SYSTEM DYNAMICS IN STRATEGIC PLANNING
By
Ali N. Mashayekhi
Department of Industrial Engineering
Sharif University of Technology
Tehran, Iran.
March 1990
ABSTRACT
One approach to strategic planning is called “gap analysis’. In gap
analysis, the future of an organization under its present strategy is
forecasted. Then, objectives, or the desired future for that organization, is
identified and the gap between the objectives and the future conditions
under current strategy is determined. Finally, new strategies which will help
to close the gap will be designed. System Dynamics can be used in two
important ways in the gap analysis. First, System Dynamics model can be
used to forecast the future of an organization under current strategies and
identify the gap between that future and the objectives. Second, System
Dynamics model can be used to examine how much each strategy can be
helpful to close the gap. The application of System Dynamics in gap analysis
method is shown by an example of developing a strategy for water resource
development in Iran.
1. INTRODUCTION
Gap analysis is an approach to strategic planning (Kami 1968), (Hussey
1982, Ch. 10), (Glueck and Jauch 1984,P.57). The essence of gap analysis is
shown in Figure 1. In gap analysis approach, expected state of the enterprise
under current strategy is forecasted in the future, (point A in Figure 1).
Then, the desired state of the enterprise is identified (point B in Figure 1).
Management should design and implement new strategies to close the gap
between the desired states and those expected under current strategies. Each
strategic program and action is to contribute to closing the gap. Thus, in
application of gap analysis approach there are two important tasks to be
done. First, forecasting the future state of the system under current
strategies, and second, predicting the effect of each new strategic action in
closing the gap.
742
System Dynamics ’90
743
None of the two tasks can be done properly in qualitative and
intuitive way. As Foreman (1983) correctly argues, the complexity of the
corporation (and socio-economic systems, in general) operating in an
environment characterized by rapid changes precludes intuitive analysis of
the policies and strategic actions. A sound and proper analysis of the
consequences of current and new strategies requires some quantitative
approach which can consider the complex relationships between different
elements creating the behavior of a system. System Dynamics (Richardson
and Pugh 1982) could be very helpful in performing both of the above
mentioned tasks. System Dynamics mode! could be built to show the
behavioral consequences of the current strategy in the past as well as in the
future. Future behavior of the system shows the gap between the desired
and expected states of the system. Then the model can be used to examine
the behavioral effect of each strategic action to close the gap. The remaining
of this paper describes a case study of applying System Dynamics in gap
analysis for water resources development.
2. WATER RESOURCES DEVELOPMENT SYSTEM
The water resources development system consists of five sectors:
water supply facilities to control surface and ground water resources ,
distribution channels which transfer water from supply facilities to
agricultural lands, transfer pipelines which transfer water from supply
facilities to city distribution network, city water refinery and distribution
network, and water sewages.
In Iran, water resources facilities in all five sectors are developed by
government investments which take place through development budget.
Table 1 shows estimates of the values of facilities, annual depreciation, and
average annual investment during 1983 to 1988. As the table shows,
average annual investment in water supply facilities and in water
distribution channels are less than their respective annual depreciation. As a
result, water facilities in these two important sectors of the system
experienced a net deterioration.
While water resource facilities are deteriorating, population and
demand for water are rising. Growing demand for water necessitates
increase in the capacity of the facilities. As the result of increasing demand
for water and the lack of growth of water supply, price of water, eg., in
agricultural sector has increased considerably.
Figure 1 shows a sketch of past performance and expected behavior of
the water resource facilities under current strategies. Figure 1 also shows the
desired behavior of water facilities in the future to satisfy the growing
demand. New strategies should now close the gap between desired and
expected behavior.
744 System Dynamics '90
A System Dynamic model is developed to generate the future behavior
under current strategies, and to examine the effect of different other
strategies in closing the gap.( for a detailed description of the model see
Mashayekhi and Bakhoda, 1989).
3. THE MODEL
The overall structure of the System Dynamics model of concern is
shown in Figure 2. The mode! consists of ten endogenous sectors. Population
and ground water are exogenous to the model. Four sectors that represent
water resource facilities are: Water supply facilities, water distribution and
draining channels, water transfer facilities to cities, and city water
distribution facilities. As shown in Figure 3, development of each sector
consists of five stages: development planning, feasibility study, engineering
design, project construction, and operation (Mashayekhi 1989).
