1. Architectural Strategy and Open/Distributed Innovation
Carliss Y. Baldwin
DRUID/Scanscor Conference on Distributed Innovation
Stanford, CA
March 27, 2008
Slide © Carliss Y. Baldwin 2008

2. Formal Models of Open/Distributed Innovation
Johnson 2002
Private provision of public goods
Bessen 2002
User innovation addresses complexity of needs
Harhoff-Henkel-von Hippel 2004
Reasons for free revealing
Henkel 2004
Why firms collaborate on open innovation projects
Baldwin-Clark 2006
Conditions for collaborative user innovation to be a self-sustaining equilibrium
Why the institution is “open”
Slide © Carliss Y. Baldwin 2008

3. Formal Models of Open/Distributed Innovation (cont)
Baldwin-Hienerth-von Hippel 2006
Collaboration dominates isolation for user-innovators
Commercialization of user innovations
Baldwin 2008
Open innovation as an “unencapsulated” task network in contrast to corporations which are “encapsulated” by transactions
This paper
Open innovation as a complement to a firm’s competitive strategy
Baldwin-von Hippel (on hold)
Competition between collaborative open innovation and proprietary innovation based on property rights
Slide © Carliss Y. Baldwin 2008

4. Open innovation as a complement to a firm’s competitive strategy
Task Network for a complex system (Baldwin, 2008)
Boxes are activities/components;
Lines are dependencies/interfaces
Slide © Carliss Y. Baldwin 2008

5. Two forms of organization
Task Network for a complex system
All in One Big Firm F
Boxes are activities/components;
Lines are dependencies/interfaces
Slide © Carliss Y. Baldwin 2008

6. Two forms of organization
All in one big Firm
Distributed Innovation (and Production) F U F
F = Firms;
U=Users in an open innovation setting
Slide © Carliss Y. Baldwin 2008

7. My questions
Can a firm gain advantage from a technical system based on distributed innovation and production?
When and why would a firm set up its technical system in this hybrid fashion?
Such firms will be collaborators, supporters and perhaps predators of systems of open/distributed innovation
Slide © Carliss Y. Baldwin 2008

8. My Main Argument (Remember this slide)
“B’s” Technical System
“A’s” Technical System A F U B
–With selective outsourcing, A’s system can beat B’s system, causing B to exit
–Open/distributed innovation and open standards are a key part of A’s system
Slide © Carliss Y. Baldwin 2008

9. Potential Examples Google IBM and other corporate sponsors of Linux
“sucking up” and subsidizing the creation of open source code
IBM and other corporate sponsors of Linux
Platforms in two-sided markets
E-Bay; NTT-Docomo
Sun Microsystems
Ancient history, but interesting
Slide © Carliss Y. Baldwin 2008

10. The Sun story
Two parts
What they knew
Their capabilities
What they did
Deployment of capabilities
Both parts of the story are essential to my argument
Slide © Carliss Y. Baldwin 2008

11. Their capabilities—what they knew
Third generation of computer architecture
Hennessy and Patterson: quantitative analysis of bottlenecks in a complex system
Hardware-software interactions
“Make the common case fast…”
Textbook lags
Stanford-Berkeley vs. Boston
Slide © Carliss Y. Baldwin 2008

12. Example—Sun 2 Bottleneck remedies • Patented MMU chip • Fast bus
Slide © Carliss Y. Baldwin 2008

13. Deployment of capabilities— what they did
To have a superior product, you only need to control the bottleneck(s) and make them better
All other parts of the system architecture
Don’t affect performance or cost very much
Strategy: Keep control of bottlenecks and let go (outsource) the rest
Slide © Carliss Y. Baldwin 2008

14. Comparative “Footprints”
Apollo (main competitor)
Sun
Opportunistic commoditization—
Notice selective use of open standards (Ethernet) and open source code (BSD Unix) to make non-bottleneck components into commodities
Slide © Carliss Y. Baldwin 2008

15. Result => Smaller Technical Core => Smaller “Footprint”
Fewer inhouse activities
Relative to competitors that don’t have same architectural knowledge…
Remember textbook lags!
No penalty in performance and cost
Because of the optionality of modular designs
Architects can select the best treatment for each module
Slide © Carliss Y. Baldwin 2008

16. When outsourcing… This means…
The focal firm must maintain its power in the supply chain
This means…
Competitive production=>lots of potential suppliers
Board stuffers
Competitive innovation=>Open standards, open source, and open innovation
Berkeley Unix
Slide © Carliss Y. Baldwin 2008

17. Smaller “Footprint” means…
Fewer inhouse activities
No penalty in performance and cost
Means…
Equal machines with same unit cost
But less investment in R&D, Net Working Capital and Fixed Assets
Higher Return on Invested Capital ROIC at any level of pricing
Structural advantage based on design of the technical system
Slide © Carliss Y. Baldwin 2008

18. Competitive Dynamics
Higher ROIC is a loaded gun pointed at competition
Competitor may survive for a while, may even grow
But eventually must exit from the market
See paper for many gory details…
Slide © Carliss Y. Baldwin 2008

