No Business is an Island: Embracing Systems Thinking

Traditional value chains have dropped us on an island

With all the discussion around and pledges toward transitioning to a more sustainable future, we must acknowledge that such a transition requires a shift in mindset from business leaders and other market participants about the role businesses play. Conventional business wisdom has taught us that to determine the success of a business, we must distill a company’s business model, management, and operations into certain quantitative points of measure, almost in isolation. Occasionally, we look a little broader to see whether the company has performed better or worse than peers by comparing ratios such as return on equity, debt-to-equity, and income margins.

In this view, the company immediately presented in front of us takes focus, and its strategy decisions are made through the lens of operationalizing its business model. Whether we are talking about the value chain or the supply chain, a typical graphic, like the one below, displays a linear path from sourcing inputs, turning them into a product or service, and then delivering to customers.

However, all these processes start and stop within the confines of a company without giving attention to what happens outside either end of the value chain. This value chain assessment is commonly taught in business schools and, therefore, implicitly teaches business leaders to ignore parameters outside this linear structure. As such, the reality of the broader systems in which businesses operate and the more complex nature of those systems are chronically overlooked. If this is the narrow scope through which business decisions are made, it misses critical factors and feedback loops that could affect the long-term success and resilience of a company, and the role companies play in driving a sustainable transition.

Complex Adaptive Systems rescue us from the island

If, instead, business leaders view their companies within the complex adaptive systems that they actually operate in, they would have a richer breadth of information on which to base strategy decisions and a better understanding of the interplay between variables both inside and outside the company. A complex adaptive system is one in which individual agents’ actions within the system result in certain patterns and processes, in turn affecting other individual agents within the system, creating a cycle of response and adaptation that can ultimately alter the system over time. Within a company, this can look like prioritizing certain business units over others and the resultant reshuffling of resources, both financial and human capital, allocated to those business units. It can also look like incentives, like the presence or magnitude of commissions or bonuses, that dictate the rewarded behaviors and reinforce business practices.

Furthermore, beyond being a complex adaptive system itself, businesses also operate in nested systems, meaning there are multiple layers of systems with each outer system being broader than the system within it. Each layer of a nested system has its own forces that influence that immediate system. At the same time, the forces that characterize a layer in the nested system also have the ability to influence events and interactions between them. Thus, impacting the nested system as a whole.

Businesses operate within the financial system, which operates within a societal system, which operates within the natural environment. For instance, businesses may contain their manufacturing processes and their labour force management. Financial systems have banks willing to extend credit and investors willing to offer capital. Societal systems include governments, laws and social norms. And the natural environment includes systems like ocean currents, ecosystems, and the atmosphere. At any layer in this nested system, changes or disruptions can impact other layers in the system, causing the need to adapt and, potentially even permanently, adjust the system in order to handle the changes imposed upon it.

Take changes in interest rates as a tangible, discrete example. A sudden interest rate hike can put pressure on individuals and businesses who use credit as a way to make purchases or investments. Similarly, individuals who have variable or adjustable rate loans may also find it more difficult to repay their obligations. The higher interest rates can cause a sudden increase in non-performing loans both from companies and individuals. If a large enough population of businesses and individuals can no longer repay their obligations this can affect the financial institutions that have lent money. In even more severe cases, such drastic shifts can possibly put pressure on the whole financial system, resulting in restricting credit as they manage the credit risk stemming from the changing interest rate environment. Restricting credit has implications for individual buying behavior, company investment, possible layoffs due to changing market sentiment, developments in technology, etc.

In such an example, one parameter can affect the business, financial, and societal systems. There can be several knock-on effects from this one change in the system and, if we expanded the interest rate example, we could explore additional feedback loops affecting each layer of the nested system. These interactions become more complex when we understand that changes within systems can happen simultaneously with various triggers catalyzing different changes in each of the systems. The interrelationship of these changes and the impact on and across systems can be hard to predict.

We can take a look back at the last several years to find a few sources of change or disruption that have forced systems to adapt: the prevalence and advancement of artificial intelligence, geopolitical tensions in North America, Asia, and the Middle East, Covid-19, the divergence in attitudes about ESG and sustainability issues and regulations, to name a few. Some of these changes have occurred at the same time, causing a push and pull in governmental and business responses, financial resources, labour shifts, and public sentiment, among other drivers. These simultaneous changes have had significant implications on the business, financial, and societal nested systems.

Let’s Not Forget Natural Systems (Anymore)

If we add another critical, but historically neglected, system into the mix, the balancing act becomes even more complex. When we acknowledge the rapid changes being observed in the natural environment, this shift to a systems mindset becomes more important. If we take a look at the nine planetary boundaries measured and assessed by the Stockholm Resilience Centre, we see an alarming change over the last fourteen years. In 2023, it was estimated that six of the nine assessed boundaries have been crossed, and far exceeding their acceptable limits, up from three boundaries crossed in 2009.

It might seem that the discussion around climate or other nature-related topics is only relevant for the industries directly impacted by those issues, but the reality of the matter is that every industry depends on the natural environment to function. Whether it is raw materials for production, or energy for power, or ecosystem services for agriculture and food production, or water for processing, cooling, or drinking, the natural environment is an integral part of the business equation. When our natural environment cannot sustain the current pace at which we consume it, businesses across industries face the challenge of sourcing or using natural inputs that are increasingly scarcer and without substitute, of a lower quality, or more prone to supply disruption. In the worst case, businesses may struggle to operate to such a degree due to a complete breakdown in the natural systems on which they depend.

While it is simpler to think of business linearly, the numerous and varied drivers of change and their related feedback loops, some of which have been highlighted here, suggest that a systems thinking approach misses fundamental information flows key to business decision making. Taking into consideration the financial, societal, and natural systems, businesses cannot assume that parameters in these systems will remain constant or that changes in those systems won’t influence the way businesses will need to adapt going forward.

Our Approach at RiskSphere

The first step in ensuring a business is resilient and adaptable in the face of these potential systemic changes is to consider the variables within each system that the business influences and vice versa. We understand that mapping these dependencies within and between systems is a complicated task. Recent regulation, such as CSRD, is an initial step in addressing this issue by requiring businesses to define and measure the impact on society and the environment from both an inside-out and outside-in perspective. Working with RiskSphere enables business leaders to better identify the ESG issues most prevalent for a company’s business model and offer insights into how to incorporate these into the company’s long-term strategy.

A systems thinking approach, however, goes beyond CSRD compliance and reevaluates the the dynamics of systems and their impact on businesses. RiskSphere supports decision-makers in adopting a systems thinking approach using methods like life cycle analysis, the iceberg model, and the coupled human and natural systems (CHANS) framework to build operational resilience. We combine sustainability expertise with technical knowledge, such as performing scenario analysis, to demonstrate the impact of ESG and sustainability issues on a company’s business. These qualitative and quantitative insights allow for a broader understanding of how businesses shape and are shaped by the interrelationship between systems. From this understanding, business leaders are better able to identify a set of paths they can take to adapt to a multivariate and ever-changing environment.