Modularity in Design: How the Building Blocks of Design Influence the Structure of Industries Carliss Y. Baldwin Harvard Business School Presented at MIT Media Lab “Building Blocks” Symposium October 21, 2003

Three Points Modularity in Design is a financial force that can change the structure of an industry. Value and Cost of Modularity it can increase financial value, but it is NOT free. What is Modularity in Design? How to map it, measure it. Slide 2 © Carliss Y. Baldwin and Kim B. Clark, 2003

The Market Value of the Computer Industry By sector, 1950-1996 in constant 1996 US dollars Slide 3 © Carliss Y. Baldwin and Kim B. Clark, 2003

The Market Value of the Computer Industry By sector, 1950-1996 in constant 1996 US dollars Slide 4 © Carliss Y. Baldwin and Kim B. Clark, 2003

Modularity is powerful, but… NOT always a good thing. I advocate— rigorous mapping, measurement, and analysis of modularity Not blind adoption Its virtues: Makes complexity managable Enables parallel work “Welcomes experimentation” —> Creates Options Slide 5 © Carliss Y. Baldwin and Kim B. Clark, 2003

Types of Modularity Modular in Design Modular in Production Modern computers Eclectic Furniture (not “modular” furniture) Recipes in a cookbook Modular in Production Engines and Chassis Hardware and software NOT chips, NOT a cookbook Modular in Use “Modular” furniture, bedding Suits and ties Slide 6 © Carliss Y. Baldwin and Kim B. Clark, 2003

Modularity-in-Design Creates Design Options Split options, decentralize decisions, fragment control Evolution Slide 7 © Carliss Y. Baldwin and Kim B. Clark, 2003

Design Options are Valuable How Valuable? Ask a financial economist…

What is the value of… Splitting a design into J modular building blocks…and Running multiple experiments (K of them) on each of the modules… and Choosing the “best of breed” of each module… and Combining the best modular building blocks to arrive at the system? Slide 9 © Carliss Y. Baldwin and Kim B. Clark, 2003

Robert C. Merton “Theory of Rational Option Pricing”, Written for— MIT PhD thesis, 1971; Published in— Bell Journal of Economics and Management Science, 1973; Awarded— Nobel Prize in Economics, 1997 “A portfolio of options is worth more than the option on a portfolio.” Slide 10 © Carliss Y. Baldwin and Kim B. Clark, 2003

What is the value of… Splitting a design into J modular building blocks…and Running multiple experiments (K of them) on each of the modules… and Choosing the “best of breed” of each module… and Combining the best modules to arrive at the system? Going from one big indivisible block…. To many smaller building blocks Where each building block is a (little) option That gets recombined with others in a (large) portfolio Slide 11 © Carliss Y. Baldwin and Kim B. Clark, 2003

Slide 11 © Carliss Y. Baldwin and Kim B. Clark, 2001

The Value of Splitting and Substitution Slide 13 © Carliss Y. Baldwin and Kim B. Clark, 2003

Modularity in design is compelling, surprising and dangerous… When and if it arrives… Modularity in design is compelling, surprising and dangerous… Slide 14 © Carliss Y. Baldwin and Kim B. Clark, 2003

The Market Value of the Computer Industry By sector, 1950-1996 in constant 1996 US dollars Slide 15 © Carliss Y. Baldwin and Kim B. Clark, 2003

IBM System/360 The first modular computer design IBM did not understand the option value it had created Did not increase its inhouse product R&D Result: Many engineers left to join “plug-compatible peripheral” companies San Jose labs —> Silicon Valley “Compelling, surprising, dangerous” Slide 16 © Carliss Y. Baldwin and Kim B. Clark, 2003

We can “see it” via a Design Structure Matrix (DSM) Map What is Modularity? We can “see it” via a Design Structure Matrix (DSM) Map

Design Structure Matrix Map of a Laptop Computer Slide 18 © Carliss Y. Baldwin and Kim B. Clark, 2003

Design Structure Matrix Map of a Modular System Slide 19 © Carliss Y. Baldwin and Kim B. Clark, 2003

A “modularization” (splitting) of a complex design goes from Map A to Map B Via Design Rules, which specify Architecture, Interfaces and Module Tests, that provide Encapsulation and Information Hiding.

The Costs of Modularity

Costs eat up the option value Every important cross-module interdependency must be addressed via a design rule. This is costly Costs eat up the option value Modularization may not pay Slide 22 © Carliss Y. Baldwin and Kim B. Clark, 2003

Experiments are also costly, thus each module has a unique “value profile”. Value Profile of a Sun Microsystems Workstation circa 1992 Slide 23 © Carliss Y. Baldwin and Kim B. Clark, 2003

The Perils of Modularity

IBM Personal Computer Highly modular architecture IBM outsourced hardware and software Controlled one high-level chip (BIOS) and the manufacturing process Then Compaq reverse-engineered the BIOS chip Taiwanese lowered manufacturing costs By 1990 IBM was seeking to exit the unprofitable PC marketplace! Slide 25 © Carliss Y. Baldwin and Kim B. Clark, 2003

Compaq vs. Dell Dell did to Compaq what Compaq did to IBM… Dell created an equally good machine, and Used process modularity to reduce its production, logistics and distribution costs and increase ROIC Negative Net Working Capital Direct sales, no dealers By 1990 Compaq was seeking to exit the unprofitable PC marketplace! Slide 26 © Carliss Y. Baldwin and Kim B. Clark, 2003

“Modularity-in-design is not good or bad “Modularity-in-design is not good or bad. It is important and it is costly. And dangerous to ignore.”

Just remember— “Compelling, surprising, dangerous…”

Thank you!