slide 1 © carliss y. baldwin and kim b. clark, 2005 unmanageable designs: what some designs need...
TRANSCRIPT
Slide 1 © Carliss Y. Baldwin and Kim B. Clark, 2005
Unmanageable Designs: What Some Designs Need from the Economy and How They Get It
Carliss Y. BaldwinHarvard Business School
2005 SDM ConferenceOctober 27, 2005
Slide 2 © Carliss Y. Baldwin and Kim B. Clark, 2005
Three Points Designs “need” to become real
– They become real by creating the perception of “value” Designs act as a financial force
– Perception of value = Incentive to invest– In making the design— “use value”– In making the design better— “option value”
Modular Designs with Option Potential– Create hurricane-type forces– Will change their economic “space”– Unmanageable and dangerous (unless you understand
them)
Slide 3 © Carliss Y. Baldwin and Kim B. Clark, 2005
Metaphor— “Selfish Designs” “Selfish” designs want to become real Their tool is human motivation
– A user perceives use-value => willingness to make or willingness-to-pay
– Designers and producers estimate willingness to pay
– The result is an asset => financial value
Humans move mountains for financial value– Value operates “as a force” in the economy
– Some designs have so much of this force that we work for them…
Slide 4 © Carliss Y. Baldwin and Kim B. Clark, 2005
Strong value forces can change the shape of an industry
Andy Grove described a vertical-to-horizontal transition in the computer industry:
“Modular Cluster”
“Vertical Silos”
Slide 5 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 6 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 7 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 8 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 9 © Carliss Y. Baldwin and Kim B. Clark, 2005
Value Migration: 1950-1996
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737773747373
7372 ex Microsoft
Microsoft
737173703678
3674 ex Intel
Intel3672367035773576357535723571
3570 ex IBM
ADRsIBM
0
20
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$ billion
Significant Option-Rich Modular Design Architectures
IBM System/360
DEC PDP 11; VAX
IBM PC
Sun 2; 3; Java VM
RISC
Internet Protocols (end-to-end principle)
Unix and C; Linux
HTML; XML(?)
Slide 10 © Carliss Y. Baldwin and Kim B. Clark, 2005
This was the puzzle Kim Clark and I began to tackle in 1987
Where was the value shown in the slide coming from?
Designs, yes, but what part and why?
Slide 11 © Carliss Y. Baldwin and Kim B. Clark, 2005
After studying the designs and correlating their changes with value changes
We concluded that modularity was part of the answer…
Slide 12 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 13 © Carliss Y. Baldwin and Kim B. Clark, 2005
1965—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 14 © Carliss Y. Baldwin and Kim B. Clark, 2005
IBM System/360
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 15 © Carliss Y. Baldwin and Kim B. Clark, 2005
1975—What actually happened: Entry on 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 and Kim B. Clark, 2005
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 and Kim B. Clark, 2005
Short History (continued) 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)– Over time, general principles for evolvable software
design (Unix philosophy) Mead and Conway, Intro to VLSI Systems (1980)
– Principles of modular design for large-scale chips
Slide 18 © Carliss Y. Baldwin and Kim B. Clark, 2005
Short History (continued) 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
Visions of $$$ dance in your heads!
Slide 19 © Carliss Y. Baldwin and Kim B. Clark, 2005
As scientists, we can visualize and measure modularity in design— after the fact
DSMs, Design Hierarchies
Methods are tedious, non-automated
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
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
Mozilla April 98 Mozilla Dec 98Location On left On rightSize 1684 1508Coordination Cost 30,527,703 10,234,903 Change Cost 292.0932 41.8561Change Cost % 17.35 2.78
Mozilla Before Redesign Mozilla After Redesign
!!
Slide 23 © Carliss Y. Baldwin and Kim B. Clark, 2005
But modularity is only half the story—options matter, too
“Creates” vs. “Frees up” Designs have “option potential”, denoted varies by system and by module
Modularity in the absence of option potential is at best breakeven, at worst an expensive waste of time
Slide 24 © Carliss Y. Baldwin and Kim B. Clark, 2005
Modularity without (enough) option potential
Auto front-end modules (Fourcade)– Much experimentation, leading nowhere
Mobile computers (Whitney-Weinstein)– Power management favors more integral designs
Semiconductors (Strojwas)– IDMs vs. Fabless-Foundry pairs
– Competing types of option potential
– Both forms seem viable for now
Slide 25 © Carliss Y. Baldwin and Kim B. Clark, 2005
Stack View of the Semiconductor Industry (Strojwas, 2005)
Top 10 Firms:
1994 and 2004
Slide 26 © Carliss Y. Baldwin and Kim B. Clark, 2005
What is this elusive property that gives rise to option value?
