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Nearly Modular Structure Offers the Best of Both Worlds

2/26/2008 --

Firms that adopt a modular organizational structure can accelerate innovation, but run the risk of being imitated more easily by competitors.

ANN ARBOR, Mich.—While modularity has gained popularity as an organizational and technical architecture in complex systems, its proponents have overlooked the down side, says a Ross School professor.

Granted, firms can improve their flexibility, increase innovation and respond faster to changes in the marketplace by reducing the complexity of their organizational structure through modularization. But there is a price to pay because the benefits of modular structures are highly susceptible to imitation by competitors, making it harder for leading companies to retain their competitive advantage, says Sendil Ethiraj, assistant professor of strategy.

IBM is a case in point, he says. Industry observers conjecture that the technology giant sowed the seeds for the decline of its domination in computer hardware by adopting a modular architecture that accelerated design evolution but also enabled competing firms to mimic its products.

Research by Ethiraj and colleagues Daniel Levinthal of the University of Pennsylvania and Rishi Roy of McKinsey and Co. suggests, however, that there is a promising middle ground between the two extremes of modular and nonmodular organizational structures.

Their study, forthcoming in the journal Management Science, reveals that firms are better able to balance both short-term and long-term considerations by adopting what they call a "nearly modular" structure. The researchers say this is the "least risky" option for managers because it provides greater incremental innovative benefits compared with nonmodular structures yet offers better deterrence to imitation than fully modular structures.

Ethiraj and colleagues examined the dual impact of modularity on innovation and imitation using several controlled experiments in a mathematical model. First, they set up three alternative structures that vary in the extent of design complexity. The first is a perfectly modular structure with no interdependencies between modules. The second is a "nearly modular" structure with minimal interdependencies between modules. And the third is a nonmodular structure with interdependencies randomly distributed.

In their model, the researchers allow the firms in each structure to pursue independent incremental innovation and then compare the differences in their success at innovating. After grouping the firms according to their performance results, they subsequently allow the low-performing firms to imitate high-performing firms and contrast the trade-offs between innovation performance and imitation deterrence in the three structures. Here, imitation refers to the process whereby a low performer replaces some of its own decisions, modules and/or linkages with those copied from a high performer.

The results show that both perfectly modular and nearly modular structures make innovation faster and easier, thereby generating significant benefits, compared to nonmodular structures. However, the innovation benefits of fully modular structures also turn out to be highly susceptible to imitation efforts by competitors, whereas the nearly modular and nonmodular structures prove more effective in deterring imitators.

Thus, the nearly modular structures outperform both the nonmodular and the perfectly modular alternatives, because on the one hand their lesser degree of design complexity spurs innovation, while on the other hand their sufficient degree of organizational interdependency makes it difficult for imitators to achieve the same benefits.

"Our results suggest that if firms expect to be innovators, then nearly modular structures provide the best trade-off between incremental innovation benefits and imitation deterrence," Ethiraj says. "Modular structures are preferable for firms that expect to profit from imitation, provided of course that the innovators they seek to imitate also choose modular structures. However, in cases where industry standards are imposed externally on manufacturers, as in the product design of PCs, innovators cannot rely on design structures to deter imitation efforts."

Written by Claudia Capos



For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847, bernied@umich.edu