slide 1 © carliss y. baldwin 2006 the power of modularity: the financial consequences of computer...
TRANSCRIPT
Slide 1 © Carliss Y. Baldwin 2006
The Power of Modularity: The Financial Consequences of Computer and Code Architecture
Carliss Y. BaldwinHarvard Business School
AOSD 06March 22, 2006
Slide 2 © Carliss Y. Baldwin 2006
Unmanageable Designs—What They Are and their Financial Consequences
Carliss Y. BaldwinHarvard Business School
AOSD 06March 22, 2006
Slide 3 © Carliss Y. Baldwin 2006
Three Points to begin Large, complex, evolving designs
– Are a fact of modern life– Need design architectures—
» “Description of the entities in a system and their relationships”» Way of assigning work (Parnas)
Designs create value– Value operates like a force in the economy– We fight to create it and to keep it—using strategy
Design Architecture and Strategy– How can you create and capture value in a large,
complex evolving set of designs?– Subject of this talk
Slide 4 © Carliss Y. Baldwin 2006
In the economy, value acts like a force
Value = money or the promise of money
Consider the computer industry…
Slide 5 © Carliss Y. Baldwin 2006
The changing structure of the computer industry
Andy Grove described a vertical-to-horizontal transition in the computer industry:
1995-“Modular Cluster”
1980-“Vertical Silos”
Slide 6 © Carliss Y. Baldwin 2006
Andy’s Movie
Stack View in 1980Services S
PSystems Integration E
RR
Applications Layer Y D CVCMiddleware Layer U H E
Operating Systems IBM N P CS
Hardware Y XRCSAMP
ComponentsTI Intel
Top 10 Public Companies in US Computer Industry
Area reflects Market Value in Constant US $
Slide 7 © Carliss Y. Baldwin 2006
Andy’s Movie
Stack View in 1995SPERRY D CVCU H E
IBM N P CSY XRCSAMP
TI Intel
Top 10 Public Companies in US Computer Industry
Area reflects Market Value in Constant US $
ServicesFirst Data
Systems Integration EDSOracle
I CAApplications Layer B MSFTMiddleware Layer M
Operating Systems
Hardware: Printers HPHardware: Servers IBMHardware: Routers Cisco
Components IntelMicron
Slide 8 © Carliss Y. Baldwin 2006
Andy’s Movie—the Sequel
Stack View in 2002SPERRY D CVCU H E
IBM N P CSY XRCSAMP
TI Intel
Top 10 Public Companies in US Computer Industry
Area reflects Market Value in Constant US $
ServicesFirst Data
Systems Integration EDSOracle
I CAApplications Layer B MSFTMiddleware Layer M
Operating Systems
Hardware: Printers HPHardware: Servers IBMHardware: Routers Cisco
Components IntelMicron
Services First DataADP
Systems Integration
OracleApplications Layer IBM
Middleware Layer MSFT
Operating Systems
Hardware: Printers HPHardware: PCs Dell
Hardware: Servers IBMHardware: Routers Cisco
Components Intel TI
Slide 9 © Carliss Y. Baldwin 2006
Turbulence in the Stack
Departures from Top 10: Xerox (~ bankrupt) DEC (bought) Sperry (bought) Unisys (marginal) AMP (bought) Computervision (LBO)
Arrivals to Top 10: Microsoft Cisco Oracle Dell ADP First Data
Sic Transit Gloria Mundi … Sic Transit
Slide 10 © Carliss Y. Baldwin 2006
Contrast to the Auto Industry
Top 10 Public Companies in US Auto Industry
Area reflects Market Value in Constant US $
Other Chassis/Powertrain
Other Interior
Other MultipleElectrical/Electronics
Other Misc.
Toyota Nissan DaimlerChrysler
Honda GM Ford VW
Oth
ers
Johnson Controls
Magna
Eaton
20031982
AftermarketAUGAT (electronics)
General Motors
FORDC
hry
sler
Tenneco
Toyota
Ho
nd
a
Dana Eaton
TRWInterior
Other Powertrain
Value stayed in one layer!
Slide 11 © Carliss Y. Baldwin 2006
Two patterns
“Manageable” designs = auto industry “Unmanageable” designs = computer
industry
What makes computer designs so unmanageable?
This was the question Kim Clark and I set out to answer in 1987.
