeling is embedded in the system.
Real
World

Decisions
Information
(Organizational
Feedback
Experiments) 1. Problem Articulation
(Boundary Selection)

5. Policy
2. Dynamic
Formulation
Hypothesis
& Evaluation

4. Testing 3. Formulation

Strategy, Mental
Structure, Models
Decision of Real
Rules World

Figure 3-2 Effective modeling involves constant iteration between experiments

and learning in the virtual world and experiments and learning in the real world.
Business Dynamics
 18
Consumption

Million Barrels/Day
12 Imports

6 Alaska

Production,
Lower 48 States
0
1986 1988 1990 1992 1994 1996

30

25

20
1990 $/bbl

15

10

0
Figure 3-3 1988 1986
1990 1992 1994 1996

US oil production, consumption, imports, and price over a 10-year time horizon
Source: EIA (US Energy Information Agency) Annual Energy Review.
Business Dynamics
 18
Consumption

Million Barrels/Day
12 Imports

Alaska

6
Production,
Lower 48 States

0
1870 1890 1910 1930 1950 1970 1990
50

40
1990 $/bbl

30

20

10

0
1870 1890 1910 1930 1950 1970 1990
Figure 3-4
US oil production, consumption, imports, and price over a 130-year time horizon
Source: Production & consumption: 1870-1949, Davidsen (1988); 1950-1966, EIA Annual Energy Review. 1880-
1968, Davidsen (1988); 1968-1996, EIA Annual Energy Review, Refiners Acquisition Cost.
Business Dynamics
 The fossil fuel era shown with a time horizon of 15,000 years
Fossil Energy Production

-10000 -5000 Iron 0 5000

Age Industrial First Oil
Year Revolution Shock
Figure 3-5
Source: Adapted from Hubbert (1962).

Business Dynamics
 Formulation of Dynamic Hypothesis

Initial hypothesis generation: What are current theories of the problematic

behavior?

Endogenous focus: Formulate a dynamic hypothesis that explains the

dynamics as endogenous consequences of the feedback structure.

Mapping: Develop maps of causal structure based on initial hypotheses, key variables,
reference modes, and other available data, using tools such as:

• Model boundary diagrams

• Subsystem diagrams
• Causal loop diagrams
• Stock and flow maps
• Policy structure diagrams
• Other facilitation tools

Business Dynamics
 Model Boundary

Chart for a long term model of energy – economy interaction

Business Dynamics
 Computer Security

• Exogenous view: Hacking happen sometimes; the greater

the hacking, the worse the damage.

• Policy implication: When hacking happen to occur, recover and

rebuild.

• Endogenous view: Hacking occurs when system meets

vulnerability; vulnerability is a result of computer security
policies

• Policy implication: Recognize human role in hacking. Work

with stakeholders to minimize vulnerabilities.

Business Dynamics
 Feedback Loops as a Consequence of the
Endogenous Point of View

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 Expanding the Boundary

Business Dynamics
 “Systems thinking is the mental effort to uncover
endogenous sources of system behavior.”
Business Dynamics
 Classic examples

“The fault, dear Brutus, is not in our stars, but in

ourselves …” [Cassius, in Julius Caesar]

Business Dynamics
Dynamic Hypothesis and Fundamental Modes of Dynamic
Behavior

R B
R B

B + delay
floating
goal

R B + delay R B + R

Figure from Business Dynamics (Sterman 2000), reproduced by permission of the McGraw-Hill Companies.
 Patterns of corporate growth

Figure 3-6
Source: Adapted from Forrester (1964).

Business Dynamics
 Subsystem diagram for Forrester’s corporate growth model

Figure 3-7
Source: Adopted from Forrester (1964).

Business Dynamics
 Subsystem Diagram

• Shows the overall architecture of a model

• Each major subsystem is shown along with the

flows of material, money, goods, information, and
so on coupling the subsystems to one another

• Subsystem diagrams convey information on the boundary

and level of aggregation in the model by showing the
number and type of different organizations or agents
represented

Business Dynamics
 Market Competing Competitor
Products
• Market
Share
New • Potential
Figure 3-8 Products Market Competitor
Subsystem diagram Price

for model of a
Price
semiconductor firm New Product Developm ent
On Time
Delivery, Shipments Pricing
and its quality • Breakthrough Products
Defects

improvement • Line Extensions

Orders
• R&D Staff Utilization Unit Costs
program • Development Projects
Source: Adapted from Manufacturing Managem ent
Sterman, Repenning, and Accounting
• Capital
Kofman (1997). • Cost of Goods Sold
Process Yield, • Labor Product
Cycle Time Costs • Budget Variances
Improvement • Inventory
• Quality
Improvement
Hiring/Firing
• Process
Improvement Investment
• Workforce Financial
Commitment Stress
• Management Costs • Operating Income
Support • Labor Variances
• Takeover Threat
Financial
Accounting
R&D Spending
• Income Statement
• Forecasted Revenue • Balance Sheet
• Desired Fraction to R&D • Flow of Funds

The Firm

Market Value
Financial Markets of the Firm
• Share Price
• Market Capitalization
Business Dynamics
 Formulation of a Simulation Model

• Specification of structure, decision rules.

• Estimation of parameters, behavioral relationships,

and initial conditions.

• Tests for consistency with the purpose and boundary.

Business Dynamics
 Testing
• Comparison to reference modes: Does the model reproduce the problem
behavior adequately for your purpose?

• Robustness under extreme conditions: Does the model behave realistically

when stressed by extreme conditions?

• Sensitivity: How does the model behave given uncertainty in parameters, initial
conditions, model boundary, and aggregation?

• Many other tests…

Business Dynamics
 Policy Design and Evaluation
• Scenario specification: What environmental conditions might arise?

• Policy design: What new decision rules, strategies, and structures might be tried
in the real world? How can they be represented in the model?

• “What if. . .” analysis: What are the effects of the policies?

• Sensitivity analysis: How robust are the policy recommendations under

• Interactions of policies: Do the policies interact? Are there synergies or

Business Dynamics