Case Study: Equipment Company Restores Financial Stability with Help from iThink®
Nothing inspires an analysis of a business system like a decline in performance.
When financial metrics trend downward, businesses typically turn a critical eye
toward marketing strategy, pricing, distribution channels, and product quality and
positioning. Unfortunately, small changes in the business environment can break
underlying operational systems that appear to be working. Diagnosing the impacts
of those system breaks on financial performance can be extremely difficult.
Perplexed by its own decline in revenue, Rent-a-Dozer* turned to Lexidyne, LLC,
a consultancy that provides insight into the dynamic processes that drive system
behavior, and iThink Systems Thinking software to determine the systemic cause of
revenue erosion, test remedies, and return the company to profitability.
“Rent-a-Dozer rents out heavy equipment to clients in the construction industry,” explains Corey Peck, Managing Director of Lexidyne, LLC. “The company had enjoyed steady sales volumes for years earning revenue by sending machines to its customers’ construction sites. Clients paid a monthly fee for equipment that was on site and, when equipment broke down, returned it to the Rent-a-Dozer’s maintenance facility for repair and reissue.”
It was critical to maintain an inventory of parts to facilitate the repair process and ensure that equipment could be returned to customers in a timely manner. The parts required to repair equipment were often expensive and, given the number of machines handled by Rent-a-Dozer, the inventory was extensive.
The company relied on a system for purchasing and stocking replacement parts that was driven by a long-standing policy. “The decision rule was to set a fraction of revenue as the ‘parts budget’ which the facility manager could use to maintain a sufficient inventory,” says Peck. “The system had worked well in the past. Inventory levels were always appropriate, costs were relatively low, and Rent-a-Dozer maintained a fairly constant number of machines at client sites that generated a steady revenue stream.”
The Rent-a-Dozer management team began to notice a disturbing trend, however. Revenue numbers (which had previously been fairly stable, even in the wake of changing economic conditions) were starting to drift downward. The pattern was unmistakable and indicated that the volume of equipment at client sites was declining as well.
“Downward trending revenue lines, especially those that are unexpected, beg for an explanation,” says Peck. “Rent-a-Dozer executives were presented with several theories.” Customers were hinting that the quality of machines was to blame. Maintenance people said that the equipment was being subjected to heavy use and experiencing more rapid wear and tear.
As revenue declined, arguments between the facility manager, sales team, and upper management broke out. The sales team was pressed to demand alternative contracts from customers. Maintenance teams were accused of doing sub-par work or turning over machines that hadn’t been fully repaired. Executives speculated that competitors were encouraging customers to return equipment early and end their contracts.
Several remedies were tried and failed; the decline in revenue continued. After months of frustration, Rent-a-Dozer decided to step back and look at their business from a more aggregate, systems perspective. With Lexidyne’s assistance, the Rent-a-Dozer team used iThink, Systems Thinking software from isee systems, to develop a high-level map that allowed them to visualize the structure and relationships inherent in their business model.
Even before adding data and simulating the results, the map displayed a simple but potentially devastating reinforcing feedback loop that had gone unnoticed. “It became apparent that any scenario in which machines were returned at a faster rate than they could be repaired caused revenue to fall,” says Peck. “When revenue decreased, there was less money to allocate to purchasing parts. Parts shortages delayed repairs which throttled back the return of machines to the field which, in turn, reduced revenue even more.”
Mental simulation of the feedback loop suggested that the worst was yet to come and a basic iThink simulation concurred. What had appeared to be a simple linear decline in revenue was just the beginning of a nasty trajectory in which revenue would fall at an ever-accelerating rate.
This insight was a turning point for the Rent-a-Dozer team. “They realized that their decision rule which linked parts budgeting and ordering with revenue flow was creating a vicious cycle that would eventually drive the company out of business,” says Peck. “The root cause of the dynamic – the reduction of average time that clients kept the machines on site before they were returned – had to be investigated but the team knew that wasn’t, in and of itself, the problem. Instead, Rent-a-Dozer was inviting instability by continuing to implement a policy that had worked well in the past but was no longer working in the face of changing market conditions. The iThink modeling exercise proved to be an excellent example of one of the central tenants of System Dynamics, the link between the structure of a system and its eventual behavior.”
Armed with new insight, the Rent-a-Dozer team used their basic model to test a number of new decision rules against a wide variety of potential scenarios in order to craft a robust policy for purchasing parts. Equally important, the team gained a more thorough understanding of their business model and saw how some seemingly effective decision rules were actually making a marginally bad financial situation even worse.
About Lexidyne — Lexidyne, LLC specializes in framing, quantifying, and answering specific business questions using the principles of System Dynamics and data analysis. Our facilitated modeling projects offer a unique way for clients to integrate data and institutional knowledge, analyze marketplace dynamics, and quantify the expected impact of strategic decisions.
*Rent-a-Dozer is a fictional name for a real company.
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