A MacWEEK editorial (April 3, 1990) summarized the downfall of this company that was once a “Mac user’s dream.” According to the editorial, Jasmine became successful because it sold directly to users at a low cost. Its quality product, coupled with a reputation for superior customer support, vaulted the company’s revenues to S30 million in 1988. But when money became tight, quality and customer service were the first to go.

The editorial hit upon all the right points but lacked a coherent framework for explaining why Jasmine failed and how other promising startups can avoid the same fate. If we try to understand Jasmine’s downfall from a systems perspective, we can see the classic “limits to success” principle.

A strong reinforcing loop (right) fueled Jasmine’s growth. Eventually demand out-stripped production capacity. Jasmine’s management allowed the demand pressure to create an unavoidable balancing effect by letting quality deteriorate and raising delivery delay (left).

Jasmine’s initial success was fueled by a strong reinforcing feedback loop. The introduction of a quality product created demand, which increased the installed base of users. Word-of-mouth advertising from the users raised the awareness of the product, which led to further demand and created rapid growth.

Rather than allowing the demand pressure to balance itself, management could have actively designed balancing loops (left) by reducing marketing and increasing prices.

But after a certain point, demand began to outstrip the company’s capacity. In order to keep up with demand, management shortened production time by lowering quality standards. The effects were not felt right away. It took time before word got around that the product quality had deteriorated. While the perceived attractiveness remained high, demand increased even further. With limited production capacity, Jasmine continued to fall behind demand and customers had to wait longer and longer to receive their product. By the time the low quality and high delivery delay were widely reported in the trade press, the company was already in deep trouble.

What would have happened if management had actively designed its own balancing effect rather than allowing the demand pressure to force one on the company? For example, management could have sharply reduced marketing, thus decreasing product awareness. Or they could have raised prices, thus decreasing product attractiveness. Both policies would generate more funds for capacity investments, which would enable them to maintain their product and service quality. In contrast, the passive approach of letting the system create its own balancing loops generated customer disappointment without any benefit for the company.

Ernst W. Diehl is the president of MicroWorlds, Inc., a software development and management consulting company that specializes in interactive training and the design of model-based executive information systems

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The goal of a seesaw ride is to always keep things in a state of imbalance (it would be pretty boring to sit on a perfectly balanced one). But the goal in the marketplace is exactly the opposite—to bring supply in balance with demand. Unfortunately, the supply and demand balancing process feels a lot more like a seesaw ride than a smooth adjustment to a stable equilibrium. As shown in the causal loop diagram, the dynamics of this adjustment process are produced by two balancing loops that try to stabilize on a particular price. But the process is complicated by the presence of significant delays.

Balancing Supply and Demand

FREE MARKET ECONOMY SEESAW

A free market economy is a lot like a seesaw with supply at one end and demand on the other. The dynamics that result from trying to balance supply and demand are produced by two balancing loops that try to stabilize on a particular price. Due to the presence of significant delays, a cycle of overshoot and collapse occurs.

Tracing through the loops, we see that if demand rises, price tends to go up (all else remaining the same), and as price goes up, demand tends to go down (Cabbage Patch dolls notwithstanding). If there is enough inventory or capacity in the system to absorb the increased demand, prices may not go up immediately. As demand outstrips supply, however, price will rise.

On the supply side of the seesaw, an increase in price provides a profit incentive for firms to produce more. Of course, it takes time for firms to expand. The length of the delay depends on how close they already are to full capacity and how quickly they can add additional capacity to produce more. Hiring new workers may only take a few days, while obtaining additional capital equipment or factory floor space may take months or even years. While firms are making supply adjustments, the gap between supply and demand widens and price goes even higher. The higher price spurs companies to increase their production plans even more.

As supply eventually expands and catches up with demand, price begins to fall. By this time, firms have over-expanded their production capacity and supply overshoots demand, causing price to fall. When the price falls low enough, the product becomes more attractive again and demand picks up, starting the cycle all over.

Airplanes on Seesaws

The supply and demand seesaw is played out in all but the most tightly regulated markets. A good example of this balancing act is described in a Forbes article entitled “Fasten seat belts, please” (April 2, 1990, pp. 84–85), about airplane leasing companies.

Leasing companies, which account for roughly 20% of all commercial jet aircraft currently on order, have enjoyed enormous profits during the latest boom in air travel. One carrier alone has put in an order to lease 500 planes. Based on leasing and buying rates in the industry, the total number of airplanes is expected to increase by 50% over the next five years. But in the meantime, air traffic growth has been slowing during the last three years. The leasing companies, however, do not seem too worried.

According to the article, “eight years of unbroken prosperity have created the illusion that many cyclical businesses aren’t cyclical any longer.” But, as one airline executive warned, “This is a cyclical business. Always has been, always will be. With a small change in load factor, the airlines can go from spilling cash to bleeding red ink like the Mississippi River going through the delta.”

AIRPLANE LEASING SEESAW

A causal loop diagram of the airplane leasing industry shows the same seesaw structure at work.

If we draw out a causal loop diagram of this industry, we see the same supply and demand structure at work. An increase in air traffic growth over the past three years fueled a strong demand for airplanes. That in turn sparked an increase in airplane lease rates as airlines scrambled for additional airplanes. The high lease rates led to increased profits and a surge in airplane orders. Since airplanes take many months to build, the supply of leasable airplanes did not adjust right away, making lease rates go even higher. This led to higher profits which attracted more capital which was plowed into even more orders for airplanes.

As the supply catches up to demand, however, the airplane lease rates will fall (the slowing of air traffic growth will accelerate this process). With so many airplanes in the pipeline, the supply will begin to outstrip demand and drive lease rates down even further. This will put a squeeze on profits and force marginal firms out of business. Some orders will be canceled; others will be renegotiated.

All the pieces of the airline leasing industry seem to be operating within a seesaw structure. Although the extended period of air traffic growth has kept demand ahead of supply for several years, it has not changed the nature of the delays in the supply line. When the supply adjustments bring the seesaw back down, airline leasing companies could be in for a bumpy landing.

Summary

In this article, we focused on a variation of one of the basic feedback loop structures—the balancing loop—with delays. This structure is at once simple and complex: simple, because it seems to be an innocuous single loop structure that is easy to comprehend; complex because the resulting behavior is neither simple nor easily predictable. The delays in a typical system are rarely consistent or well-known in advance, and the cumulative effects are usually beyond the control of any one person or firm.

Daniel H. Kim and Colleen P. Lannon cofounded The Systems Thinker.

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