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Predicting the Profit Potential of a Microeconomic Process: An Information Theoretic/Thermodynamic Approach

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  • George, Michael

Abstract

Abstract It would be of great benefit if management could predict the huge profits that would result from modest investments in process improvement initiatives such as Lean, Six Sigma and Complexity reduction. While the application of these initiatives was initially restricted to manufacturing, they have been expanded to transactional processes such as product development, marketing, and indeed all microeconomic processes... This paper derives an equation that, subject to further testing, appears to make such a profit prediction possible allowing a rational investment in microeconomic process improvement. That the profit of a company is greatly increased by the reduction of internal waste was originally demonstrated by Henry Ford, but has been greatly extended by Toyota. All waste in a process results in longer lead times, measured from the injection of work into the process until its delivery to the customer or user. Thus the increase in profit is principally driven by the reduction of lead time through process improvement. The lead time of any process is governed by the Queuing Theory formula known as Little’s Law. The central result of this paper is that the reduction lead time as expressed by Little’s Law leads to an equation for the reduction of process Entropy. The expression is identical with the reduction of entropy and thermodynamic waste in a heat engine. Case studies are used to estimate the magnitude of Boltzmann’s Constant for Microeconomic processes. The resulting Equation of Profit allows the prediction of the amount of waste cost elimination based on explicit Lean, Six Sigma and Complexity reduction process improvement parameters. More data is needed to more accurately estimate the magnitude of Boltzmann’s constant for microeconomic processes.

Suggested Citation

  • George, Michael, 2007. "Predicting the Profit Potential of a Microeconomic Process: An Information Theoretic/Thermodynamic Approach," MPRA Paper 5175, University Library of Munich, Germany, revised 05 Oct 2007.
  • Handle: RePEc:pra:mprapa:5175
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    Keywords

    Profit Increase Prediction; Process Entropy; Information; Complexity; Waste; Equation of Profit; Little’s Law; Business Analogies with Thermodynamics; Boltzmann’s Constant of Business; Carnot; Shannon;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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