Slide 12 © Carliss Y. Baldwin 2006
After studying the history of computer designs and correlating their changes with value changes
We concluded that modularity was part of the answer…
Slide 13 © Carliss Y. Baldwin 2006
Modularity is
The degree to which a set of designs (or tasks) is partitioned into components, called modules, that are
highly dependent within a module, nearly independent across modules
A property of architecture, somewhat under the architect’s control
Slide 14 © Carliss Y. Baldwin 2006
Modularity in computers—IBM System/360
First modular computer design architecture (1962-1967)– Proof of concept in hardware and application
software– Proof of option value in market response and
product line evolution– System software was NOT modularizable
» Fred Brooks, “The Mythical Man Month”
» Limits of modularity
Slide 15 © Carliss Y. Baldwin 2006
Strategically—IBM wanted to be the sole source of all of System/360’s Modules
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
1 SLT architecture and standard circuits2 Erich Bloch - August 19613 New Processor Line Architectural Ground Rules4 SPREAD Task Group - 12/28/615 New Processor Line control, product and programming standards6 Corporate Processor Control Group (CPC) - 4/1/62
7 SLT Transistors8 SLT Modules9 SLT Cards
10 SLT Boards and Automatic Wiring11 Processor 1 - Endicott, New York12 Processor 2 - Hursley, England13 Processor 3 - Poughkeepsie, New York14 Processor 4 - Poughkeepsie, New York15 Processor 5 - Poughkeepsie, New York16 Main memories, Corporate Memory Group (1)17 Internal memories, CMG18 Read-only memories for control, CMG19 "Binary-addressed" Random Access Files20 Corporate File Group (2)21 Tape devices running at 5000+ char/sec22 Corporate Tape Group (3)23 Time-multiplex system for switching I/O devices24 DSD Technical Development Group
25 Techniques to measure processor performance, system26 throughput and software efficiency, Group Staff27 A unified Input/output Control Structure (IOCS)28 System Software for Configuration I (4)29 System Software for Configuration II (4)30 System Software for Configuration III (4)31 FORTRAN and COBOL compilers32 A unified programming language
33 Announcement and Marketing34 Production, Testing and Integration35 Shipment, Delivery and Installation
Slide 16 © Carliss Y. Baldwin 2006
By 1980, 100s of firms made S/360 “plug-compatible” components
Code Category Definition 1960 1970 1980
3570 Computer and Office Equipment 5 2 93571 Electronic Computers 1 8 293572 Computer Storage Devices 1 6 36 *3575 Computer Terminals 2 5 23 *3576 Computer Communication Equipment 1 1 10 *3577 Computer Peripheral Devices, n.e.c. 3 5 12 *3670 Electronic Components and Accessories 11 7 11 *3672 Printed Circuit Boards 2 19 39 *3674 Semiconductors and Related Devices 8 4 10 *3678 Electronic Connectors 5 15 16 *7370 Computer Programming, Data Processing,
and Other Services 1 9 26 *7371 Computer Programming Services 0 2 12 *7372 Prepackaged Software 0 7 13 *7373 Computer Integrated Systems Design 1 3 167374 Computer Processing, Data Preparation
and Processing 0 5 29 *7377 Computer Leasing 0 10 7 *
41 108 298
* Firms in these subindustries make modules of larger computer systems. Firms making modules = 34 95 244Percent of total = 83% 88% 82%
Slide 17 © Carliss Y. Baldwin 2006
Modularity and Option Value Interact
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
Slide 18 © Carliss Y. Baldwin 2006
Modularity in computers, cont. Bell and Newell, Computer Structures (1971)
– General principles of modular design for hardware– Basis of PDP-11 design—another ORMDA
Thompson and Ritchie, Unix and C (1971-1973)– Modular design of operating system software (contra
Brooks Law) Parnas (1972) abstract data structures, info hiding
– Object-oriented programming, C++, Java Mead and Conway, Intro to VLSI Systems (1980)
– Principles of modular design for large-scale chips
Slide 19 © Carliss Y. Baldwin 2006
Modularity in computers (cont.) IBM PC (1983)
– DEC PDP-11 minimalist strategy (exclude and invite) – + Intel 8088 chip– + DOS system software – + IBM manufacturing – + Lotus 1-2-3– A modular design architecture with a mass market
Slide 20 © Carliss Y. Baldwin 2006
Creating a modular architecture
Slide 21 © Carliss Y. Baldwin 2006
. x x x x xx . x x x x x x x x x
Drive x x . x x xSystem x x x . x x x x x x x x
x x . xx x x x . x x x
x x x . x xx x x . x x x x
x x x . x x x x xMain x x x . x x xBoard x x x x x x x x . x x x x x
x x x x x . x xx x x x x x . x x x
x x x . x
x x x . x x xx x x x . x x x x
LCD x x x . x xScreen x x x x . x x x
x x x x x x x . x x xx x x . x
x x x x . x x x xx x x . x x x x
x x x x x . x x xPackaging x x x x . x x
x x x x x . x xx x x x . x x
x x x x x .x x x x x .
