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.

1. 6/27/2013
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

2. 6/27/2013
Agenda
Research Motivation
Case Studies
Research Objectives
Literature – Behavior Under Pressure
Managerial Views
Research Method and Approach
Preliminary Findings
Conclusion

3. 6/27/2013
Research Motivation
National Science Foundation grant
3M – behavior, feedback and delays
Corning – innovation

4. 6/27/2013
A Profitability Gap Leads to Pressure…
Desired
Profits
Profit Gap
+
Actual
Profits
-
+
-
Total
Revenues
Total
Costs

5. 6/27/2013
… to Improve Customer Satisfaction…
Desired
Profits
Profit Gap
+
Effort Allocated to
Customer Satisfaction
Customer
Satisfaction
Focus
B1
Actual
Profits
Pressure to Improve
Customer Satisfaction
-
+
-
+
+
+
Total
Revenues
Total
Costs
Customer
Satisfaction
Market
Share+
+

6. 6/27/2013
… and Pressure to Cut Costs.
Desired
Profits
Profit Gap
Effort Allocated to
Cost Cutting
+
Effort Allocated to
Customer Satisfaction
Customer
Satisfaction
Focus
B1
Actual
Profits
Pressure to
Cut Costs
Pressure to Improve
Customer Satisfaction
+
+
-
+
-
+
+
+
Cost Cutting
Focus
B2
Total
Revenues
Total
Costs
-
Customer
Satisfaction
Market
Share+
+

7. 6/27/2013
Cost Focus Reduces Effort Allocated
to Customer Satisfaction …
Desired
Profits
Profit Gap
Effort Allocated to
Cost Cutting
+
Effort Allocated to
Customer Satisfaction
Customer
Satisfaction
Focus
B1
Actual
Profits
Pressure to
Cut Costs
Pressure to Improve
Customer Satisfaction
+
+
-
+
-
+
+
-
+
Cost Cutting
Focus
B2
Costs Cuts Over
market Share
R1 Total
Revenues
Total
Costs
-
Customer
Satisfaction
Market
Share+
+

8. 6/27/2013
… and Generates More Effort to Cut
Costs.
Desired
Profits
Profit Gap
Effort Allocated to
Cost Cutting
+
Effort Allocated to
Customer Satisfaction
Customer
Satisfaction
Focus
B1
Cost Cuts Over
Customer
Satisfaction
B3
Actual
Profits
Pressure to
Cut Costs
Pressure to Improve
Customer Satisfaction
+
+
-
+
-
+
+
-
-
+
Cost Cutting
Focus
B2
Costs Cuts Over
market Share
R1 Total
Revenues
Total
Costs
-
Customer
Satisfaction
Market
Share+
+

9. 6/27/2013
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

10. 6/27/2013
Desired
ProfitsGap in
Profits
+Effort Allocated
to Customer
Satisfaction
Process
QualityInvestment in
Quality
Actual
Profits
Total
Effort
Effort Allocated
to Cost Cutting
Change in
Allocation
Time to Change
Allocation
Initial Effort
Allocated to Cost
Cutting
Base Allocation for
Improvement
Indicated
Process Quality
Time to Invest
in Quality
Minimum
Process Quality
Indicated
Allocation to
Cost Cutting
Maximum
Process Quality
Step
Input
Step
Height
Step
Time
Minimum
Alocation to
Cost Cutting
Unit
Costs
Initial Unit
Costs
Effect of Cost
Cutting Effort
on CostsTable for Effect of
Cost Cutting Effort
on Costs
Initial Process
Quality
Demand
Industry
Demand
Market
Share
Company
Attractiveness
Competitor
Attractiveness
Effect of
Quality on
Demand
Quality Elasticity
of Demand
Unit
Price
Initial Dolar
Margin Actual
Dolar
Margin
Price
Elasticity
of Demand
Effect of
Price on
Demand
Initial Unit
Price
Fraction Cost
Reduction to
Customers
Ratio Cost
Cutting EffortFraction of Effort
to Customer
Satisfaction
Fraction of Effort
to Cost Cutting
Desired
Dolar Margin
Desired
Demand
Desired Effort
Allocated to Cost
Cutting
Desired Unit
Costs
<Initial Unit
Price>
Desired Cost
Ratio
<Initial Unit
Costs>
<Initial Effort
Allocated to Cost
Cutting>
<Table for Effect of
Cost Cutting Effort on
Costs>
Desired
Market
Share
Desired Company
Attractiveness
Desired
Process
Quality
<Actual Dolar
Margin>
<Total Effort>
<Desired
Process Quality>
Model Overview: A little more complicated

11. 6/27/2013
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?

12. 6/27/2013
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 performance
Regardless 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

13. 6/27/2013
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).

14. 6/27/2013
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)

15. 6/27/2013
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)

16. 6/27/2013
Preliminary Findings
Finding #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.