Simulation as an aid in strategy making
Malcolm Brady
Dublin City University Business School
Dublin 9
Ireland
Tel. +353 1 7005188
Fax +353 1 7005446
Email malcolm.brady@dcu.ie
Presented at
OR42 - Operational Research Society
Annual Conference
University of Wales, Swansea
12-14 September 2000
© Copyright, Malcolm Brady, 2000, all rights reserved.
Abstract
The subject of this paper is the use of simulation as a tool to assist managers develop strategy
in the business firm. The paper refers to a simulation model of a hypothetical business firm's
profit and loss account and balance sheet statement. The simulation model comprises
accounting identities and behavioural statements represented as a set of difference
equations. The model is parsimonious in that as few equations as possible are used while still
reasonably representing a business firm. The paper examines how simulation can be used to
assist strategy makers in formulating strategy.
This work is part of the author's PhD research and represents ongoing rather than completed
work. Please do not quote without prior permission.
Introduction
This short paper begins by briefly surveying the main schools of thought in strategy
formulating and implementing. It then briefly examines simulation as a technique and
discusses the main approaches to simulating. The paper then goes on to examine how
simulation may be useful to strategy makers and at which particular points of the strategy
making process it would be most beneficial. The paper ends by examining briefly a
simulation model developed by the author as part of his ongoing research.
Strategy
Strategic management is rather a new field of knowledge. It developed originally in the
1960's, two of the original leaders in the field being Andrews, who examined the process of
strategy development and who played a major role in founding the design school of strategy
at the Harvard Business School (Mintzberg et al, 1998:ch2), and Chandler, who examined the
links between strategy of organisations and their structure. The work carried out in this
period provided the foundation for most of the process models still prevalent in text books
today: for example, the formulation-implementation model of Bower et al (1991:111), and the
analysis-choice-implementation model of Johnson and Scholes (1999:18).
In the 1980's a further impetus was given to the field due to the work of Michael Porter (1980,
1985) who applied concepts from industrial organisation economics. He coined the term
'competitive advantage', developed the key concepts of focused and differentiated generic
strategies as a means of gaining competitive advantage, and identified the value chain of
activities of an organisation as one of the key influencers of an organisation's strategy.
Also in the 1980's another movement began that suggested that the process of strategy
formulation and implementation did not take place separately. Instead it was suggested that
formulation and implementation take place together in an incremental way (Quinn, 1989) or
that strategy emerges out of the process of strategy making (Mintzberg et al, 1998:ch.7).
In the late 1980's the focus of attention of strategy researchers moved from the position of
organisations in the marketplace to the internal capabilities of the organisation. Prahalad and
Hamel's (1990) research suggested that firms were successful because they had a small
number of core competences that they were exceptionally good at and which allowed the
organisation compete in a number of different markets. Canon's success in the camera,
photocopier, and printer marketplaces due to their competence in microelectronics and optics
is an often cited example (Canon, 1992).
Much of the strategic thinking in the early 1990's focused on improving operational
effectiveness (Porter, 1996) and in this era movements such as total quality management and
business process reengineering (Hammer, 1990) gained ground. Recent research has tended
to focus more on the speed of change in the business world and the difficulty that firms have
in adapting and reacting to a complex, dynamic and fast-changing environment
(Chakravarthy, 1997). A recent issue of the Sloan Management Review was devoted to this
topic: Beinhocker (1999) suggests that strategic thinking can benefit from complexity and
evolutionary theories; Markides (1999) suggests a dynamic model for strategy-making based
on building internal variety, a premise of evolutionary theory.
Simulation
A model is essentially an imitation of something real and simulation is a process of using a
model to imitate the behaviour of something real. It is important to remember that a model is
only an imitation of reality and is not in itself reality. This is both an advantage, in that it is
usually much easier to manipulate and understand the behaviour of a model than reality, and a
disadvantage in that one must be careful in generalising from conclusions drawn from
examining the behaviour of a model.
Ackoff (1962:109) suggests that models fall into three categories: iconic, analog and
symbolic; he includes mathematical models under the symbolic category. Law and Kelton
(1991) also suggest a similar taxonomy of models and further subdivide mathematical models
based on the solution approach: analytical or simulation. Many mathematical problems
cannot be solved analytically and simulation offers a means of 'solving' such problems.
Simulation is a process of 'driving a model of a system with suitable inputs and observing the
corresponding outputs' (Bratley et al, 1987); in effect simulation is a means of experimenting
with a model of reality. Nelson and Winter (1982) see a computer program as 'a type of
formal theoretical statement' and simulation as 'a technique of theoretical explanation'.
Simulation is particularly useful where it is impossible, dangerous or inordinately expensive
to experiment with reality. This is generally speaking the case with real-life business firms or
economies and hence simulation offers the business researcher a means of examining and
experimenting with economic and business systems.