Graphics controller on Main Board or not?If yes, screen specifications change;If no, CPU must process more; adopt different interrupt protocols
Design Structure Matrix Map of a Laptop Computer
Slide 22 © Carliss Y. Baldwin 2006
. x x x x xx . x x x x x x x x x
Drive x x . x x xSystem x x x . x x x x x x x x
x x . xx x x x . x x x
x x x . x xx x x . x x x x
x x x . x x x x xMain x x x . x x xBoard x x x x x x x x . x x x x x
x x x x x . x xx x x x x x . x x x
x x x . x
x x x . x x xx x x x . x x x x
LCD x x x . x xScreen x x x x . x x x
x x x x x x x . x x xx x x . x
x x x x . x x x xx x x . x x x x
x x x x x . x x xPackaging x x x x . x x
x x x x x . x xx x x x . x x
x x x x x .x x x x x .
Graphics controller on Main Board or not?If yes, screen specifications change;If no, CPU must process more; adopt different interrupt protocols
Every important cross-module interdependency must be addressed via a design rule.
This is costly
Modularization may not pay
Slide 23 © Carliss Y. Baldwin 2006
Design Structure Matrix of a Modular Laptop Computer
. x x x xx . x x
Design x . x x Design Rules Task GroupRules x x . x
x x x .x . x x x
x x . x x xDrive x x x x . xSystem x x x x x . x x Hidden Modules
x x x . x many Task groupsx x x x .
x . x xx x x x x . x x
x x . x x x xMain x x x x x . x xBoard x x x x x x x . x x
x x x x x . xx x x x x x . x
x x x x x .x x . x x x
x x x . x x xLCD x x x . xScreen x x x x x . x x
x x x x x . xx x x x x x .
x x . x x x xx x x . x x x x
x x x . x x xPack- x x x x x x . x xaging x x x . x x
x x x x x . x xx x x x x .
x x x x x x .x x x x x x . x x x x
System x x x x x x x x . x x System Testing x x x x x x x x x . x x x Integration& Integ- x x x x x x x x x x x x and Testingration x x x x x x x x . x Task Group
x x x x x x x x x x x .
Slide 24 © Carliss Y. Baldwin 2006
Measuring modularity
Mozilla just after becoming open source Linux of similar size
Coord. Cost = 30,537,703Change Cost = 17.35%
Coord. Cost = 15,814,993Change Cost = 6.65%
Comparison of different software systems with DSM tools
© Alan MacCormack, Johh Rusnak and Carliss Baldwin, 2006
Mozilla just after becoming open source Linux of similar size
Coord. Cost = 30,537,703Change Cost = 17.35%
Coord. Cost = 15,814,993Change Cost = 6.65%
Conway’s Law: Different organizations deliver different architectures
One Firm, Tight-knit Team, RAD methods
Distributed Open Source Development
© Alan MacCormack, Johh Rusnak and Carliss Baldwin, 2006
Mozilla Before Redesign Mozilla After Redesign
Refactoring for modularity
© Alan MacCormack, Johh Rusnak and Carliss Baldwin, 2006
Change Cost = 17.35% Change Cost = 2.38%
Slide 28 © Carliss Y. Baldwin 2006
What about Aspects?
Slide 29 © Carliss Y. Baldwin 2006
Creating an Aspect Module
Imagine 100s of A’s and B’s!
APIsXPIs
A
B
C
Design Rules = APIs and XPIs
APIs
A
B
Design Rules = APIs only
Modular Operator “Inversion”
Cross-cutting concern
Slide 30 © Carliss Y. Baldwin 2006
What is the Aspect worth?
If no change ever, Aspect is worthless Reasons to change the Aspect sub-blocks
– Achieve consistency– Better approaches– Changes in policy
Option value = the value of an unforeseen change
Slide 31 © Carliss Y. Baldwin 2006
An Option is
The right but not the obligation to take an action– Action = Use a new design– If new is better than old, use new;– Otherwise, keep the old.
