Because the future is unpredictable.

Thinking systems is a fundamentally new way of thinking which eliminates guessing. It’s a technique where you don’t imagine a perfect outcome as much as you try to anticipate the various processes and problems that lie in your path.

What is systems engineering?

The best way to describe systems engineering is with an example.

All systems have three elements. A time element, a space element, and a knowledge element. These elements are part of a greater space-time continuum.

Imagine you want to save for your child’s education.

Let’s imagine he’s 6 years old. You might say the time element is 11 years, the time before he graduates from high school. The space element is where you are. You have a job or business and earn X. Your house payment is Y, car payment is Z, etc.

The knowledge element is what you can anticipate the cost will be, among other things.

Systems engineering is more complex and far more valuable.

In fact, you don’t have 11 years. All you have to pay is the first-year tuition in the first year. Even then, you can pay monthly. Look at the university. How can your child get into a university with a large endowment and rich financial aid like the Ivy league.

What qualities will help them get in? A high SAT, or perhaps they play a sport. Are they a minority like a native American which has a scholarship program?

What is the time horizon of your investments? How can you do this with tax deductible dollars.

All of these factors will change over time, and you will have to adjust your plan, perhaps yearly. Things might help you, like earning more on your savings. We call these forward generating loops. Some things may hold back or freeze your plans. We call these stabilizing loops.

In systems thinking this is a process.

This process is like a sport. You have a game, but you also have a season. During that season things change.

The trick is not to try and predict what might happen, but to make lists of what might change during your space time continuum.

At Landon Fillmore we call this, “working in duration space.”

Duration space is the most critical part of systems thinking for three reasons.

  1. It forces you to try and anticipate an end point. 
  2. It makes the system manageable.
  3. It allows us to determine a rate of return for the process and therefore, it’s profit margin.

Spoiler alert: Most business don’t know what their rate of return on assets is.

Imagine for a moment you own a manufacturing company and want to expand into manufacturing Christmas ornaments.

Step one would be to look at the market for Christmas ornaments.

Step two is to create a proforma. This is a financial tool that estimates the cost of a process. It is (typically) a monthly spreadsheet of projected income and expenses for this process, including inventory, labor, equipment, etc.  

This proforma will tell you the potential rate of return on the process.

Step three is to make lists of the possible forward generating and stabilizing loops. These loops are often processes inside processes.

For example, you may create a team in the paint department. That team may come up with a strategy that cuts the time by having one person always paint the same thing and pass it on.

This process may speed up the operation, which is what you want, but is the packaging stage ready for the increases volume? If not, this would be a forward generating loop that creates a stabilizing loop. The process is thwarted by the next stage.

Systems thinking is complex and difficult.

There is no sense telling you otherwise. It’s the main reason why no one does it and why so many great ideas fail.

This is why Starbucks does 4-5 times the business of the average mom and pop coffee shop. If you want to compete against them, it’s not enough to have good food and great coffee. You must have processes that work.

Another example of duration is home mortgages.

When banks create new mortgages, they typically bundle them together in what are called mortgage pools.

They take hundreds of similar mortgages, (E.g. 30 year mortgages) with similar credit and rate characteristics and create one mutual fund which they sell to the public as mutual fund shares.

Even though these are all 30-year mortgages, the pool does not have a 30-year duration. This is because many if not most will be paid off due to refinancing or new home purchases in less than 30 years.

Duration in a mortgage pool can be anywhere from 10 years during a housing boom and 20 years in a stable economy. But at some point, the number of mortgages left in the pool is so small, it no longer can function as a mutual fund and must be added to another group of mortgages and repackaged.

All process duration space works this way.

But there’s another side to duration that few business owners see.

Often, business owners buy new equipment or undertake new processes without thinking of duration. Using our criterion above, they don’t think of #1. What is the end point?

Businesses are notoriously hard to sell and used equipment is often impossible to sell. Commercial space often takes years to sell if it’s sold at all. This causes businesses to take investment losses.

We had a client that manufactured chips for auto flushing toilets. A Polish engineer, he was keenly aware of duration. He knew the exact day he’d close shop and retire. On that day his lease expired almost everything in his shop was either sold or thrown out.

Another way of thinking in systems…

Is the earth flat or round? Relative to YOU it may be either.

If you are walking (or driving) it’s flat. If you’re piloting an airplane, the earth is a sphere. (Technically it’s a semi-spherical obloid) The earth is round in a picture.

From a growth perspective, flat distances are measured as point A minus point B. The area in a circle is pi R squared. The outer area of a sphere is 4/3 pi R cubed. These are very different growth projections.

