To Main Proceedings Document
Leadership, Management and Management Control - a System
Dynamics Approach
Authors: Dr. Stefan C. Gueldenberg
Assistant Professor
Department for Strategic Management, Management Control and
Consulting
Vienna University of Economics and Business Administration
Augasse 2-6
A-1090 Vienna
AUSTRIA
Tel.: [+43] (1) 31336-4569
Fax: [+43] (1) 31336-723
E-Mail: stefan.gueldenberg@ wu-wien.ac.at
Dr. Werner H. Hoffmann
Director
Oesterreichisches Controller- Institut
Vienna University of Economics and Business Administration
Doeblinger Hauptstrasse 7
A-1190 Vienna
AUSTRIA
Tel.: [+43] (1) 3686888-81
Fax.: [+43] (1) 3686838
E-mail: werner. hoffmann@ oeci.at
Key Words: System Dynamics, Viability, Leadership, Management, Management
Control
Leadership, Management and Management Control Gueldenberg and Hoffmann
Leadership, Management and Management Control - a System
Dynamics Approach
Abstract:
Utilizing a system-dynamic interpretation of the term leadership, we aim to identify the current
challenges to companies from their environments, and to explain the consequences of these
challenges for company design and control
As well, we aim to develop a dynamic approach to leadership based on theories of system
dynamics and living systems. The purpose of leadership is to create a living and learning
organization capable of development that is both internally guided and externally oriented. For a
company to achieve sustained development, there must be a healthy proportion of growth and
balance. Management needs to be counterbalanced by control: management and management
control together enable viable leadership.
Leadership, Management and Management Control Gueldenberg and Hoffmann
Leadership, Management and Management Control - a System
Dynamics Approach
1. Research Question and Objectives
Why do so many brilliant management strategies lead firms directly into decline? Why do so many
other strategies not produce the anticipated sustainable success? Why do some companies grow
while others shrink? Why are some firms extraordinarily successful over the years while others -
even those in the same industry - slide from crisis to crisis? Why do so many classical theories of
business administration fail to explain these phenomena and help to overcome these problems?
Business administration - and in particular management science - is constantly seeking the best
approach to understanding reality, so that the patterns and structures underlying tangible events
can be more easily understood (cf. Ulrich 1970, Morgan 1986, Nelson and Winter 1982).
Apparently, traditional reductionist methods - ones that analyze a system’s tangible events - are
unable to adequately explain the dynamic structure of the business environment, i.e. they are
unable to explain "reality." Otherwise, systems would not so often behave differently than had
been "predicted" (Sterman 1985). Thinking in terms of determination and regularity has gradually
shifted to thinking in terms of systems and chaos (f.e. Brown and Eisenhardt 1998). Little by little,
our perception of today’s business organizations as "machines" is changing to regard them as
evolving organisms, i.e. living systems (Miller 1978, Morgan 1986). Accordingly, a definition of
the business world in terms of simple formulas, numbers and tangible events is becoming less and
less pertinent. Our complex business world can be described and explained only in terms of
structures and dynamic behavior (McKelvey 1997, Sterman 2000). Linearity in our thinking has to
be complemented or replaced by non-linearity.
In Wester culture, successful corporate leadership is usually measured by visible results
(Freedman 1992). We look only at the visible” - the tip of the iceberg - and neglect its
underlying structure and dynamic development patterns (see Illustration 1). In firms focused on
the short term, management's main objective is to deliver results on a daily basis. Such short-term
optimization, however, can take place only within boundaries set by the structure of the underlying
system. Organizations are shaped by individual human beings. Within the same system, however,
Leadership, Management and Management Control Gueldenberg and Hoffmann
participating individuals basically produce the same results - independent of how different such
individuals may actually be (Senge 1990). Consequently, we need to change our focus from visible
events and individuals to the connections between them and to a system’s underlying behavior
pattern and structure.