Slide 32 © Carliss Y. Baldwin 2006
An Aspect changes the “Net Option Value” (NOV) of the codebase
Without Aspect:Net Option Value (NOV) =
Change Benefit – 100 Change Costs With Aspect:
Net Option Value (NOV) =Change Benefit – 1 Change Cost
If Change Benefit > 100 Change CostsNOV = 99 Change Costs
As Change Benefit decreases, NOV goes down:If Change Benefit= 0, NOV = 0
Slide 33 © Carliss Y. Baldwin 2006
To justify an Aspect (to your CFO)
You need to argue:– Change Benefit is high
» consistency, better approaches, policy
– Difference in Change Costs is high» “99 changes vs. 1”
– Cost of refactoring is low» “You are going to have to refactor anyway, so do it right… .”
The NOV approach attempts to quantify the elements of this argument– Option value resides in “Change Benefit”– This is the bleeding edge of our science
Slide 34 © Carliss Y. Baldwin 2006
What is this elusive property that gives rise to option value?
Where does it arise?
Can we measure it?
Slide 35 © Carliss Y. Baldwin 2006
Global Design Rules v.1
Version 1.0Version 1.2
Version 1.5Version 1.8
Low Medium Zero High
Measuring Option Potential Successive, improving versions are evidence of option
potential being realized over time—after the fact Designers see option potential before the fact What do they see?
Slide 36 © Carliss Y. Baldwin 2006
Major challenge in research and practice right now
Science may not be able to deliver tools to measure ex ante option potential reliably
But ex ante estimates are what’s needed
Slide 37 © Carliss Y. Baldwin 2006
/Option potential is like dark matter in the universe
Scientists can measure its effects but we can’t measure “it”
“Wizards” can perceive /option potential– But wizards don’t talk to scientists!
Thus we lack ways to measure /option valuescientifically– It is a “research frontier”
Slide 38 © Carliss Y. Baldwin 2006
/Option potential at work—Matlab programming contest
Slide 39 © Carliss Y. Baldwin 2006
/Option potential at work—Transaction Processors and CPUs
1
10
100
1,000
10,000
100,000
1,000,000
10,000,000
Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05
System Availability Date
tpm
C a
nd
Sp
ec C
Int
Key Pfister TPC-C v.3 TPC-C v.5 Spec CPU 95 Spec CPU 2000
Architectural experimentation
Component experimentation
Slide 40 © Carliss Y. Baldwin 2006
Sources of /option value Physics—
– Moore’s Law (dynamics of miniaturization) applies to MOSFET circuits and systems (Mead and Conway)
– Power and heat systems vs. logic systems (Dan Whitney)
User innovation– Users’ discovery of their own needs
– “Killer apps”
Architecture– Experimenting with different relationships among
components
Slide 41 © Carliss Y. Baldwin 2006
But you might not want to tell your CFO that …
High option value makes designs unmanageable …
Call your venture capitalist, instead!
Slide 42 © Carliss Y. Baldwin 2006
High option potential induces entry => industry structure change
Other Chassis/Powertrain
Other Interior
Other MultipleElectrical/Electronics
Other Misc.
Toyota Nissan DaimlerChrysler
Honda GM Ford VW
Oth
ers
Johnson Controls
Magna
Eaton
ServicesFirst Data
Systems Integration EDSOracle
I CAApplications Layer B MSFTMiddleware Layer M
Operating Systems
Hardware: Printers HPHardware: Servers IBMHardware: Routers Cisco
Components IntelMicron
Autos Computers
Slide 43 © Carliss Y. Baldwin 2006
High ’s are what make designs unmanageable
“Unmanageable” = Cannot be confined in a single company or supply chain
There are modular design architectures that are very manageable– Example: Toyota Production System (TPS)
If System/360 had had low /option potential, IBM would be like Toyota
It would be a different world…
Slide 44 © Carliss Y. Baldwin 2006
Recapping the argument Designs create value
– Value operates like a force in the economy– Changes the structure of industries
Designs have architectures– Modularity and /Option value are the key economic
properties of a design architecture– Modularity + High /Option value => Unmanageable
» Why computers are not like autos» Why IBM is not Toyota
We have NOT talked about—
How do you capture value in a modular, high-design?
