Pres. Clark talked about harnessing the power of modularity. I reviewed his book, Design Rules, in January. Design Rules is about modularity in IT and the advantages that it gives. Design Rules was hands down the best book I read in 2005. I think anyone interested in infotech should study it.
He begins by pointing out (with a graphic) the staggering dominance of IBM in the IT industry in the 60's and how that dominance has dissipated over time. IBM and others were vertically integrated. DEC did it's own injection molding to create computer cases. Now, the industry has reorganized in modular clusters that are more horizontal. This change has also caused value to migrate from the vertically integrated companies and it more spread out.
These changes were made possible through changes in the underlying design architecture. What makes a design architecture industrially powerful, and unmanageable. This unmanageability means that it can't be contained inside a single company.
Modularity is on the key change in the design architecture. Modules are highly interdependent internally, but independent of each other. The power of modularity is that the system can be decomposed and designed independently. The design rules allow these independently designed modules to work together in an integrated way.
The Design Structure Matrix (DSM) is a tool for gauging the independence of modules. You can use DSM to determine at design time the modularity of the system you're building. Once a system has been modularized, complexity becomes manageable and groups can work in parallel. Modularity welcomes experimentation.
Pres. Clark goes into the IBM 360 example. IBM understood the first points: managing complexity and working in parallel. They misunderstood the last point. Once a system has been modularized, you can conduct many more profitable experiments on a module. IBM missed the fact that they could profitably invest more R&D in it's modules. Disk drives were the first. In 1967, Alan Shuggart and others left IBM to essentially found the entire disk drive industry.
Modularity creates options. You get the right, but not the obligation to use a new design. Before modularity, you have a single option: design a new system or not. With modularity, there are thousands of options. Each of those options can become a new company. These companies are formed around modules.
Option value can be high or low. Some systems have very high option value. This value can be seen in products where there are lots of versions and innovation happens very quickly. Where you have high option value and modularity, you get an explosion of industry.
One key factor in option value is physics. Digital systems are a good example. Another factor is user innovation. Knowing about customers creates option value. This is the notion of the "killer app." The third factor is architecture. Being able to take existing modules and rearrange them creates option value. Japanese copier manufacturers engages in this kind of architectural redesign and moved in on Xerox.
The potential value of a given system is a factor of the number of modules and the number of experiments. This is the idea behind the notion of "best of breed."
Strategy in this kind of modularity is a lot like chess. There are lots of contingencies. There are many wining strategies. There are strategic patterns (gambits, to continue the chess analogy).
There are four strategies:
- Blind competition. Many times players have no sense of what will happen and how it will play out, but companies get in and compete hoping to get bought if they're good enough. Compaq, Kaypro, and others followed this strategy.
- High return on invested capital (ROIC) on a small footprint. Examples: Dell vs. HP/Compaq. Sun vs. Apollo.
- Lead firm competition. Microsoft is an example. Being a monopoly is a key strategy. Other smaller players also do this in niches. Mergers and acquisition (Cisco) is another example here
- Open source development. Apache, Linux, etc. IBM is using this strategy.
He elaborates on the High ROIC strategy, going into detail on Apollo, "the darling of Wall Street." Apollo kept control of many key aspects of the design. Then comes along Sun and the do even less. Their strategy was to use as many off the shelf parts as they could. Sun knew that you could focus on the core parts of the system and outsource everything else. Sun's secret sauce was a piece of hardware that did memory management. Sun's other key choice was to adopt industry standards wherever possible. Sun had half the working capital per dollar of sales compared to Sun. Their ROIC was 20% at Sun while Apollo's was 2%. Sun needed less capital to compete. Dell has done even better. They have negative working capital. Their suppliers are funding the company.
He moves to "lead firm." As the lead firm, you're always under attack. Everyone is after you. The strategy is to deter potential competitors, even be threatening. Creating FUD is a key tactic. This is an unstable situation, as Microsoft has found out. A more stable "lead firm" strategy is Cisco's approach. By buying small firms with big potential, they absorb the attackers.
So, how do you compete in a modular industry with modular clusters?
- Expect turmoil.
- Use M&A to become the lead firm in some slice of the stack.
- Use design architecture to reduce your footprint and increase ROIC.
- Use open source software to clone your complimentor's products. That maintains discipline and innovation.