Visible
Results
The “Waterline” Behavior and Patterns
As with an Iceberg,
the more important
and substantial
Part is hidden. Dynamic Systems Structure
Illustration 1: System Structure and System Behavior (Senge 1990)
Since, however, sustainable success and successful leadership of an enterprise can be explained by
factors other than visible results and the behavior of individual persons, it is necessary to
understand the enterprises from a lower-level perspective that allows us to see what is below the
“waterline,” each system behavior and system structure, to observe and understand it better
(Mintzberg 1979).
If this approach succeeds, the knowledge gained will help design and improve companies’
structures and behavior patterns, facilitating desirable results in day-to-day management.
Leadership, in this sense, doesn’t primarily mean optimizing day-to-day business; more
importantly, it means enabling overall success by daily creation and cultivation of structures and
behavior principles that guarantee the viability of the whole firm. This approach to understanding
leadership represents a fundamental shift from such traditional management concepts as
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Leadership, Management and Management Control Gueldenberg and Hoffmann
¢ the separation of management functions into planning, decision-making, organization,
execution, control and motivation (See Schreyégg 1998),
¢ the charismatic leadership theory,
the exclusively reactive management concept (adaptive organization).
These traditional approaches are giving way to an evolutionary definition of leadership based on
system dynamics.
This paper, using theories of system dynamics, evolution, learning, complexity and living systems,
aims to work out a model for system dynamics evolutionary leadership, and to detail the two most
important dimensions of leadership: management and management control.
Leadership, Management and Management Control Gueldenberg and Hoffmann
2. Theoretical underpinnings
2.1, System Dynamics Theory
Jay Forrester, in his 1961 classical "Industrial Dynamics," originated the ideas and methodology
of system dynamics (Forrester 1961). He pointed out that traditional reductionist and static
approaches of management sciences could not satisfactorily explain the causes for corporate
growth and sustainable economical success:
"The solutions to small problems yield small rewards. Very often the most important problems
are but little more difficult to handle than the unimportant. Many [people] predetermine
mediocre results by setting initial goals too low. The attitude must be one of enterprise design.
The expectation should be for major improvement (...). The attitude that the goal is to explain
behavior, which is fairly common in academic circles, is not sufficient. The goal should be to find
management policies and organizational structures that lead to greater success." (Forrester
1961, p. 449)
Growth and sustainable success have to be understood dynamically. Accordingly, they can be
analyzed, understood and explained only by dynamic models. A system's behavior is a product of
its structure. Complex systems consist of an interconnected structure of feedback loops.
Therefore, the elementary behavior of structured systems should be identified in terms of their
underlying feedback loops. Such behavior patterns include growth (caused by positive feedback);
balancing (caused by negative feedback); and oscillations (caused by negative feedback combined
with a time delay). Other behavior patterns of complex systems — for examples, S-shaped growth
or overshoot and collapse — are caused by a non-linear interconnection of these underlying
feedback loops. (Sterman 2000).
2.2. Complexity Theory
Stafford Beer is regarded as the founder of a system-oriented management approach (cf. Beer
1975). His basic assumption is that the "substance" of management science is not money or
capital, not machines or materials or employees, but mainly complexity (see also Malik 1993).
Such other "variables" as profit, sales, cash flow, investments, products, prices and customer
Leadership, Management and Management Control Gueldenberg and Hoffmann
needs represent merely "manifestations of complexity" and therefore are only forms in which
complexity appears. These visible results of system behavior combine to form the tip of the
iceberg. The complexity itself originates in the dynamic structure of the underlying system and can
be represented by the measure of variety.
According to Ashby's law of requisite variety, a high degree of external variety can be "destroyed”
only by a high degree of internal variety (Ashby 1958). Organizations without sufficient internal
complexity endanger their very existence because they lack a vital capability: the ability to
neutralize external structural challenges by making internal structural changes. In systems theory,
this capability is known as structural plasticity (see the following chapter). Every viable system
must remain structurally fit to survive in a constantly changing environment.
