Why “theory” matters – if it is General, Useful and True

Yes, yes – I know! … we’re all practical folk who have no patience with theory!! But stick with me …

We all use theory, all the time. If a theory is a set of ideas intended to explain something, then every decision we make is based on some theory we hold in our head,

“Hire more service staff” because we believe that “poor service is caused by having too few service staff”.

“Increase the price” because we believe that “the added gross margin per unit will be more than the loss of total gross profit from lower sales”.

But you can see the obvious problem – those decisions are only OK if our theory is good. In both these cases, the theory is inadequate.

By the way, better people than me have made the same case, more eloquently – see Christensen, C.M. and Raynor, M.E., 2003. Why hard-nosed executives should care about management theory. Harvard business review, 81(9), pp.66-75.

So what make for a “good” theory that executives can rely on? My long-ago Finance professor told us that a good theory meets 3 criteria:

It should be general – being applicable ideally to all cases, or at least to all of a substantial class of cases. (It’s no use if it applies only to a random selection of differing cases)

It should be useful – it’s not much use having some causal explanation that we can’t exploit to get outcomes we want.

It should be true – no surprise that we would make poor decisions if based on causal explanations that are untrue.

Unfortunately, many methods and frameworks across the management field fail – or fall badly short – on one or more of these requirements. For example,

A theory saying that the success of airlines like Southwest Airlines, Ryanair or Air Asia is due to their focus on cost-conscious travellers is useful and true. But it is not general, because very many other airlines have the same focus while being unsuccessful or failing.

Something called the “resource-based view” of strategy (RBV) says that profitability is strongly explained by intangible factors. That might be general, and it might be true. But it’s not useful, because those intangible factors are so badly defined as to be unmeasurable and unmanageable. (No surprise then, that most executive have never heard of it!)

The theory behind the Net Promoter Score says that this one number drives sales growth. (See my post on this management fad). This would be general, and useful, but it’s not true to any reliable degree – too many cases of great NPS scores and modest sales growth, and vice versa, simply because so many other factors are involved.

What is the underlying theory behind Strategy Dynamics? The method is just one manifestation of a deep underlying theory, from Prof. Jay Forrester at MIT in the 1960s:

The issue of concern – the thing to be explained – is why performance outcomes change over time as they do.

Performance at any time, on any of the common measures of concern, depends on the quantities of accumulating stocks (“resources”) at that time, and on certain decisions we take, and on some identifiable external factors.

The amount by which each of those accumulating factors changes, from one point in time to another, is axiomatically set by the rates at which that factor is added to minus the rate at which it is depleted. (I.e. this is precisely true, with no residual error.)

Those rates of change to the accumulating factors ALSO depend on the existing quantities of accumulating stocks at that time, and on certain decisions we take, and on some identifiable external factors.

Taken together and repeated, these relationships describe any business system or phenomenon that changes over time. (Sorry for the stilted, formal language – there’s a super-simple case illustration of this theory in action at sdl.re/AgileSD.)

So does strategy dynamics pass the good-theory test? 

Well, it’s general, for sure. Try subjecting it to the scientific test of ‘falsification’ – find any case where it is not true. (In fact, it is far more general, as it applies to every social, economic, environmental system and many more).

And it’s useful. Every element in the theory can be specified and measured. Most can be measured precisely, and most others estimated close enough to be included in the system.

And it’s true, provided that the theory is properly applied, for example by repeating the measurements sufficiently often that no asset stock changes by a substantial fraction from one point in time to the next. In fact, it is SO true that there cannot be any other explanation for why performance changes over time as it does.

Why should you care about this theoretical guff !?  … because it means that the digital-twin business models that you can build by rigorously following the 4 steps matching the theory will be reliable – and that means that you can have confidence in any strategies and decisions you make, based on that model.

Now of course no model can give you a 100% match to how a business system performs, or a 100% accurate forecast. Some of the causal relationships within the system cannot be known precisely – notably those concerning people’s behaviour. And there is much uncertainty about those external factors. But it is reliable enough to be very, very useful.

And just consider for a moment – all this is in a quite different league from other management methods, simply because the underlying theory is so rock-solid.

Incidentally, you may wonder how such an important field as business management has come to be cursed with such a plethora of poor theories. It might be due to its huge reliance econometric-type regression methods to test hypotheses about what causes what.

Unfortunately, part 3 of the theory on which strategy dynamics rests destroys any ability for such methods to prove causal explanations. If the quantity of an accumulating stock (e.g. customers) is 100% explained by its entire history of gains and losses (customers won and lost in every period since the business started), then there is no possibility that the same number can be explained by anything else … and therefore there is no possibility of explaining anything that depends on that stock with regression methods either – like sales and profits!

To be fair, the similar failings apply across the social sciences, for the same reasons.

So – That’s why we should care about theory!

PS: If you want to how all this translates into powerful digital twin business models, check out my free workshop.

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