Simulation as a strategy making tool
Phelan and Wigan (1995) points out that it is particularly difficult for researchers in the
strategy field to successfully carry out experiments in order to determine the 'laws' of
successful strategic management. They suggest that three distinct difficulties arise: that of
observation, manipulation, and replication; they go on to suggest that simulation may assist
strategy researchers in overcoming some of these difficulties.
The tools and technique of simulation can be useful to practising managers in two ways: for
training in strategy-making and for use in actual strategy-making. Simulation is used as an
aid for training managers in the art and science of strategy-making by universities and by
management training consultants. Within academia, simulations are increasingly becoming
an integral part of strategy textbooks; for example, Thompson and Stappenbeck's (1998)
simulation game is a companion to the Thompson and Strickland (1999) textbook. Many
universities and business schools use simulation as a teaching aid; for example, Dublin City
University uses simulation games to give teams of students near-practical experience in
running a business, London Business School (2000) offers an executive education programme
devoted to systems thinking and strategic modeling that uses simulation software to model
business situations. Simulations are also increasingly used by management training
consultants; for example, Strategic Management Group (2000) use many different simulation
games in their training and development programmes. Many of these learning vehicles are
termed microworlds and are based on systems thinking and learning organisation ideas
originally developed by MIT's system dynamics group (Sterman, 1992; Senge, 1990a); for
example, Mike's Bikes simulation from SmartSims.com (2000) and the Beefeater simulation
from Strategydynamics (2000).
It is interesting to note that the simulations being used in universities have tracked the
movement in theories underpinning strategic thinking from industrial organisation economics
theory to the resource-based view to systems and complexity theories. Older business
simulations tend to use a competitive model whereby teams compete in a marketplace of four
or five teams and prices are determined according to standard neoclassical theory; Dublin
City University business school uses two simulations of this type in undergraduate teaching.
More recent business simulations, such as those mentioned above, tend to use the system
dynamics modeling approach and use dynamical systems theory and feedback as a driving
mechanism for the simulation. Some of these simulations, for example Beefeater, are also
draw strongly on the resource-based view of the firm as an underlying theory.
Secondly, simulation can be used in the actual process of strategy-making. When examining
the external environment during the analysis phase of strategy-making, simulation could be
used to develop and test various business scenarios (Johnson and Scholes, 1999:112-3).
Simulation could also be used in the choice or matching phase of strategy-making. This
phase is rather underdeveloped in the strategic management literature and relatively poorly
supported by formal techniques (Moroney, 2000). Textbooks tend to describe the relevant
parameters when considering strategic choice but avoid giving specific guidelines on how to
go about making a choice (see for example Thompson and Strickland, 1999:ch.6). Simulation
could assist in generating and evaluating strategic options. Other techniques from the field of
management science such as the multi-criteria decision approach (the subject of the paper
following this one at this conference) could also be applied to the choice-matching phase of
the strategy-making process.
This use of management science techniques by strategists could also have the effect of
improving the profile of management science and operations research within the business
firm; these functions are often seen by managers suited only to operations analysis and are
pushed 'further and further down in their organisations' (Ackoff, 1979a). In a sister paper
Ackoff (1979b) argues that the systems view taken by management scientists/ operational
researchers has a role in planning. While corporate planning is no longer as in vogue as it
was in the nineteen seventies (Mintzberg, 1994) Ackoff is not alone in the promotion of a
systems view of an organisation in the context of corporate or business strategy (Senge,
1990b).
Simulation can be carried out using several different mechanisms. Straightforward
spreadsheet models may be used to carry out 'what-if' type analyses. Specialised simulation
packages, for example Powersim, from Powersim (2000) and Stella and iThink from High
Performance Systems (2000), can be used to develop more sophisticated models. Customised
models can also be developed using standard programming languages such as Basic, C, or
Fortran; this is rare in business but common in engineering eg. custom development of
software to simulate the behaviour of networks (eg. gas, water, sewerage), structures (eg.
buildings, bridges), mechanisms or vehicles.
Finally, simulation can be used as a research tool by business academics in the field of
business and corporate strategy. Simulation offers a means of experimenting with virtual
business organisations and economies, something that is not possible with real organisations
and economies. Several papers on simulation of different aspects of business firms featured
at this year's young operational researchers conference (YOR11, 2000). This author's own
research has examined the growth of business firms using simulation as a research technique
(Brady, 1999 and 2000). This research has identified a critical point in the growth of firms where production of the firm first exceeds demand - such that the behaviour of firms is
significantly different before and after this point.
Summary and Conclusion
This paper has attempted to show how simulation can be a useful addition to the strategic
manager's toolkit. It has pointed out that simulation is in essence an experimental approach to
problem solving and is particularly appropriate to business situations where real-life
experiments are generally impossible or undesirable. It has identified in particular the choice
phase of strategy-making as one that is underdeveloped and where simulation could be
particularly useful.
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