Where does it arise?
Can we measure it?
Slide 27 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 28 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 29 © Carliss Y. Baldwin and Kim B. Clark, 2005
Sources of option value 1 Physics—
– Whitney: VLSI is different, more splittable– But there is also Moore’s Law
» Dynamics of miniaturization
» Virtuous cycle in mfr. cost and power consumption as chips get smaller
» Explained by Mead and Conway in 1980
– Option value lies in seamless, asynchronous upgrading
» Modeled in Design Rules
Slide 30 © Carliss Y. Baldwin and Kim B. Clark, 2005
Sources of option value 2 Users—new perceptions => new preferences
– Perceptions of desires emerge through use – Value of discovery, direct experience, play– Unexplored preferences = option potential
Kim Clark (1985): Evolving design hierarchies create new preferences w.r.t. each module
Case studies of vertical disintegration driven by search/discovery of new preferences – Frozen food in the UK– Mortgage banking in the US (IO vs. PO)
Slide 31 © Carliss Y. Baldwin and Kim B. Clark, 2005
Sources of option value 3
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10,000,000
Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05
System Availability Date
tpmC and Spec CInt
Key Pfister TPC-C v.3 TPC-C v.5 Spec CPU 95 Spec CPU 2000
Slide 32 © Carliss Y. Baldwin and Kim B. Clark, 2005
Sources of option value 3 Pfister’s Observation (in my language)
– Recombining modules in new ways has more option value than the modules themselves
Amdahl’s Law “Make the frequent case fast”—– First architecture is not the best – Fred Brooks: “Build one and throw it away” – Value of architectural experimentation/optimization
present in all complex systems Not what we model in Design Rules
– Architecture should be a (process) module– Stage in the value chain, node in the network
Slide 33 © Carliss Y. Baldwin and Kim B. Clark, 2005
Where we are in the argument: Designs “need” to become real
– They become real by creating the perception of “value” Designs act as a financial force
– Perception of value = Incentive to invest– Use value– Option value = Potential to improve
Modular Designs with Option Potential– Create hurricane-type forces– Will change their economic “space”– Unmanageable and dangerous (unless you understand
them)
Slide 34 © Carliss Y. Baldwin and Kim B. Clark, 2005
Next questions
What do option-rich modular designs do to the economy?
How do you manage something inherently unmanageable?
Will you always get a modular cluster of firms?
Slide 35 © Carliss Y. Baldwin and Kim B. Clark, 2005
QUICK Answers What do option-rich modular designs do in the
economy?– Attract entry with a promise of lots of $$$
How do you manage something inherently unmanageable?– At first, you don’t– Then, small footprints yield high ROIC– Then, lead firm M&A
Will you always get a modular cluster of firms?– Yes, almost certainly
Slide 36 © Carliss Y. Baldwin and Kim B. Clark, 2005
Faced with this value proposition, what should you do?
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No. of Experiments
One module or many?
In each module you chose, how many design searches?
Which modules are most attractive?
Slide 37 © Carliss Y. Baldwin and Kim B. Clark, 2005
Lots of stories They all make sense When you see them play out, the moves are
logical and in some cases “inevitable” But our strategic advice for managers and
financiers today comes down to: – “plunge in,”
– “get lucky,”
– “watch out for Microsoft,” and
– “get bought by HP”
Slide 38 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 39 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 40 © Carliss Y. Baldwin and Kim B. Clark, 2005
Three Stable Patterns (not quite Equilibria…)
“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 …
“Blind” Competition
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
4.00-6.00
2.00-4.00
0.00-2.00
-2.00-0.00
-4.00--2.00
-6.00--4.00
-8.00--6.00
-10.00--8.00
All Zeros
All Ventures All Fighters
ESS (1/8, 3/8, 4/8)
Slide 42 © Carliss Y. Baldwin and Kim B. Clark, 2005
Footprint Competion 1980—IBM provided few PC 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 Intel 80882 Instruction Set3 IBM PC Technical Reference Manual4 for Hardware and Software —published5 Microsoft DOS6 Application Programmer Interfaces (APIs)
78 PC Hardware Components9
10111213 Intel 8088 Microprocessor14151617 Japanese DRAMs181920 Outsourced Floppy Disk Drives2122 Tape drives 2324 Time-multiplex system for switching I/O devices
25 Techniques to measure processor performance, system26 throughput and software efficiency, Group Staff27 IBM BIOS28 Microsoft DOS29 Microsoft Basic30 Lotus 1-2-331 Word Perfect32 Other Applications