Flow of projects through different stages in each sector can be
conceptualized by a series of rate and level variables. Figure 4 shows the
flow of projects during development process for water supply facilities - for
a detailed description of rate variables and correspondence decision rules,
see Mashayekhi (1989). The flow of projects in other sectors of water
development system is similar to what is shown in Figure 4.
4. USAGE OF MODEL TO EXAMINE EXPECTED BEHAVIOR UNDER
CURRENT STRATEGIES
A model is constructed to show the expected behavior of the system
under current policies. Current policies are as follow. (1)_ Investment for the
development of water facilities is financed only by the government through
development budget. In the last decade government's revenues have not
increased, but because of population growth, demand on government
expenditures has increased and raised budget deficit. For this pressure on
government's financial resources, water development budget has been either
constant or decreasing. It is assumed that water development budget is
financed only by the government's revenues and will remain constant in the
future. (2)_ The allocation of budget to different sectors of water resources
system at different stages is proportional to the amount of budget required
for the work in process in different sectors and stages. (3)_ Starting rate of
development projects at different stages are based on the volume of projects
at the previous stage. (4)_ Inactivating rate of the projects in the
construction stage is zero. (5)_ Price of water is assumed to be constant. (6)_
Starting rate of feasibility study is a function of the discrepancy between
projected demand for water and sum of water supply capacity under
System Dynamics '90
745
operation, construction, design, and study. With the current policies the
behavior of the model is shown in Figure 5.
Analysis of the model behavior showed that under current policies,
net deterioration of the water supply facilities is due to two factors. The first
is inadequate investment to circumvent depreciation, and the second which
was not quite clear prior to the analysis is the fact that under current
policies, the cost of completing water resource projects is more than normal.
The analysis of the model behavior showed that due to the pressure
from demand, starting rate of feasibility study increases and raises the
number of feasible projects. As the number of feasible projects increases, the
feasible projects move automatically forward into design stage, and next,
into construction stage, and thus the number of projects under construction
increases. This in turn, raises the fixed cost to keep projects ready for
progress in construction. When total budget is constant and fixed cost
increases, the remaining budget for construction work decreases and hence
make the completion rate of the projects under construction fall. The fall of
completion rate of the projects under construction rises more rapidly and
causes fixed cost to increase to a higher value. As fixed cost rises, unit cost of
projects increases. With higher unit cost and a constant development budget,
fewer projects can be completed. Lower completion rate increases the gap
between completion rate and depreciation, and accelerate the decline of
water resources facilities.
5. USAGE OF MODEL TO EVALUATE THE NEW STRATEGIES
One strategy which was thought to be effective to improve the
behavior of the model, is to make the starting rate of new projects at
different stages and different branches a function of available budget. When
allocated development budget is less than desired budget, the starting rate is
decreased relative to what it would be in the base run. The new strategy was
thought to be effective because when due to inadequate budget, starting
rates of new projects at different stages decrease, the number of projects
under study, design, or construction would not rise, and therefor completion
cost and completion time of the projects would not increase as before, and
thus the behavior of the system would improve.
However, model simulation showed that the new strategy is not
effective as was thought. The behavior of water supply facilities under the
new strategy is shown in Figure 5, along with the behavior of the same
variable under other strategies. As the figure shows, under the new strategy,
water supply facilities decline in the same manner that it does under the
base run policies. The reason for such behavior is the existence of a
compensating negative feedback loop: When due to lower starting rate of the
746 System Dynamics '90
new projects, growth of projects under study, or construction decreases, the
gap between growing demand for water (which is the result of growing
population) and capacity of water facilities under design, construction, and
operation increases. As the gap increases, pressures to start new projects rise
and compensate the effect of inadequate budget on the starting rates of the
new projects. As a result, the number of projects under development
increases and the model shows the same behavior as in the base run. Thus,
the new strategy can not help to close the gap between the desired and
expected states of the system.
ivati cess Proje d struction:
In this section, in addition to the consideration of the new starting rate
policies, some of the projects in construction phase are inactivated when the
available budget is less than desired. Inactivated projects have a lower fixed
cost relative to active projects. Inactivated projects are activated when
insufficiency of budget disappears. No construction activity takes place in
inactivated projects and therefor no money is spent as variable cost. The
behavior of the water supply facilities in the model under the new strategy
is shown in Figure 5.
