When We Create Our Own 'Market Limitations'

When We Create Our Own “Market Limitations”

This case comes from Peter Senge’s The Fifth Discipline.

In the mid-1980s a new electronics company was founded with a unique high-tech product—a new type of high-end computer. Thanks to its engineering know-how and distinctive technology, WonderTech had a virtual lock on its market niche. There was enormous demand for its products, and there were enough investors to guarantee no financial constraints.

Yet the company, which began with meteoric growth, never sustained its rapid growth after its first three years. Eventually it declined into bankruptcy.

That fate would have seemed unthinkable during WonderTech’s first three years, when sales doubled annually. In fact, sales were so good that backlogs of orders began to pile up midway through its second year. Even with steadily increasing manufacturing capacity (more factories, more shifts, more advanced technology), the demand grew so fast that delivery times slipped a bit. Originally the company had promised to deliver machines within eight weeks, and it intended to return to that standard; but with some pride, the top management told investors, “Our computers are so good that some customers are willing to wait fourteen weeks for them. We know it’s a problem, and we’re working to fix it, but nonetheless they’re still glad to get the machines, and they love ‘em when they get ‘em.”

The top management knew that they had to add production capacity. After six months of study, while manufacturing changed from a one-shift to a two-shift operation, they decided to borrow the money to build a new factory. To make sure the growth kept up, they pumped much of the incoming revenue directly back into sales and marketing. Since the company sold its products only through a direct sales force, that meant hiring and training more salespeople. During the company’s third year, the sales force doubled.

But despite this, sales started to slump at the end of the third year. By the middle of the fourth year, sales had dropped off to crisis levels. Sales rose rapidly before dropping into the first crisis.

At this point, the new factory came on-line. “We’ve hired all these people,” said the vice president of manufacturing. “What are we going to do with them?” The top management began to panic about what to tell their investors, after they had spent all this money on a new manufacturing facility. It was as if everyone in the company simultaneously turned and looked at one person: the marketing and sales vice president.

[Image: Sales curve with rapid growth then decline]

Not surprisingly, the marketing and sales VP had become a rising star in the company. His force had done so well during the initial boom that he had anticipated a promotion. Now there was a slump, and he was under pressure to turn sales around. So he took the most likely course of action. He held high-powered sales meetings with a single message: “Sell! Sell! Sell!” He fired the low performers. He increased sales incentives, added special discounts, and ran new advertising promotions describing the machine in an exciting new way.

And indeed, sales rose again. The sales and marketing VP found himself once more hailed as a hero, a born-again motivator who could take charge of a tough situation. Once again, WonderTech was in the happy position of having rapidly rising orders. Eventually, backlogs began to grow again. And after a year, delivery times began to rise again—first to ten weeks, then to twelve, and eventually to sixteen. The debate over adding capacity started anew. But this time, having been stung on the last occasion, the top management was still more cautious. Eventually, approval of a new facility was granted, but no sooner had the papers been signed than a new sales crisis started. The slump was so bad that the sales and marketing vice president lost his job.

Over the next several years, and through a succession of marketing managers, the same situation recurred. High sales growth occurred in spurts, always followed by periods of low or no growth. The sales curve showed repeated booms and slumps.

The company prospered modestly, but never came close to fulfilling its original potential. Gradually, the top managers began to fear that other firms would learn how to produce competing products. They frantically introduced ill-conceived improvements in the product. They continued to push hard on marketing. But sales never returned to the original rate of growth. The “wonder” went out of WonderTech. Eventually, the company collapsed.

[Image: Sales curve with repeated boom-bust cycles]

In his final statement to the lingering members of his executive team, the CEO said, “We did great under the circumstances, but the demand just isn’t there. Clearly it was a limited market—a niche which we have effectively filled.”

The tale of WonderTech is hardly a novel one. Of every ten startup companies, one-half will disappear within their first five years, only four survive into their tenth year, and only three into their fifteenth year.[2] Whenever a company fails, people always point to specific events to explain the “causes” of the failure: product problems, inept managers, loss of key people, unexpectedly aggressive competition, or business downturns. Yet, the deeper systemic causes for unsustained growth go unrecognized. With the aid of the systems archetypes, these causes often can be understood and, in many cases, successful policies can be formulated. The irony of WonderTech is that, given its product and its market potential, it could have grown vigorously for many years, not just two or three.

WonderTech’s managers could not see the reasons for their own decline. This was not for lack of information. They had all the significant facts—the same facts that you have after reading this story. But they could not see the structures implicit in those facts.