33 Announcement and Marketing34 Production, Testing and Integration35 Shipment, Delivery and Installation
Slide 43 © Carliss Y. Baldwin and Kim B. Clark, 2005
But then … Compaq reverse engineered the BIOS Chips and Technologies made “chipsets” Taiwanese clones had cheaper/better
manufacturing Intel refused to second-source 80386 Microsoft sabotaged OS/2
Slide 44 © Carliss Y. Baldwin and Kim B. Clark, 2005
1990—IBM PC is the standard, but IBM makes no money
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 Intel 80882 Instruction Set3 IBM PC Technical Reference Manual4 for Hardware and Software —published5 Microsoft DOS6 Application Programmer Interfaces (APIs)
78 PC Hardware Components9
10111213 Intel 8088 Microprocessor14151617 Japanese DRAMs181920 Outsourced Floppy Disk Drives2122 Tape drives 2324 Time-multiplex system for switching I/O devices
2526 Magazines rate components' quality and compatibility27 Clones28 Microsoft DOS29 Microsoft Basic30 Lotus 1-2-331 Word Perfect32 Other Applications
33 Announcement and Marketing34 Clones Production, Testing and Integration35 Shipment, Delivery and Installation
Slide 45 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 OEMsT D42 x x x x x x x x x x T D
Keeps Design Control
Slide 46 © Carliss Y. Baldwin and Kim B. Clark, 2005
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 47 © Carliss Y. Baldwin and Kim B. Clark, 2005
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!
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 performance
Public Standards for outsourcing
Slide 48 © Carliss Y. Baldwin and Kim B. Clark, 2005
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
Slide 49 © Carliss Y. Baldwin and Kim B. Clark, 2005
Compaq vs. Dell Dell did to Compaq what Sun did to Apollo …
Dell created an equally good machine, and Used modularity-in-production to reduce its
footprint in production, logistics and distribution costs– Negative Net Working Capital– Direct sales, no dealers
Result = Higher ROIC
Slide 50 © Carliss Y. Baldwin and Kim B. Clark, 2005
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.
Like Apollo, they were acquired by HP!
Slide 51 © Carliss Y. Baldwin and Kim B. Clark, 2005
Lead Firms vs. Others
“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 52 © Carliss Y. Baldwin and Kim B. Clark, 2005
Monopoly or M&A?
Monopoly 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 53 © Carliss Y. Baldwin and Kim B. Clark, 2005
Industry Outcomes
“Blind” competition – Cluster (entry everywhere in the architecture)
“Footprint” competition – Cluster (small footprint => vertical
disintegration) M&A Lead Firm
– Cluster (lead firm does not deter all entry) Monopoly
– One Big Firm
Slide 54 © Carliss Y. Baldwin and Kim B. Clark, 2005
Designs as an object of economic analysis—Remember
Designs “need” to become real– They become real by creating the perception of “value”
Designs act as a financial force– Perception of value = Incentive to invest
Modular Designs with Option Potential– Create hurricane-type forces– Will change their economic “space”– Unmanageable—cannot be confined in one firm or a
supply chain – Dangerous (unless you understand them)
Slide 55 © Carliss Y. Baldwin and Kim B. Clark, 2005
One more story before we close—
5053
5659
6265
6871
7477
8083
8689
9295
737773747373
7372 ex Microsoft
Microsoft
737173703678
3674 ex Intel
Intel3672367035773576357535723571
3570 ex IBM
ADRsIBM
0
20
40
60
80
100
120
140
160
180
$ billion
Significant Option-Rich Modular Design Architectures
IBM System/360
DEC PDP 11; VAX
IBM PC
Sun 2; 3; Java VM
RISC
Internet Protocols (end-to-end principle)
Unix and C; Linux
HTML; XML(?)
Slide 56 © Carliss Y. Baldwin and Kim B. Clark, 2005
The Bright Side of the Option-rich Modular Designs
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Slide 57 © Carliss Y. Baldwin and Kim B. Clark, 2005
But there was The Dark Side …
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$ 2.5 trillion appeared then disappeared in the space of four years!
Slide 58 © Carliss Y. Baldwin and Kim B. Clark, 2005
Bubble followed by a Crash
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A failure,
not of the Internet’s design architecture,
but of the economic institutions built on that architecture
Slide 59 © Carliss Y. Baldwin and Kim B. Clark, 2005
Ultimate unmanageability
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Slide 60 © Carliss Y. Baldwin and Kim B. Clark, 2005
A reason—if we need one—to try to turn our stories into science…
Slide 61 © Carliss Y. Baldwin and Kim B. Clark, 2005
Thank you!