Recent years have seen the emergence of another stream of research in complexity theory, rooted
in the work of the Santa Fe Institute (Kauffman 1993, Gell-Mann 1994). These researchers
created the notion of CAS (complex adaptive systems) to describe and explain the (co-)evolution
of complex systems and their environments (Kauffman 1992, Waldrop 1992, Holland 1995). A
few attempts have been made to utilize these ideas for business management (f.e. Stacey 1995,
Brown and Eisenhardt 1998, Sachs 1997). Leadership assessments that consider companies as
CAS regard leadership as the process of mastering complexity — reducing external complexity
while increasing internal (organized) complexity, i.e. the capacity to absorb complexity.
2.3. Theory of system viability
In newer systems theory, one influential idea comes from the Chilean neurobiologists Maturana
and Varela. They used a series of neuro-physiological experiments to develop a theory about the
basic principles of the human nervous system and then derived an epistemology theory, which was
extended into a theory of living systems and their self- generation.
Their approach is used to distinguish between living, or viable, and non-living systems. According
to Maturana and Varela (1987), living systems are complex systems that have the ability to self-
generate. Losing this ability is tantamount to the death of the system. In terms of the business
world, a company that loses its ability to renew (re-create) itself dies. Therefore a viable
organization is an organization that has the capacity to create its own future. But when, in
practice, does this capacity exist?
Leadership, Management and Management Control Gueldenberg and Hoffmann
To answer, Maturana and Varela introduce the term of structure into their concept (1987). By
system structure, they mean the elements of the system and their relationships, which constitute
the specific system and represent the organization. The elements of a system allow system
boundaries to exist and thus enable the emergence of an identity. Accordingly, within an ever-
changing environment, the extent to which the structure of the system makes modifications
possible is decisive for the viability of that system. The number and scale of potential modification
options for a systems structure are defined as the structural plasticity of the system and can be
measured indirectly using the coefficient of measure of variety (Maturana and Varela 1987).
To sum up, a viable organization has to fulfill two requirements: (a) to preserve its identity by
repeatedly drawing system boundaries (defining what is "internal" and "external") and (b) to
maintain the system’s ability to adapt to a changing environment — structural plasticity.
A system’s structural plasticity is closely associated with the system’ s intelligence (Wilensky 1967)
and, as part of intelligence, its learning capability, e.g. the ability of the system to master new
challenges with structural modifications (G ueldenberg 1997). In this regard, a firm’s learning
capability can be understood as its capacity to recognize, vary and advance the underlying
mechanisms of the learning process itself along with its ability to anticipate, influence and quickly
react to, both present and future environmental changes (Reinhardt 1993). Therefore,
organizational learning is continuous shared self-renewal, a process involving, in particular, the
determinants of strategy, culture and structure together with personnel development (Gueldenberg
and Hoffmann 1998).
To summarize the basic aspects of the theories underlying our concept: Leadership depends
on dynamic feedback processes set up to master complexity with the goal of maintaining the
firm's capacity to self-generate (i.e. preserve its identity while continuously renewing its
structure in co-evolution with its environment.)
2.4 The mutual principle of growth and balance in the development of living systems
The structural ability to grow is necessary for the viability of evolving systems. Is growth in itself,
however, sufficient for survival? Nothing grows forever. The decisive question is: where and what
are the limits of growth? In nature, self-reinforcing processes are slowed by balancing processes
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Leadership, Management and Management Control Gueldenberg and Hoffmann
(Maruyama 1963), which assure that the evolving system remains within a viable developmental
corridor. Balancing processes keep the overall system alive. Their strengths are considerably
greater than the ones of self-reinforcing processes.
The population of an animal species, for example, can increase in a specific area only as long as it
is within the boundaries of the carrying capacity of its environment. Powerful balancing processes
- the natural enemies of the animal, plus limited food resources or epidemics - normally assert
themselves before this boundary is reached. In these ways, they balance the population of the
animal species. We can observe the same processes in the spreading of plants, during variations in
the world climate or when viruses are spread.
Are there similar natural boundaries to the development of technical, social or cultural systems?