As a systems thinker trying to diagnose WonderTech’s problem, you would look for clues—anything that might suggest an archetype. You’d begin with the most obvious pattern of behavior: growth leaped up at first, amplifying itself to grow stronger and stronger. But the growth gradually slowed, and eventually sales stopped growing altogether. This pattern is the classic symptom of limits to growth.

There are many possible reinforcing (amplifying) processes that could have produced WonderTech’s original rapid sales growth.

Investment in products, investment in advertising, good word of mouth—all could have reinforced past success into future success. But one especially evident in the WonderTech story was the reinforcing process created by investing revenues in increasing the sales force: more sales meant more revenues, which meant hiring salespeople, which meant more sales.

[Image: Reinforcing loop diagram]

The other part of any limits to growth structure, of course, are balancing (stabilizing) processes. Something made sales growth slow. Possible explanations include market saturation, stronger competition, or customer dissatisfaction. In this case, the need for the WonderTech computer was still strong, and there was no significant competition. There was one factor which turned customers off: long delivery times. As backlogs rise relative to production capacity, delivery times increase. A reputation for poor delivery service builds, eventually making it harder for WonderTech’s salespeople to make more sales. The limits to growth structure, then, looks like this:

[Image: Limits to growth diagram with reinforcing and balancing loops]

In a limits to growth structure, the worst thing you can do is push hard on the reinforcing process. But that’s exactly what WonderTech’s managers did. They tried to reignite the “engine of growth” through sales incentives, marketing promotions, and minor product improvements—none of which had any leverage. In a limits-to-growth structure, the leverage lies with the balancing process.

Why wasn’t that balancing process noticed? First, WonderTech’s financially oriented top management did not pay much attention to their delivery service. They mainly tracked sales, profits, return on investment, and market share. So long as these were healthy, delivery times were the least of their concerns. Plus, delivery times were rising when sales growth and profits were rising rapidly, so there was little overall concern. When financial performance weakened, pressures shifted to boost orders. Usually, by this time, delivery times were already starting to come down because orders were falling. Thus, whether times were good, or times were bad, the top management paid little attention to the time customers had to wait to get their computers.

Even if they had, they would not necessarily have seen delivery time as a key factor affecting sales. Delivery times had been getting longer and longer, for more than a year and a half, before the first sales crisis hit. This reinforced an attitude among top management: “Customers don’t care about late shipments.” But that complacency was misplaced; customers were concerned, but their concern was obscured, to WonderTech’s management, by a built-in delay in the system. A customer would say, “I want the machine delivered in eight weeks.” The salesperson would say fine. But after nine, ten, or twelve weeks, there would still be no machine. After several more months, gossip would filter out. However, the number of potential customers was vast. And the gossip had little effect until it eventually mushroomed into a widespread reputation. This delay between “Delivery Time” and “Sales Difficulty” could be six months or longer.

WonderTech’s managers had fallen prey to the classic learning disability of being unable to detect cause and effect separated in time. In general, if you wait until demand falls off, and then get concerned about delivery time, it’s way too late. The slow delivery time has already begun to correct itself—temporarily. At WonderTech, delivery times grew worse during the third year, the last year of rapid growth. They then improved during the downturn that followed; but grew worse again when sales rose.

Over the entire ten-year history of the firm, there was an overall trend of rising delivery times, interrupted by periodic improvements. Alongside that was a gradual decline in the overall health of the system—as seen in slowing growth and declining profits. The company made money in spurts, but lost money like mad in every downturn. The euphoria of the early growth period gave way to discouragement and, eventually, despair. People felt, at the end, as if they were victims. Privately, the CEO said the company had been misled by initial marketing projections that forecast a huge potential market that was never realized.

What no one realized was that the situation at WonderTech also characterized a classic shifting the burden structure. There was a problem symptom (delivery time) that worsened steadily, albeit with periodic improvements. The overall health of the enterprise was also steadily worsening, and there was a growing feeling of victimization. As a systems thinker, you would first identify that key problem symptom, and then the symptomatic and fundamental responses to it. In this case, the fundamental response (the lower circle in the diagram below) is to expand production capacity to control delivery time. Delivery times above WonderTech’s standard indicate the need for more capacity, which, once it comes on-line, will correct long delivery times. But if this fundamental response is slow in coming, the burden shifts to the symptomatic response (the upper circle) of customer dissatisfaction in declining orders. Since WonderTech’s managers didn’t solve the problem of long delivery times by adding manufacturing capacity rapidly enough, disgruntled would-be customers “solved” the problem by walking away.