Slide 45 © Carliss Y. Baldwin 2006
How can you capture value?
Architectural/Technological question:– Where/when does modularization stop?
Business/Strategic question: – How do you make money in a modular, high-
world?
Slide 46 © Carliss Y. Baldwin 2006
Where does modularization stop?
Strojwas (2005)
Semiconductor Industry
Top 10 Firms:
1994 and 2004
Slide 47 © Carliss Y. Baldwin 2006
How do you make money in a high-world?
Old paradigm
– “Plunge in”
– “Get lucky”
– “Watch out for Microsoft”
– “Get bought by HP”
Slide 48 © Carliss Y. Baldwin 2006
A new paradigm…– Expect a cluster– Use M&A to be the “lead firm” in some slice(s)
of the stack– Use design architecture to reduce your
“footprint” in each slice => high ROIC– Use open source methods to clone your
complementor’s products => price and innovation discipline
How do you make money in a high- world?
Slide 49 © Carliss Y. Baldwin 2006
Our research strategy—Look for
Stable patterns of behavior involving several actors operating within a consistent framework of ex ante incentives and ex post rewards
==> Equilibria of linked games with self-confirming beliefs (Game theory)
Slide 50 © Carliss Y. Baldwin 2006
How a “stable pattern” works
Anticipation of $$$ (visions of IPOs) Lots of investment Lots of design searches Best designs “win” Fast design evolution => innovation Lots of real $$$ (an actual IPO)
“Rational expectations equilibrium”
Slide 51 © Carliss Y. Baldwin 2006
Three Stable Patterns
“Blind” Competition– PCs in the early 1980s
High ROIC on a Small Footprint – Sun vs. Apollo– Dell vs. Compaq (and HP and …)
Lead Firm Competition– Monopoly—MSFT– Mergers & Acquisitions—Cisco, Intel …
Slide 52 © Carliss Y. Baldwin 2006
“Blind” Competition
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
All Zeros (1, 0, 0)
All Ventures (1, 0, 0) All Fighters (1, 0, 0)
ESS (1/8, 3/8, 4/8))
Ventures do best
Fighters do best
Zeros do best
x A
B x
Slide 53 © Carliss Y. Baldwin 2006
“Blind” Competition
Slide 54 © Carliss Y. Baldwin 2006
“Footprint” Competition—Apollo1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42
1 O Processor chip—CPU2 Outsourced—Motorola 680x0 Key:3 O Floating Point Accelerator x= transfer of material or information from column4 Outsourced task to row task;5 O Memory chips DRAMs, ROM T= transaction: sale of good by column owner to row6 Outsourced—Commodity owner;7 O Storage—Disk Drives O= outsourced task blocks;8 Outsourced D= downstream or complementary task blocks;9 O Storage—Tape Drive highly interdependent task blocks with many iterations
10 Outsourced and high within-block mundane transaction costs;
11 O Printed circuit boards Apollo's footprint (tasks performed inhouse).
12 Outsourced—Commodity13 O Display Monitor14 Outsourced15 O Keyboard, Cabinet, Fans16 Outsourced
17 x x x x x x x x x x x x x x x x Aegis proprietary18 Inhouse Operating System19 Design20 x x x x x x x x x x x x x x x x OS DOMAIN proprietary21 Network Network Architecture2223 x x x x x x x x x x x x x x x x Hardware Design24 DN series = 3-4 boards incl.
25 Hardware IO and Display controllers,26 Power supply27 T T T T T T T T T T T T T T T T x x x x Purchase Components28 Component Test x x x x x29 Kits x x x x x x Inhouse30 Board stuff and Solder x x x x x x Manu-31 Test Boards x x x x x x facturing32 Board Assembly x x x x x x33 System Assembly x x x x x x34 System Test x x x x x x35 Quality Assurance x x x x x x36 Consolidate and Ship x x x x x x
37 x x x x x x D38 x x x x x x Many Software Applications D39 x x x x x x D40 x x x x x x x x x x T D41 x x x x x x x x x x Many OEMs T D42 x x x x x x x x x x T D
Keeps Design Control
Slide 55 © Carliss Y. Baldwin 2006
Then Sun came along…Apollo Computer
Aegis proprietaryInhouse Operating SystemDesignOS DOMAIN proprietary
Network Network Architecture
Hardware DesignDN series = 3-4 boards incl.
