Harvard Business Review on Managing the Value Chain THE HARVARD BUSINESS REVIEW PAPERBACK SERIES The series is designed to bring today's managers and professionals the fundamental information they need to stay competitive in a fast-moving world. From the preeminent thinkers whose work has defined an entire field to the rising stars who will redefine the way we think about business, here are the leading minds and landmark ideas that have established the Harvard Business Review as required reading for ambitious businesspeople in organizations around the globe. 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Title: Managing the value chain. III. Series. HD38.5.H37 2000 658.5—dc21 99-28452 CIP The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Publications and Documents in Libraries and Archives Z39.48-1992. Contents Managing in an Age of Modularity 1 Carliss Y. Baldwin and Kim B. Clark Fast, Global, and Entrepreneurial: Supply Chain Management, Hong Kong 29 Style An Interview with Victor Fung Joan Magretta How Chrysler Created an American Keiretsu 61 Jeffrey H. Dyer The Power of Trust in Manufacturer-Retailer Relationships 91 Nirmalya Kumar What is the Right Supply Chain for Your Product? 127 Marshall L. Fisher Make Your Dealers Your Partners 155 Donald V. Fites From Value Chain to Value Constellation: Designing Interactive Strategy 185 Richard Normann and Rafael Ramírez From Lean Production to the Lean Enterprise 221 James P. Womack and Daniel T. Jones About the Contributors 251 Index 257 . . . Managing in an Age of Modularity Carliss Y. Baldwin and Kim B. Clark Executive Summary Modularity is a familiar principle in the computer industry. Different companies can independently design and produce components, such as disk drives or operating software, and those modules will fit together into a complex and smoothly functioning product because the module makers obey a given set of design rules. Modularity in manufacturing is already common in many companies. But now a number of them are beginning to extend the approach into the design of their products and services. Modularity in design should tremendously boost the rate of innovation in many industries as it did in the computer industry. As businesses as diverse as auto manufacturing and financial services move toward modular designs, the authors say, competitive dynamics will change enormously. No longer will assemblers control the final 1 . . . product: suppliers of key modules will gain leverage and even take on responsibility for design rules. Companies will compete either by specifying the dominant design rules (as Microsoft does) or by producing excellent modules (as disk drive maker Quantum does). Leaders in a modular industry will control less, so they will have to watch the competitive environment closely for opportunities to link up with other module makers. They will also need to know more: engineering details that seemed trivial at the corporate level may now play a large part in strategic decisions. Leaders will also become knowledge managers internally because they will need to coordinate the efforts of development groups in order to keep them focused on the modular strategies the company is pursuing. In the Nineteenth century, railroads fundamentally altered the competitive landscape of business. By providing fast and cheap transportation, they forced previously protected regional companies into battles with distant rivals. The railroad companies also devised management practices to deal with their own complexity and high fixed costs that deeply influenced the second wave of industrialization at the turn of the century. Today the computer industry is in a similar leading position. Not only have computer companies transformed a wide range of markets by introducing cheap and fast information processing, but they have also led the way toward a new industry structure that makes the best use of these processing abilities. At the heart of their remarkable advance is modularity—building a complex product or process from smaller subsystems that can be 2 . . . designed independently yet function together as a whole. Through the widespread adoption of modular designs, the computer industry has dramatically increased its rate of innovation. Indeed, it is modularity, more than speedy processing and communication or any other technology, that is responsible for the heightened pace of change that managers in the computer industry now face. And strategies based on modularity are the best way to deal with that change. Many industries have long had a degree of modularity in their production processes. But a growing number of them are now poised to extend modularity to the design stage. Although they may have difficulty taking modularity as far as the computer industry has, managers in many industries stand to learn much about ways to employ this new approach from the experiences of their counterparts in computers. A growing number of industries are poised to extend modularity from the production process to the design stage. A Solution to Growing Complexity The popular and business presses have made much of the awesome power of computer technology. Storage capacities and processing speeds have skyrocketed while costs have remained the same or have fallen. These improvements have depended on enormous growth in the complexity of the product. The modern computer is a bewildering array