If your marketing plan is to capture customers that drive by your location, that’s arithmetic. If you imagine your customer base as circular moving away from your location, (As Starbucks does) that’s a much bigger number. (When a Starbucks store has to close for repairs or a strike, their app sends a message to their customers with the next closest location WITH DRIVING DIRECTIONS!)

If you imagine a company as worldwide, that’s an order of magnitude larger.

One way to think of this is using fractals.

A fractal is simply a drawing whose complex often exponential growth comes from the expansion of simple shapes.

In business, this type of growth can take many forms. In hiring, you could ask your employees if they know anyone who might fit in your company. Those people might refer others even if they don’t take a job with you.

In sales, companies typically use referral services or enticements to expand their customer base exponentially.

These fractals must plug into your processes.

A successful marketing expansion may create a huge forward generating loop, (more sales) but it could also create a big stabilizing loop.

Sales are great, but using our Christmas ornament example, if you can’t finance the increase in business, that’s another stabilizing force. If your employees can’t handle the increase in business, that’s another stabilizing force.

Beware of what’s dumped on your employees. They may revolt!

We call this stabilization, rigidity.

Rigidity is one of the key factors in process failure.

Processes become rigid when they can’t be changed or improved.  It’s FAR more common than people, even business executives think.

Processes (Even in a home) can become rigid for dozens perhaps hundreds of reasons. People are reluctant to change and often change only after extreme pain is applied. (Loss of job or the threat of divorce.)

More often though it’s because the change at first makes the process LESS efficient. This is a problem we always encounter when we suggest that companies get rid of their financial systems.

There is ZERO value in billing and counting money. Companies spend enormous amounts of money on credit card transactions, batching, depositing checks and money, adding numbers, invoicing and reinvoicing.

But eliminating these functions is difficult and takes time. (Not to mention massive amounts of employee hand holding and spats with your accountant.)

But in the long run, these changes free up significant amounts of time and can create enormous amounts of profit.

This is because of the REAL advantage of systems thinking.

It allows processes to combine with other process to become exponential forward generating loops and reduce stabilization.

This is covered extensively in the Landon Fillmore website and is too complex to mention here but an example is in order.

Imagine you have a flower shop. At point of sale, your customer is giving you information. This information is the golden ticket.

“Miss client, I see you love flowers, do you buy them for yourself or others.”

“Both”

“Do you ever miss sending flowers because you forget?”

“We have a service where we’ll send you a text message on dates that are important to you. These may be birthdays or holidays. Also, if you give us your husbands number, we’ll message him for your important dates. We offer 10% discounts to our customers on our lists.”

This is just one very simple example.

There could be hundreds that involve sales, production, inventory, marketing, etc.

It’s not a good idea that will cause forward generating loops and exponential growth by itself. To make it work, your forward generation must overcome system rigidity.

Why systems thinking fails in small business.

In the 30’s two German chemists, Karl Bosch and Fritz Haber came up with a unique process. Prior to this process all nitrogen fixing for plant fertilizing occurred underground in the roots of plants.

Haber and Bosch discovered a process that “fixes” nitrogen from the atmosphere. By using this to create fertilizer, they could exponentially expand plant growth. (Faber has been rubbed from history because he was Jewish and invented Zircon B. Bosch went on to start the IG Farben chemical company.)

At Landon Fillmore we call this the reduction-expansion model. A process (Growing vegetables) is reduced to one thing, (nitrogen fixing) and expanded out to farms.

This produced huge yields, cheap calories and fed hundreds of millions of people. It also caused massive degradation of the environment and a crisis in the general heath of people worldwide.

Reduction-expansion can destroy your business.

Here are a few examples that we have seen.

  • A retailer finds a product that sells well and quadruples the next order. The bigger order doesn’t sell.
  • A small manufacturer has a few customers with big orders and high margins and unloads all his small customers. One of his big customers goes belly up.
  • A company offers several services and cuts the ones not profitable, not realizing that their customers wanted all of them.

In the case of nitrogen fixing above, the manufacture of synthetic fertilizer DID work. In fact, it was perhaps the most important discovery of the 20th century. But the long-term effects are devastating.

Systems thinking in duration space is the answer.

At Landon Fillmore we have been involved in many small business sales. It’s not a place you want to be.

We were largely successful, but only because we were trusted by the buyer and seller. Our advice though is to never build a business whose plan is to sell it.

If you end up selling it, great, but we like to think of business as a duration investment, like a 5-year treasury bond. In 5 years, it’s game over and we buy something new.

The best hedge fund managers in the world spend their entire lives in duration space, although they don’t call it that. They don’t try to pick absolute bottoms and sell at peaks. They’re goal is to get, on average, 65% of an investment’s overall gains.

Define duration first.

You may not get it right, but at least you’ll have something manageable. From there you create your process and look for forward generating loops being cognizant of stabilization and rigidity.

That’s as good as it gets.