Growth in these systems typically does not stop as original objectives are achieved — on the
contrary, the reinforcement of such forces leads to exponential growth. The growth of social or
cultural systems, however, does have boundaries. For example, a firm’s growth can be limited by
its production capacity, the market size and/or the number of competitors. The faster the company
grows, the more rapidly these boundaries are reached. (Sterman 1989)
From time to time, such limits of growth change or can be changed, for reasons extemal or
internal. Examples of external reasons are changes in the environmental conditions that increase or
decrease the carrying capacity. An internal reason, for instance, could be more efficient use of
limited resources. In organizational evolution, this means that the evolving system (the
organization) passes from one state of internal and external fit to the next, creating a
developmental path that can be described as a punctuated equilibrium model (Tushmann and
Romanelli 1985, see Illustration 2). Periods of balanced growth are interrupted by periods of
exponential growth:
Leadership, Management and Management Control Gueldenberg and Hoffmann
"Stages of organizational Evolution"
Ability to
Master
Complexity
Time
Illustration 2: The stages of organizational evolution
We humans regularly underestimate the tremendous strength generated by exponential growth
(Sterman 1989) because we tend to assume that an amount grows about the same absolute factor
per unit of time, while exponential growth, which means reinforcing growth, doubles the same
amount in that unit of time. If the time frame is short, linear growth reasonably approximates
exponential growth. If, however, the observation period lengthens, the gap becomes enormous.
Our evolution has oriented our perception to the short run rather than the long term. Since
exponential growth doubles in a given unit of time, the boundaries of growth are reached faster
than we anticipate, often completely unexpectedly. This distorts our perceptions, leading to
unpleasant surprises and even to existence crises for the whole enterprise.
Sustaining the development of such social organizations as companies requires a balanced
evolution — offsetting positive growth impulses with timely negative feedback processes. This is
the only way to ensure that companies remain in a corridor of ”sound growth" as they develop and
don’t exceed the carrying capacity of their environment and/or their resource endowment. This is
especially critical in periods of exponential growth, when the organization is at a much higher risk
to lose its viability than in periods of balanced growth. On the other hand, the punctuated
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Leadership, Management and Management Control Gueldenberg and Hoffmann
equilibrium model shows us that an active change in the limits of growth needs - for a restricted
period of time - an offsetting by the negative, and therefore balancing, feedback loops. Such leaps
in development are often triggered by fundamental changes in the surrounding environment (e.g.
deregulation, new developments in technology) or by changes in top management (Tushman and
Romanelli 1985).
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Leadership, Management and Management Control Gueldenberg and Hoffmann
3. Leadership
In accordance with our theory and that of Peter Senge (1998), leadership can be defined as the
inner capacity of a human community to create its own future. Accordingly, a firm must have a
clear vision — what it wants to create — while continually developing its capability to move
successfully toward that goal. Leadership is always closely tied to designing and guiding. Ina
viable and learning firm, leadership assumes both functions: that of a designer who shapes the
system and a pilot who guides the system to its destination. A social system that is able to shape
its own future successfully has a high leadership capacity.
Leadership comprises all processes that must be performed for a firm to remain viable. According
to Maturana and Varela (1987), a system’s viability depends on maintaining its capacity to self-
generate. In turn, maintaining a firm’s capacity to create its own future depends on its emergence
of an identity and on its degree of structural plasticity — the scale of how alterable its structure is
— and therefore on its learning capability with respect to itself and its environment. The plasticity
of structure determines whether system structure can be modified within the scale and time
circumscribed by the environment. A company that lacks the learning capacity necessary to make
the adjustments required by environmental influences loses viability over the long term. If, on the
other hand, the firm makes the required structural modifications without sacrificing its identity, it
not only guarantees its survival but increases its future learning ability. Learning capability is the
basis for viability, and viability in turn increases the learning ability of the firm. This forms the
basis of the reinforced dynamic leadership cycle (see Illustration 3).