Hardware IO and Display controllers,Power supply
x x x x Purchase ComponentsComponent Test x x x x x
Kits x x x x x x InhouseBoard stuff and Solder x x x x x x Manu-
Test Boards x x x x x x facturingBoard Assembly x x x x x x
System Assembly x x x x x xSystem Test x x x x x x
Quality Assurance x x x x x xConsolidate and Ship x x x x x x
And did even less!
How?
x x x x x Customize Unixx x x x x Inhouse Proprietary MMU
x x x x x Design Internal busx x Single Board Layout
T T T T x x x x Purchase ComponentsComponent Test x x x x x O
Kits x x x x T Manu-Board stuff and Solder x x x x x O facturing
Test Boards x x x x TBoard Assembly x x x x x
System Assembly x x x x xSystem Test x x x x x
Quality Assurance x x x x xConsolidate and Ship x x x x x
Slide 56 © Carliss Y. Baldwin 2006
Then Sun came along…Apollo Computer
Aegis proprietaryInhouse Operating SystemDesignOS DOMAIN proprietary
Network Network Architecture
Hardware DesignDN series = 3-4 boards incl.
Hardware IO and Display controllers,Power supply
x x x x Purchase ComponentsComponent Test x x x x x
Kits x x x x x x InhouseBoard stuff and Solder x x x x x x Manu-
Test Boards x x x x x x facturingBoard Assembly x x x x x x
System Assembly x x x x x xSystem Test x x x x x x
Quality Assurance x x x x x xConsolidate and Ship x x x x x x
x x x x x Customize Unixx x x x x Inhouse Proprietary MMU
x x x x x Design Internal busx x Single Board Layout
T T T T x x x x Purchase ComponentsComponent Test x x x x x O
Kits x x x x T Manu-Board stuff and Solder x x x x x O facturing
Test Boards x x x x TBoard Assembly x x x x x
System Assembly x x x x xSystem Test x x x x x
Quality Assurance x x x x xConsolidate and Ship x x x x x
Design Architecture for high performance with a small footprint
Public Standards for outsourcing
And did even less!
How?
Slide 57 © Carliss Y. Baldwin 2006
Result: ROIC advantage to SunAverage over 16 Quarters: Apollo Sun
Computer MicrosystemsInvested Capital Ratios (Annualized)Net Working Capital/ Sales (%) 29% 15% Low is goodEnding Net PPE / Sales (%) 24% 13% Low is goodInvested Capital/Sales (%) 57% 31% Low is good
ProfitabilityNet Income/Sales 0% 6% High is good
ROICROIC (excl Cash, Annualized) 2% 20% High is good
Sun used its ROIC advantage to drive Apollo out of the market
Apollo was acquired by HP in 1989
Slide 58 © Carliss Y. Baldwin 2006
Compaq vs. Dell Dell did to Compaq what Sun did to Apollo …
Dell created an equally good machine, and Used design architecture to reduce its footprint in
production, logistics and distribution costs– Negative Net Working Capital– Direct sales, no dealers
Result = Higher ROIC
Slide 59 © Carliss Y. Baldwin 2006
Higher ROIC always wins!1997 Compaq Dell
Computer ComputerInvested Capital Ratios (Annualized)Net Working Capital/ Sales (%) -2% -5% Low is goodEnding Net PPE / Sales (%) 8% 3% Low is goodInvested Capital/Sales (%) 8% -2% Low is good
ProfitabilityNet Income/Sales 8% 7% High is good
ROICROIC (excl Cash, Annualized) 101% -287% !!!
Dell started cutting prices; Compaq struggled, but in the end had to exit.
Compaq was acquired by HP in 2002
Slide 60 © Carliss Y. Baldwin 2006
Competition and Beliefs
“Blind” competitors – don’t know others exist
“Footprint” competitors – Don’t expect to influence others—just compete
“Lead firms”– Must influence the beliefs of their competitors– FUD — “Fear, uncertainty and doubt” – Others cannot be blind!
Slide 61 © Carliss Y. Baldwin 2006
“Lead Firm” Competition
Monopolist needs to deter all potential entrants with threats of price war– Very fragile equilibrium
– Potentially expensive to create “enough” FUD
M&A Lead Firm does not try to deter all entry in the design space– Expects to buy most successful entrants ex post
– More robust equilibrium
– Maybe more advantageous, when you count the cost of FUD
Slide 62 © Carliss Y. Baldwin 2006
Thank you!