This overview aims to provide just a flavour of a vast scientific and technical subject. For a good technical reference book see Competitive Strategy Dynamics, Warren 2002.

SD essentials | SD and finance | SD and valuation | Valculus' SD services

The essential nature of system dynamics

System dynamics (SD) provides a structured approach to aid the understanding of complex systems, including all kinds of organisations. SD was first developed at MIT in the 1950’s and has been applied extensively across a wide range of issues and industries.

System dynamics is most often used to capture high-level strategic issues, although it can also be used to drill down into more detail in selected areas.

System dynamics takes a time evolutionary view of organisational behaviour. It allows the analysis of organisation behaviour over time, including delays between actions and outcomes and understanding of ‘feedback’ relationships within the organisational structure.

Thus the structure of a company can be described in respect of the different resources that comprise the company and the interdependencies between those resources. Using this simple visual language it is possible to create a structural resource diagram of organisational structure. In the value cycle method, we call such diagrams ValueMaps. A key feature is that, unlike spreadsheets, all the relationships are explicit and not hidden away behind the numbers.

This simple ValueMap includes just three resources – a sales force, production capacity and a production backlog. You can think of each type of resource as being like a 'bathtub', with a tap (inflow) and/or a drain (outflow). Resources then accumulate like bathwater if the inflows are greater than the outflows, and decrease if the outflows are greater than the inflows.

Each resource is increased by inflows over time – recruitment, capacity addition and sales orders, respectively. The production backlog is depleted over time by the rate of production. Each resource stream is connected to the others by ‘information links’. The consequent interdependencies within the map create ‘feedback loops’ that determine the behaviour of the system, over time,

The ValueMap can be transformed directly into a ValueSim by including mathematical relationships – most often by using simple algebra, although a wide range of sophisticated mathematical and statistical constructs are also available. Once a ValueSim is created, it is used to generate and test different strategy scenarios, over time.

This is a ‘behaviour over time’ graph that is generated directly by simulation of the ValueSim. It records the derived behaviour of the structure of the ValueSim and the policies and strategies specified by the user. Changing the structure, the parameters or user-defined policies will change the behaviour.

Conversely, a derived (say undesired) behaviour pattern can indicate structural and/or policy improvements that might be made to change the behaviour to a more desirable pattern.

Thus the essential feature of the system dynamics method may be summarised as:

STRUCTURE <----->BEHAVIOUR <----->STRUCTURE.

ValueSims are therefore not 'black box' models like spreadsheets. Rather they are interactive tools that progressively develop strategy through management engagement and learning.

System dynamics and finance

ValueSims such as represented above need not necessarily include only physical and intangible resources. All such resources (and their inflows and outflows) can be linked to financial models, using the same resource-based language. For example, every line item in a conventional balance sheet is a resource, having inflows and outflows that arise from profit/loss and cash flow.

System dynamics and valuation

Valuation is a complex financial exercise (and an art) that depends crucially on forecasted cash flows and also involves making many subtle adjustments and rearrangements to standard accounting formats, then applying rigorous mathematical formulations and adjustments.

Cash flow forecasts generated by ValueSims are entirely consistent with changes in physical resources over time. They are therefore much more likely to be realistic than cash flow ‘forecasts’ generated by conventional means.

It is also just as possible to make the appropriate account adjustments and rearrangements in a ValueSim as it is in a spreadsheet – and to do the mathematics, too. Excepting that, the visual nature and language of a ValueSim makes all the calculations much more transparent and easy to communicate than in a spreadsheet.

Valculus system dynamics services

Valculus (and sister company Cognitus) are recognised as one of the leading suppliers of system dynamics training and consultancy in Europe and have applied the technique across a diverse range of business sectors. Valculus/Cognitus has trained several thousand managers in SD and undertaken many studies for commercial clients.

For more details, see our simulation skills courses.