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Leadership, Management and Management Control Gueldenberg and Hoffmann
Viability
a Learning Capability
Ability to ary
Self-
Generate
Structural Plasticity
Illustration 3: The Dynamic Leadership Cycle
This dynamic leadership cycle occurs on every level of a viable hierarchical system, so a company
can be considered a multistage net of interconnected positive and negative feedback loops.
Subsequently, we argue that a balanced leadership cycle requires the interaction of at least two
subsystems — management and management control.
13
Leadership, Management and Management Control Gueldenberg and Hoffmann
4, Management
The primary objective of every living system is to grow and enhance its viability. Growth, to be
sustainable, requires two conditions (Senge 1999, p. 7f):
First, a system must include the potential for growth. Sustainable growth cannot be brought in
from outside. A system cannot be compelled to grow by external forces, but has to grow through
internal self-reinforcing processes. In the sense of positive self-reinforcing growth, system
development means creating boundaries in disregard of its environment, thereby creating its own
identity (G omez and Probst 1985). A firm’s identity consists of its basic beliefs, core values and
principles. These are the foundations of every system and therefore the root from which structural
plasticity stems. This identity guides and restricts the development of a system, i.e. the evolution
of a company. Therefore, preserving this core provides the basis from which a firm can grow. The
first objective of management, therefore, is to encourage the evolution of the company by
preserving its core (identity), then to stimulate the development of the system structures based
on the core values and beliefs.
Second, conditions allowing sustainable growth must be created within the system. To do this,
management must eliminate such barriers to company development as fear, distrust, decision
centralization and too-tight control. Management also has to ensure that sufficient resources are
available to support company development. Successful management tries not to drive growth but
to influence the factors that can block or support growth. Just as a shortage of light, water or land
might prevent the plant from physical growth, such internal factors as distrust, fear, power
concentration and a shortage of resources prevent learning in the enterprise, hindering its
development and endangering its viability.
To summarize, management is the part of leadership that stimulates the growth of the company by
preserving and communicating its core values and beliefs ("culturgens"; Lumsden and Wilson
1981) and by cultivating conditions for the company’s evolution.
Many managers haven't recognized this. Managers are role models for their employees. Their
behavior and expectations influence the commitment and performance of their employees, thereby
shaping the development of the company. Their distribution of attention determines the
development of employees’ potential. Management requires communication, which injects directly
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Leadership, Management and Management Control Gueldenberg and Hoffmann
into the learning process by knowledge transfer. Management is mainly responsible for whether a
company grows or shrinks.
Regardless of how managers behave, their behavior influences the growth of the system.
Management has to initiate and stimulate sustaining growth, thereby reinforcing the firm’s
evolution.
From the basic role and objectives of management, the following functions can be derived: (a)
setting direction, (b) building resources and (c) creating infrastructure. Setting direction refers to
creating a shared vision and formulating and implementing strategy. The tension between vision
and reality provides the initial force to create corporate growth. For this paper’s purposes,
strategy isn't a detailed map of action. It is designating a corridor for company development
through cumulative learning processes. Resources are necessary for entrepreneurial activity (e.g.
Penrose's 1959 view of the firm as a bundle of resources). Basically, resources can be acquired
externally (e.g. machinery or capital) or developed internally. The resource-based view of a firm
(Barney 1991, Hamel and Prahalad 1994, Wernerfelt 1984) clearly states that only internally built
specific resources can provide the basis for competitive advantages and above-average returns.
Creating infrastructure refers to designing an organizational context that allows for growth. This
includes removing barriers to learning (such as monopolizing information) and developing
processes to promote learning (e.g. organizing flexible teams and interdepartmental processes) as
well as providing appropriate incentives.
15
Leadership, Management and Management Control Gueldenberg and Hoffmann
Growth
Creating a Setting
Infrastructure ig Direction
Building Resources
Illustration 4: The Management Loop
Setting direction, building resources and creating infrastructure are bound in a self-
reinforcing process (positive feedback loop), which we call the " management loop" and which
reinforces the growth of the company (see Illustration 4).