Inactivating excess projects under construction decreases fixed cost of
projects under construction. Lower fixed cost allows more money to be
available for construction activities and increases completion rate of projects.
As completion rate increases, water facilities would become more available
than it would be under the base run. As a result the capacity of water supply
facilities does not decline as much as it did in the base run. This can be seen
in Figure 5.The model shows that the new strategy is helpful to narrow the
gap between desired and expected state of the system. However, the model
behavior in Figure 5 shows that, although the new strategy narrows the gap,
but still the capacity of the water supply facilities still declines because of
the inadequacy of the development investment to hinder depreciation rate.
In this section, in addition to the consideration of the new starting
rates and inactivating rate policies, borrowing strategy is also examined. In
Iran, development of water facilities requires both domestic and foreign
currencies. Under the new strategy, the management of water resources
borrows domestic and foreign currencies to upgrade its financial power so as
to adequately respond to the investment need in water facilities
development. The resultant domestic debts are paid back by collecting
adequate connection fees for connecting different users to the newly
developed water facilities. And the foreign debts are assumed to be paid
back by the foreign currency saved through substitution of imported
agricultural products as production of agricultural sector increases due to
System Dynamics ‘90
747
New water facilities developed. The model can be used to examine the
behavioral results as well as the feasibility of the new strategy.
Figure 5 shows the behavior of water supply facilities under the new
strategies. As the figure shows, the new strategy is very effective in
increasing water supply facilities and closing the gap between desired and
expected state of the system. As financial resources become more available
through borrowing, available budget increases to provide the required
variable budget to make adequate progress in the projects under
development and complete them during a normal completion time. As
completion time of projects decrease, so does the total fixed cost and unit
cost of projects. With a lower unit cost, more water facilities can be
completed with a given amount of financial resources. Under the new
strategy, as far as the limits of water resources of the country allow, water
supply facilities grow to satisfy growing demand. As more water supply
facilities are developed to control the country's water resources, less water
fesources remain to be controlled by new facilities. As a result of limited
water resources in the country, eventually growth of water supply facilities
slow down, as is shown in Figure 5.
The mode! also shows the financial feasibility of the new strategy. In
the model, connection fees are set as a fraction of market price for the
availability of water on urban and agricultural lands. With such a feasible
connection fees, the water sector will be able to pay back the domestic debts
and interest expenses which occurs as a result of borrowing. Also the model
shows that substitution of the imported agricultural products by the
agricultural output from newly developed water facilities generate more
foreign exchange savings than necessary to pay back the foreign debts of the
water development sector. Figure 6 shows the behavior of domestic and
foreign debts of the water sector under the borrowing strategy. As is shown
in Figure 6, foreign debts become negative indicating net foreign exchange
saving as a result of new water facilities development because of borrowing
strategy.
6. CONCLUSIONS
System Dynamics models can be used in gap analysis to develop new
strategies in two effective ways. First, it can be developed to show the
expected state of a system in the future under current strategies and
policies. Second, the models can be used to examine the feasibility,
effectiveness, and efficiency of a proposed strategy to close the gap between
expected and desired state of a system in the future. This paper showed such
usage of a System Dynamics model in developing water resources
development strategies.
748 System Dynamics '90
REFERENCES:
1, Forman Leonard, 1983, Corporate Simulation Models, in Naylor T. H.,
Corporate Strategy, The Integration of Corporate Planning Models and
Economics, North-Holland Publishing Company, Second Printing, 1983.
2. Glueck W.F, Lawrence RJ. 1984, Business Policy and Strategic
Management, Fourth Edition, McGraw-Hill.
3. Hussey D.E. 1982, Corporate Planning Theory and Practice, Second Edition,
Pergamon Press.
4. Kami, MJ., June 1969, “Gap Analysis-Key to Super Growth”, Long Range
Planning.
5. Mashayekhi, AN, 1989, Water Resources Development Planning,
Proceedings of the 1989 International System Dynamics
Conference,Stuttgart, Federal Republic of Germany.
6. Mashayekhi A. N., Bakhoda M., Analysis and Design of Strategy for Water
Resources Development in The Country (in Farsi), Nazm Avaran Management
Counsultants Co. ,Tehran Iran, 1989.
7. Richardson, G.P., and A.L. Pugh III. 1981. Introduction to System Dynamics
Modeling With DYNAMO. Cambridge, Mass.: MIT Press.
