Chaos Theory and Strategy: Theory, Application. and Managerial Implications
Chaos Theory and Strategy: Theory, Application. and Managerial Implications
Chaos Theory and Strategy: Theory, Application. and Managerial Implications
15, 167-178(1994)
CHAOSTHEORYAND STRATEGY:
THEORY,
I APPLICATION.
DAVIDLEVY
AND MANAGERIAL
IMPLICATIONS
Department of Management, lJniversity of Massachusetfs- Boston
Boston, Massachusetts, U.S.A.
This paper argues that chaos theory provides a useful theorectical framework for
understanding the dynamic evolution of industries and the complex interactions among
industry actors. It is argued that industries can be conceptualized and modeled as complex,
dynamic systems, which exhibit both unpredictability and underlying order. The relevance
of chaos theory for strategy is discussed, and a number of managerial implications are
suggested. To illustrate the application of chaos theory, a simulation model is presented
that depicts the interactions between a manufacturer of computers, its suppliers, and its
market. The resuhs of the simulation demonstrate how managers might underestimate the
costs of international production. The paper concludes that, by understanding industries as
complex systems, managers con improve decision making and search for innovative
solutions.
-2095t94tB01.67
ccc 0143 -r2
@)1994by JohnWiley & Sons,Ltd.
168 D. Levy
RELEVANCE OF CHAOS THBORY TO errors would lead us to think that better models
STRATEGY and a more accurate specificationof starting
conditionswould yield better forecasts,useful
To understandthe relevanceof chaostheory to for perhapsmonths if not years into the future.
strategy,we need to conceptualizeindustriesas Chaos theory suggestsotherwise; the payoff in
complex, dynamic, nonlinear systems. Firms terms of better forecasts of building more
interact with each other and with other actorsin complexand more accuratemodelsmay be small.
their environment,suchas consumers,labor, the Similarly, we cannot learn too much about the
government, and financial institutions. These future by studyingthe past: if history is the sum
interactions are strategic in the sense that of complex and nonlinear interactionsamong
decisionsby one actor take into accountantici- peopleand nations,then history doesnot repeat
pated reactions by others, and thus reflect itself. Concerningurban planning, Cartwright
a recognition of interdependence.Although (1991)has noted that we have to acknowledge
interfirm behavior has been modeledformally in that 'a completeunderstandingof some of the
economicsand businessstrategy using game thingswe plan may be beyondall possibility.'
theory (Camerer, I99L), these models tend to The notion that long-termplanningfor chaotic
presumethe emergenceof equilibrium and do systems is not only difficult but essentially
not adequately reflect industry dynamics. As impossiblehas profound implicationsfor organi-
Porter (1990) emphasizes,the evolution of zations trying to set strategy based on their
industriesis dynamicand path dependent:corpor- anticipationof the future. Rather than expend
ate (and country-level) capabilities acquired large amountsof resourceson forecasting,stra-
during previous competitive episodesshape the tegic planning needs to take into account a
contextfor future competitivebattles.Moreover, number of possible scenarios.Moreover, too
the accumulationof competitive advantagecan narrow a focus on a firm's core products
be self-reinforcing,suggestingat least one way and markets might reduce the ability of the
in which industriesare nonlinear. If industries organizationto adapt and be flexible in the face
do behave as chaotic systems,a number of of change. The proliferation of joint-ventures
implicationsfor strategycan be drawn. and the acquisition by large firms of stakes
in entrepreneurialenterprisescan perhaps be
Long-term planning is very difficult understoodas attempts to keep a foothold in a
number of potential scenariosin the face of
In chaotic systems,small disturbancesmultiply uncertaintyand acceleratingchange.
over time becauseof nonlinearrelationshipsand
the dynamic,repetitivenatureof chaoticsystems.
As a result,suchsystemsare extremelysensitive Industries do not reach a stable equilibrium
to initial conditions, which makes forecasting The traditional approachto understandingthe
very difficult. This is a problem that has influenceof industry structure on firm behavior
confronted meteorologiststrying to model the and competitive outcomes has been derived
weather: the fundamentalproblem is trying to from microeconomics,with its emphasis on
use finite measurementsin an infinite world. comparativestaticsand equilibrium.More recent
A related problem is that as systemsevolve applicationsof game theory have attempted to
dynamically,they are subject to myriad small accountfor interactionsamongsmall numbersof
random(or perhaschaotic)influencesthat cannot firms (usuallytwo), yielding predictionsabout,
be incorporatedinto the model. for example, investmentsin R&D or plant
Formulatinga long-termplan is clearly a key capacity to seize first-mover advantages.Even
strategictask facing any organization.People the most complexgame theoreticmodels,how-
involved in planning,whether in business,eco- ever, are only considereduseful if they predict
nomics,or someother area,have alwaysknown an equilibrium outcome. By contrast, chaotic
that modelsare alwaysjust models,that forecasts systemsdo not reacha stableequilibrium;indeed,
are uncertain,and that uncertaintygrows over they can never passthrough the sameexactstate
time. Nevertheless.our conventionalunderstand- more than once. If they did, they would cycle
ing of linearmodelsand the influenceof random endlesslythrough the same path becausethey
Chaos Theory and Strategy I7t
cation can be delayed, and information can be INVENTORY TO DEMANDRATIOFOR lOO MONTHS
misunderstood.
A secondimportant dimensionof the supply o
chain system is the time relationship among Z .
=
the stages. As a result of the time lags in u, o
communication,production, and distribution,a -
disruptionto one elementgeneratesa sequence zF
O 2
of changesin other parts of the system. For =
example, demand fluctuationscausechangesin F
salesforecasts,productionschedules,and order Fz ' I
UJ
TO DEMANDRATIOFOR1OOMONTHS
INVENTORY
2.e
2.6
o.1t
2.4
2 2-z 2 o'r
= o.oe
tr 1.9 uJ
o
!lr, o . o .
..8
J 4.4
F 1.2 =l o.07
u-
6 1 j 0.08
= o'o l.L
Z o.os
t o.B f
O o..r o.or
$
z 0.2
llj f o.o,
ul
7 -o.z
f, o.o"
-0.4
0.01
-o.3
-o.8
Figure 3. Simulated inventory levels, product made Figure 4. Impact of demand stability on unfulfilled
and sold in U.S. demands