Managing Product Quality at FitCo

We’ll start by taking a peek at the inner workings of FitCo, a company that makes exercise equipment.3 FitCo is struggling with a problem that faces many organizations: managing product quality. We can think of this issue as a simple balancing process that comprises the interrelationships among three common variables: Product Quality, Customer Demand, and Production Pressure.4

The Simple Version. For FitCo (as with most other manufacturing firms), the higher the company’s product quality, the more customers want to buy. But FitCo—thinking that the jump in demand might be temporary—doesn’t do anything to beef up its production capacity once demand starts to rise. As a result, the folks in the production department begin feeling enormous pressure to keep FitCo’s expanding base of health-conscious customers supplied with enough exercise machines. As the frantic production staff make more and more mistakes, and as the company’s overused manufacturing machines break more and more frequently, the quality of FitCo’s products starts to suffer—and customers begin drifting away. In this story (as we’ve traced it so far), customer demand and product quality rise and fall in close synchronization. If we were to graph the two variables, the resulting picture would look a lot like something called a steady-state equilibrium (you know, the kind that most economic texts presume is an accurate description of reality!).

Now Add Delay. You may have noticed that this version of FitCo’s story is missing a key factor: delay. Because of delays, the situation at FitCo is much more likely to resemble a state of dynamic disequilibrium. Customer demand falls fast when FitCo’s product quality falls, because people tend to react quickly to visible drops in quality—and because there are lots of other exercise-machine companies out there for a disgruntled customer to choose from. However, the demand picks up more slowly when (and if) quality improves, because people become skeptical about quality improvements and want to wait and see if they’re “for real.”

The Investment Decision. There’s yet another wrinkle to this picture. We know that, like many companies, FitCo doesn’t keep its production capacity constant in the face of changing demand. Instead, it tries to adjust capacity so as to produce the right quantity of product at the desired level of quality. So, we have to add “investment in capacity” to our loop diagram (see “To Invest, or Not to Invest?”). If FitCo is managing all the dynamics well, it should end up with both quality and demand rising ever upward. This is because, as customer demand increases, the company boosts capacity, which takes the heat off the production department and thereby improves product quality, further stimulating customer demand (see the R loop in the diagram).

steady-state equilibrium

TO INVEST, OR NOT TO INVEST?

This causal loop diagram shows the bigger picture involved when we consider the impact of capacity investments on the quality-demand-pressure balancing structure we’ve been discussing. As product quality and customer demand increase, the company decides to invest in capacity. After a delay, the new capacity comes on line, which reduces the production pressure—which once more causes product quality to rise (note the “o” link). The decision to invest creates a reinforcing process. (To see how this works, trace the diagram from link to link; you’ll count two “o’s.”)

As shown in the behavior over time graph, this structure can produce a vicious or a virtuous cycle of quality levels—depending on how skillfully we manage the dynamics.

The Death Spiral. Here’s a key thing to realize about this quality demand-pressure-investment structure: Depending on the impact of delay, this exact same structure can produce the “virtuous” or the “vicious” spiral shown in the “To Invest, or Not to Invest?” graph, in which product quality and customer demand are forced ever higher or even lower, respectively. (That’s the frustrating thing about systemic structures: They don’t discriminate between the two kinds of spirals! It’s up to us to anticipate which kind of spiral might be lurking in our future—and manage the system in a way that keeps the “bad” kind at bay.)

To manage that vicious spiral, let’s look at what kinds of conditions tend to put it in motion. The vicious spiral is more likely to happen when the delay between rising customer demand and increasing production capacity (the R loop in “To Invest, or Not to Invest?”) is significantly longer than the delay in product-quality changes and shifts in demand levels (see the B loop). Here’s how this can happen to a company like FitCo—as well as to any manufacturing company:

As demand increases, FitCo holds off investing in additional capacity—perhaps because they’ve seen temporary blips in demand before, and they don’t want to end up saddled with excess capacity.
Pressure on the production folks rises, and product quality begins to slip. Yet the drop in quality does not yet affect demand, so demand continues to rise.
When FitCo becomes convinced that the rise in demand is “for real,” it authorizes expansions in capacity.
New capacity takes a while to come online. If the delay in getting capacity online is significantly longer than the other delays, then the pressure on production will continue to mount, leading to even lower product quality and eventually lower customer demand.
When customer demand starts to drop, FitCo now tries to reverse its capacity additions. This prevents the company from getting the additional capacity it needs. Pressures on production remain high, and product quality drops further. So, demand continues to fall. FitCo’s managers applaud their supposed good judgment in cutting back on capacity, because (in their view) the customers were being fickle after all.
Convinced that they were right about the temporary nature of demand “blips,” FitCo’s managers begin cutting capacity ahead of falling demand. Now they’re thinking they’re quite brilliant for saving the company so much money (even though they’re totally blind to how their “wise” actions may be driving FitCo out of business).

The lesson here is that we can sometimes make decisions based on a belief about something that can actually cause the things we are trying to prevent. In FitCo’s case, beliefs about falling demand can actually make the demand fall, in a tragic example of a self-fulfilling prophecy. When we’re in the middle of such a situation, however, it can look to us as if the fall is happening to us and that our actions are really a response to customer actions. Such is the nature of complex systems and the world of circular feedback loops: Once a loop gets going, it’s hard to tell what is driving what.

As a structure, a reinforcing loop has no directional preference. So, how might FitCo ensure that it gets the loop to go in the desired direction (upward in this case)? Look again at the figure “To Invest, or Not to Invest” on page 13. One way to manage these loops is to realize the importance of the relative delays in the two loops. If the delay in the R loop is longer than the one in the B loop, FitCo could try to figure out how to shorten the R-loop delay. For example, it could contract with other suppliers or partners who have excess capacity; that way, it could respond more quickly to upswings in demand. If that were not possible, then the company could try to create early-warning indicator systems that would alert it to unexpected jumps in production pressure or drops in quality. Both of these events are important signals that a company needs to expand its production capacity

3. The FitCo story, as well as the story about DevWare Corp. that begins on p. 14, are composite stories based on common experiences within many different companies. The company names are fictional.

4. You may have noticed that those variables don’t include an explicit gap, unlike the earlier balancing loops you’ve seen in this volume. However, in any balancing loop, there’s always an inherent gap—whether the gap is mentioned or shown in a diagram or not. In a diagram, not showing the gap is a shorthand way of drawing the loop. In the loop diagram on this page, there’s an implicit gap between product quality (which represents the actual situation) and desired product quality (which represents the goal, and is not shown in the diagram).