[Image: Shifting the burden diagram with two loops]

Because WonderTech’s managers did little to address customer dissatisfaction, falling orders took more and more of the pressure off production—the symptomatic response in this shifting the burden structure. This occurred as WonderTech’s reputation for poor delivery service spread through its market; whenever WonderTech entered a new period of rising delivery times, word spread more and more rapidly. Meanwhile, the fundamental response grew weaker. Having been stung when they added capacity that was left idle by falling orders in year four, WonderTech’s top management grew increasingly cautious in committing to new capacity additions. That meant that new capacity took longer and longer to come on-line—or never came on-line at all. By the time WonderTech’s managers were finally ready to add capacity, the symptomatic response had already relieved the pressure, delivery times had started to fall, and the capacity expansion was no longer justified. “Let’s wait a little longer before building,” they said, “to make sure the demand is there.”

In effect, there was a horse race going on between the two responses. Over time, the symptomatic response became more rapid, while the fundamental response became more sluggish. The net effect was that gradually the “disgruntled customer” response assumed more and more of the burden for controlling delivery times.

WonderTech’s fate could have been reversed. There was a point of leverage in the underlying structure that was largely overlooked: the firm’s original goal of an eight-week delivery time. In the shifting the burden structure, the first thing a systems thinker looks for is what might be weakening the fundamental response. In this case, the firm had a delivery time standard—eight weeks—but it obviously never meant a great deal to the financially preoccupied top managers.

After three years, the actual operating standard to which manufacturing had become accustomed was about ten weeks, and they had great trouble meeting that when business was booming. Over time, as delivery problems returned, the standard continued to drift. No one thought much about it, least of all top management.

As it happened, the second marketing and sales vice president periodically relayed his customers’ dissatisfaction with poor deliveries to the management team. His counterpart in manufacturing acknowledged that they occasionally got behind their backlogs, but only when their capacity was inadequate. But the top managers said, “Yes, we know it’s a problem, but we can’t rush into major investments unless we’re certain demand will be sustained.” They didn’t realize that demand would never be sustained until they made the investment.

We will never know for certain what might have happened if the company had held tight to its original goal of eight-week delivery times and invested aggressively in manufacturing capacity to meet this goal. But simulations based on this structure (combining limits to growth and shifting the burden) and on actual sales figures have been conducted in which the delivery time standard is not allowed to erode, forcing more aggressive capacity expansion. In these simulations, sales continue to grow rapidly throughout the ten years, although there are still periodic plateaus. Delivery time fluctuates, but does not drift upward and the delivery time standard is constant at eight weeks. WonderTech now realizes its growth potential. At the end of the ten years, sales are many times higher than in the original case.[3]

[Image: Improved sales curve with sustained growth]

The original sales and marketing vice president had grasped these problems intuitively. He argued from the outset that WonderTech was assessing its factory capacity all wrong. “We only compare capacity to the number of orders we have,” he said, “instead of the potential volume of orders that we would have if we were operating at our target delivery times.” Unfortunately, the VP’s arguments were interpreted as excuses for poor sales performance, and his insights went unheeded. It didn’t help that he had no way, conceptually, to explain his thinking. Had he been able to describe the systems archetypes, perhaps more people would have grasped what seemed intuitive to him.

In fact, the subtle dynamics of WonderTech confirm an intuition of many experienced managers: that it is vital to hold to critical performance standards “through thick and thin,” and to do whatever it takes to meet those standards. The standards that are most important are those that matter the most to the customer. They usually include product quality (design and manufacture), delivery times, service reliability and quality, and friendliness and concern of service personnel. The systemic structure at WonderTech converts this management intuition into an explicit theory, which shows how eroding standards and sluggish capacity expansion can undermine the growth of an entire enterprise. The complete structure comes from integrating limits to growth and shifting the burden:

[Image: Combined diagram of limits to growth and shifting the burden]

As shown here, the two structures overlap, sharing one balancing process—where disgruntled customers reduce their orders due to long delivery times. The same balancing circle that diverts attention from adding capacity (in shifting the burden) also keeps sales from expanding (in limits to growth). Whether the disgruntled customer circle becomes dominant depends on how the firm capacity expansion responds when delivery times are long. If standards are allowed to drift, the firm’s response is weakened and the burden shifts to the disgruntled customers. In other words, the company unwittingly becomes addicted to the limiting of its own growth.