System Dynamics ‘90
749
Table 1: Annual Depreciation and Investment in Water Facilities
Water Water Water Urban
Supply Distribution Transfer Water
Facilities Facilities Facilities Facilities Total
Capacity
(nit)
Unit Cost at
1988 Price
Qials)
Values at
1988 Price
(10e9 Rials)
Useful Life
(Years)
Annual
Depreciation
(i0e9 Rials/Yr)
Average Annual
Budget at 1988 Price
During 1983-88
(109 Rials/Yr)
24 852000 21 13
(10e9Cub.M) (Hectare) ( 10e9 ) ( 10e9 )
(Cub. M./Yr) (Cub. M./Yr)
31.7e9 1188500 73.29 36.8e9
761.52 974.63 153.72 4784 1937.71
50 30 30 30
15.32 32.48 5.124 159 54.48
13.24 15.72 13.56 454 47.06
750 System Dynamics '90
System DESIRED STATE
States ~_— (OBJECTIVE)
GAP TO BE FILLED
Pp BY NEW STRATEGIES
EXPECTED
STATE UNDER
—— Current
STRATEGIES
>
PAST PRESENT FUTURE Tine
Figure 1: Gap Analysis in Strategic Planning
Develpment Feasibility
Engineering Construction Operation
Planning * Study
Design
Figure 3: Stages of Water Development Projects in Each Sector.
751
System Dynamics '90
wares SURFACE WATER pssst ol
WATER REVENUES
WATER
WATER | WATER SUPPLY FACILITIES a TeAereR
REVENUES ent) FACILITIES .
5 5
i § BORROWING | BORROWING z
BE SOURCES &
=) 2) ab
ge] &
E) 53) 38 P i
uncer, REPAYPENT Sle
r—>| WATER WATER TRANSFER BUDGET. é Z
&
BL Fon | ware over. WATER TRANSFER CAPACITY
3 CAPACITY | WATER RESOURCES
3] | race jaecent NET INCOME
s NET INCOME URBAN AND INDUSTRIAL WATER DEMAND.
2
3 NET INCOME
& URBAN
g a URBAN WATER FACILITIES CAPACITY | waTeR
s| El 2 FACILITIES
2) ELS URDAN WATER FACILITIES BUDGET H
ES &
i 8) prICE OF AGRICULTURAL WATER DEVELOPRENT BOOT SRWENT 3
8 BUDGET REQUEST z
had y §
GRAUND WATER DENANO a H
AGRICULTURAL parece mares "le 3
GROUND WATER
SECIaE: falilee PRICE OF UROAN AND INDUSTRIAL WATER i
URBAN ARD
INOUSTRIAL
TOTAL POPULATION. Poruation | URBAN POPULATION SECTOR
Figure 2: Overal Structure of The Model
752 System Dynamics '90
Start of Feasibility Study
from Unplanned Projects
SZ
. > opp | PurWs
Planned Projects
Projects Under
Development Start of Study Completion
.Planning Feasibility Rate of
Study from Feasibility
Planned Projects
ST
7] pews pupws [{#— ews f+
Designed fc Projects SEDWS Feasible
Projects Under Projects
Completion Design Start of
Rate of Engineering
Engineering Design
Design
Inactive Projects
Under Construction | IPCWS
inactivating Rate
Activating Rate of Construction
of Construction Projects
Projects
SZ SZ 5
PUOWS |
Projects Water
Start of Under Completion Supply Depreciation
Construction Construction Rate of Facilities
Construction
Figure 4: Flow of Projects in Water Development System.
System Dynamics ’90
753
———— BASE BUN
——= Bett AVAILABILITY EFFECT
INACTIVATE EXCESS PROJECTS te Gubie Meter
T. BORRONING
45.09 al
30.9 wat
a a
15.9] [ee
8.
1978. 1988, 1998, 2008.
THE
Figure 5: The Behavior of Water Supply Facilities Under Different Strategies.
DOMESTIC DEBTS(B, ,300, 6) 1
908.e6— — — FOREIGN DEBIS(-2500.e6.2500.e6) 10 un woe iene
2500.66
225.6
1250,e6
=—
“
L- ‘\
150. e6) —
6
, <
75.e6
1250. e6 \
\
a. /
-2500, e6'
1978, 1988, 1998. 2088.
TIME
Figure 6: Domestic and Foreign Debts.