of elements working in concert, evolving rapidly in precise and elaborate ways. Modularity has enabled companies to handle this increasingly complex technology. By breaking up a 3 . . . product into subsystems, or modules, designers, producers, and users have gained enormous flexibility. Different companies can take responsibility for separate modules and be confident that a reliable product will arise from their collective efforts. The first modular computer, the System/360, which IBM announced in 1964, effectively illustrates this approach. The designs of previous models from IBM and other mainframe manufacturers were unique; each had its own operating system, processor, peripherals, and application software. Every time a manufacturer introduced a new computer system to take advantage of improved technology, it had to develop software and components specifically for that system while continuing to maintain those for the previous systems. When end users switched to new machines, they had to rewrite all their existing programs, and they ran the risk of losing critical data if software conversions were botched. As a result, many customers were reluctant to lease or purchase new equipment. The developers of the System/360 attacked that problem head-on. They conceived of a family of computers that would include machines of different sizes suitable for different applications, all of which would use the same instruction set and could share peripherals. To achieve this compatibility, they applied the principle of modularity in design: that is, the System/360's designers divided the designs of the processors and peripherals into visible and hidden information. IBM set up a Central Processor Control Office, which established and enforced the visible overall design rules that determined how the different modules of the machine would work together. The dozens of design teams scattered around the world had to adhere absolutely to these rules. But each team 4 . . . had full control over the hidden elements of design in its module—those elements that had no effect on other modules. (See ''A Guide to Modularity" at the end of this article.) When IBM employed this approach and also made the new systems compatible with existing software (by adding "emulator" modules), the result was a huge commercial and financial success for the company and its customers. Many of IBM's mainframe rivals were forced to abandon the market or seek niches focused on customers with highly specialized needs. But modularity also undermined IBM's dominance in the long run, as new companies produced their own so-called plug-compatible modules—printers, terminals, memory, software, and eventually even the central processing units themselves—that were compatible with, and could plug right into, the IBM machines. By following IBM's design rules but specializing in a particular area, an upstart company could often produce a module that was better than the ones IBM was making internally. Ultimately, the dynamic, innovative industry that has grown up around these modules developed entirely new kinds of computer systems that have taken away most of the mainframe's market share. The fact that different companies (and different units of IBM) were working independently on modules enormously boosted the rate of innovation. By concentrating on a single module, each unit or company could push deeper into its workings. Having many companies focus on the design of a given module fostered numerous, parallel experiments. The module designers were free to try out a wide range of approaches as long as they obeyed the design rules ensuring that the modules would fit together. For an industry like computers, in which technological 5 . . . uncertainty is high and the best way to proceed is often unknown, the more experiments and the more flexibility each designer has to develop and test the experimental modules, the faster the industry is able to arrive at improved versions. This freedom to experiment with product design is what distinguishes modular suppliers from ordinary subcontractors. For example, a team of disk drive designers has to obey the overall requirements of a personal computer, such as data transmission protocols, specifications for the size and shape of hardware, and standards for interfaces, to be sure that the module will function within the system as a whole. But otherwise, team members can design the disk drive in the way they think works best. The decisions they make need not be communicated to designers of other modules or even to the system's architects, the creators of the visible design rules. Rival disk-drive designers, by the same token, can experiment with completely different engineering approaches for their versions of the module as long as they, too, obey the visible design rules. 1 Modularity Outside the Computer Industry As a principle of production, modularity has a long history. Manufacturers have been using it for a century or more because it has always been easier to make complicated products by dividing the manufacturing process into modules or cells. Carmakers, for example, routinely manufacture the components of an automobile at different sites and then bring them together for final assembly. They can do so because they have precisely and completely specified the design of each part. In this context, the engineering design of a part (its dimensions and tol- 6