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Leadership, Management and Management Control Gueldenberg and Hoffmann
5. Management C ontrol
Considering the picture of system dynamics, one can derive that maintaining the viability of a
system (firm) requires balancing the reinforcing management loop with a complementing force, a
negative feedback loop that allows for a punctuated balancing of the expanding system (i.e. the
firm): management control. Together management and management control form a balanced
leadership cycle for guiding and controlling development of a company. While management
reinforces the company’s evolution, management control regulates and balances the development,
ie. makes sure that the evolution remains within a viable developmental corridor. It is the
objective of management control, as a complementary system, to balance, in a timely fashion,
the growth process driven by the management loop, thereby maintaining the overall system’s
viability. This, in our view, is the central task of management control as a part of the leadership
cycle.
Management C ontrol
- Synchronize the Developmental Dynamics
- Compensate for Selective Perception
- Limit the Developmental Dynamics
Management
- Setting Direction
- Building Resources
- Creating Infrastructures
Illustration 5: The Management Control Loop
In the leadership cycle, management control has three central tasks: (a) to assure internal
consistency of infrastructure, resources and direction, (b) to compensate for selective perception
and (c) to appropriately limit development dynamics. Internal consistency of infrastructure,
17
Leadership, Management and Management Control Gueldenberg and Hoffmann
resources and direction is necessary to maintain the coherence of the company. In large
companies, particularly, the responsibility for different functions of management is split among
different organizational units or departments. Management control has to ensure that, despite this
specialization of management functions, there remains a coherence of strategy, resources,
structure and systems. Therefore management control has to co-ordinate the development of the
subsystems of management (dynamic co-ordination, or synchronization). A company management,
to enable development processes, must develop a simplified "view of the world" (shared mental
model), which acts as a basis of activity (Schreyégg 1998). This model inevitably is a subjective
simplification of complex reality, therefore selective and distorted. Management control is
responsible for continually examining this model and enriching it with relevant new aspects to
compensate for the selective perception of management. In particular, managerial information
and early warning systems specifically delineate a firm's field of perception (Simons 1994). An
appropriate limit on developmental dynamics has two dimensions: content and time. To limit the
contents of company development, management control must point out whether the firm's
expansion exceeds the limits that have been set (e.g. there is too much diversification), thus
endangering the company's vitality (boundary control; see Simons 1994) . The time limit refers to
the speed of a firm's growth. Management control must assure that the speed of growth does not
overtax the current management capacity (current resources and infrastructure) or the carrying
capacity of the environment (in particular the size and growth of the market). Synergistic action
between management’ s function of reinforcing the development process and the balancing
function of control should set a pace appropriate for successful company development. Working
properly, the interplay of management (growth impulses) and management control (balancing
impulses) assures a successful rhythm of company development, a characteristic of particularly
successful firms in dynamic environments (time-pacing; Brown and Eisenhardt 1998).
Management control influences leadership by complementing the management processes of setting
direction, building resources and creating infrastructure through balancing-impulses. These
impulses (a) synchronize the developmental dynamics of the different management functions, (b)
compensate for selective perception of management (managers) and (c) limit the developmental
dynamic of the organization according to internal and external conditions. There is, however, a
time delay before these balancing-impulses take effect. Management control has to take such a
18
Leadership, Management and Management Control Gueldenberg and Hoffmann
delay into consideration to avoid triggering unintended or survival-threatening oscillations.
Further, management control must point out any oscillation effects caused by a time delay. This
closes the balanced leadership cycle.
Management-
Control
Management
wot
Setting 5 Ir
Synchronize the
Developmental
~\ TT Dynamics
m +
c +
- u ompensate +
Growth Ok | for Selective | <—Balancing
-
Perception
Resources
s
e\ +
emai * oe Limit the
y s
Infrastructure Developmental
id | Dynamics
Illustration 6: The balanced Leadership Cycle
As illustration 6 shows, the process in which leadership takes place can be understood as a
reinforcing and balancing cycle, allowing for a guided and controlled evolution of the firm.
19
Leadership, Management and Management Control Gueldenberg and Hoffmann
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