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Special Presentation during the 2004 University of Illinois 16th Symposium on Audit Research

Leveraging Systems Thinking and Systems Dynamics
to Better Understand Organizations’ Business Processes
and Business Performance Measures


John Sterman, professor of management at MIT's Sloan School of Management.John D. Sterman, Jay W. Forrester Professor of Management at the MIT Sloan School of Management, helps organizations deal with the complex challenges that they face by employing systems thinking and systems dynamics instead of the simplistic, fragmented mental models that most people use. Sterman spoke about his ideas and research on system dynamics and how they have been applied successfully in the business world at the University of Illinois' 16th Symposium on Auditing Research on October 11th.

"There's really no such thing as a side effect, there's just effects," Sterman explained.

Companies tend to blame unanticipated side effects when something goes wrong instead of looking at their policies and finding the problem there. Policy resistance occurs when the managers of an organization face a current challenge, apply what they believe is the best solution, and yet the problem still is not solved or a new problem is created.

Assembly workers may relax if a new control is implemented and come to over-rely on it; smokers may increase the number of cigarettes smoked if better filters are invented. Sometimes traffic congestion is worse after road construction, and all too often pathogens develop resistance to antibiotics.

"We are all embedded in more complex systems. In particular, your decisions have multiple effects, all those so-called 'side effects,' that you're not aware of because they're in the outside boundary of your model," Sterman said. Some steps to save money, like prescribing generic drugs, end up costing more money over time as patients stay sick longer and more frequently require further visits to physicians. In the end, patients are less satisfied and less healthy and physicians' workloads become even more squeezed.

The structurally simplistic mental models that most people develop and use prevent them from understanding feedback, stocks and flows that represent the structure of a system, non-linearities, and time delays.

Symposium attendees considered how financial-statement auditors would benefit from thoroughly understanding the dynamics of audited organizations' business processes. Auditors who used systems-thinking likely could better incorporate time delays. There is a delay, for example, in between the time that defective products are shipped and customers begin requesting return authorizations. There may be another delay in between the early product returns and slower moving inventory items due to loss of customer loyalty. By taking these kinds of delays into account, auditors likely can better assess whether management needs to increase reserves for warranty liabilities or to write down obsolete inventory.

To master how to think about time delays and other elements of systems dynamics, auditors likely need to invest in courses or training as research shows that concepts of complex, dynamic systems generally are poorly understood by adult populations, including students in top MBA programs.

The good news is that systems thinking skills do appear amenable to being learned to some extent. "Those firms that can develop this capability before the rest of the market have a tremendous opportunity to create a competitive advantage," said Sterman.

About the Speaker

John D. Sterman is Jay W. Forrester Professor of Management at the MIT Sloan School of Management and Director of MIT's System Dynamics Group. His research includes systems thinking and organizational learning, computer simulation of corporate strategy, and the theory of nonlinear dynamics. In addition to publishing numerous scholarly and popular articles on the challenges and opportunities facing organizations today, he has presented his work before corporate, financial, and government audiences worldwide.

Prof. Sterman's research centers on improving managerial decision making in complex systems. He has pioneered the development of "management flight simulators" of corporate and economic systems. These flight simulators are now used by corporations and universities around the world. Recently, in partnership with the National Science Foundation and several leading corporations, he has been studying the dynamics of organizational change and process improvement programs to help firms design and implement sustainable improvement programs.

He presented his talk at the 2004 University of Illinois 16th Symposium on Audit Research, sponsored by KPMG LLP.


--Kara McFarland
October 2004