19. Empirical Predictions
If A (Sun) pursues a smaller footprint strategy against B (Apollo) —
ROICA> ROICB
gA > gB
Eventually ROICB< Cost of Capital
A can drive B out of the market
“B” can be a set of firms, not just one, but A must have superior architectural knowledge about the bottleneck
Slide © Carliss Y. Baldwin 2008

20. ROIC
Slide © Carliss Y. Baldwin 2008

21. Growth
Slide © Carliss Y. Baldwin 2008

22. Exit
Apollo’s ROIC was consistently below their cost of capital
Acquired by Hewlett Packard in April 1989
Avoided bankruptcy
HP’s rationale— Economies of scale
“the largest engineering workstation company in the world…”
HP was clueless about bottlenecks, footprints and ROIC
Slide © Carliss Y. Baldwin 2008

23. Strategic Implications
If you are a “B” type firm, don’t go to war against an “A”
If you are an “A” type firm
Know your bottlenecks
Must know more than you make (Brusoni and Prencipe)
Be prepared to shift footprint as bottlenecks move around
Maintain your power in the supply chain
Make sure your “B” type competitors know that you are an “A” (publish your ROICs!)
Slide © Carliss Y. Baldwin 2008

24. Recap of Argument
Slide © Carliss Y. Baldwin 2008

25. Recap of Argument
Slide © Carliss Y. Baldwin 2008

26. Recap of Argument
Slide © Carliss Y. Baldwin 2008

27. Recap of Argument
Power in the Supply Chain is a strategic complement to Architectural Knowledge
Slide © Carliss Y. Baldwin 2008

28. Significance for Distributed/Open Innovation
Certain firms will be happy to build strategies on top of open/distributed innovation systems
The economic benefits of open/distributed innovation may be appropriated by strategic complementors pursuing “small footprint” strategies
Slide © Carliss Y. Baldwin 2008

29. Significance for Distributed/Open Innovation (cont)
As open innovation takes over different layers of a technical system, the overall system price may not decline
Utility to users may increase, however
if user information is “sticky”
hence user designs more functional
Firms will seek bottlenecks
Whether they find them depends on
architectural knowledge and
textbook lags
Slide © Carliss Y. Baldwin 2008

30. Significance for Distributed/Open Innovation (cont)
Sources of bottlenecks
Technical determinants of performance (discussed in the paper)
Absolute
Fractional
Transactional efficiencies—Indirect network externalities—(two-sided markets literature)
Standards of compatibility (design rules)
Interoperability (artifact level)
Design of transactions (agent/organization level)
Search funnels and filters
Systems can have multiple bottlenecks, causing firms to bet on different footprints
Mobile telephony today
Slide © Carliss Y. Baldwin 2008

31. Can one break a bottleneck?
As architectural knowledge diffuses, technical bottlenecks disappear
Memory management for CPU
In contrast, standards of compatibility tend to be very stable—a chokepoint, not a bottleneck
Windows APIs (owned by Microsoft)
New York Stock Exchange (owned by members/users)
Don’t know about search funnels/filters
Google
Slide © Carliss Y. Baldwin 2008

32. In closing…
Slide © Carliss Y. Baldwin 2008

33. B Remember this slide? “B’s” Technical System “A’s” Technical System AF U B
Slide © Carliss Y. Baldwin 2008

34. B My Main Argument “B’s” Technical System “A’s” Technical System A U F
–With selective outsourcing, A’s system can beat B’s causing B to exit
–Open/distributed innovation and open standards are a key part of A’s system
Slide © Carliss Y. Baldwin 2008

35. I hope you are convinced.
Slide © Carliss Y. Baldwin 2008

36. Thank you!
Slide © Carliss Y. Baldwin 2008

37. Architectural Knowledge
Architecture = entities and relationships
Function-to-component mapping
Interfaces between components
Linkages and interactions (“dependencies”)
Architectural knowledge means knowledge about all these things
Slide © Carliss Y. Baldwin 2008

38. Dynamics —Textbook lags
1962—IBM task group figures out how to build a modular computer system
1974—Bell and Newell publish textbook
1980—Hennessy and Patterson begin to teach graduate students about quantitative approaches to computer architecture
1990 H&P publish first text
1994 H&P publish second text
Slide © Carliss Y. Baldwin 2008

39. Architectural Innovation
Generation 1—Integral systems
Build a whole new system
Generation 2—Modular systems
Modular operators: split, substitute, augment, exclude, invert, port
Recombine, link, compose
Generation 3—Quantitatively measured systems
Find a bottleneck and remedy it
“Make the common case fast” (Amdahl’s Law)
Slide © Carliss Y. Baldwin 2008

40. Third-generation architectural knowledge tells you
Where bottlenecks are
How to remedy a bottleneck
How much the remedy is worth in terms of system performance
“Speedup formula”
How to change modular structure
2nd generation knowledge
Can have multiple objectives (cost and speed)
Multiple bottlenecks
Slide © Carliss Y. Baldwin 2008