Complementarities, Momentum, and the Evolution of Modern Manufacturing

In the nineteenth century, the railroad and telegraph were at the center of a set of technological advances, physical investments, and managerial innovations that transformed American industry (Alfred Chandler, 1977). Later, the automobile and telephone played a similar role in another transformation. Today, the high-tech industries include computers, telecommunications, and electronics. Working on our remarkably powerful computers (even as they rapidly become obsolete), co-authoring papers by electronic mail and fax, and conversing on our portable cellular telephones, we are struck by what appears to be a self-supporting and -reinforcing dynamic to the technological improvements across the electronics industries. An advance almost anywhere in the sector seems to call forth more advances across the sector. These advances are occurring contemporaneously with a broad pattern of other changes, not only in the electronics industries, but in manufacturing more generally, and not just in hardware, but in methods and organization as well. A new paradigm has begun to emerge. In contrast to traditional manufacturing firms, modern firms frequently 1) make greater use of flexible, programmable equipment and of computeraided design and manufacturing technologies, 2) have fewer job classifications, 3) offer more varieties of their major products and/or update their product lines more frequently, 4) put more emphasis on speed in order processing, production, and delivery, 5) hold much lower inventories of intermediate and finished goods, 6) rely on subcontractors to supply a greater proportion of the total value added, and 7) overlap design, product, and process engineering to speed the introduction of new products. These features of modern manufacturing firms encompass technology choices, marketing strategies, personnel policies, supplier relations, lines of internal communications, and other operational policies in a far-reaching and coherent pattern whose existence, in the words of Michael Piore (1986), poses a "challenge to economic theory. " In a recent paper, Milgrom and Roberts (1990), proposed a theory to explain the emergence of this new paradigm, arguing that the various characteristics and activities described are mutually complementary and so tend to be adopted together, with each making the others more attractive. In that theory, the falling costs of high-speed data communication, data processing, and flexible, multitask equipment lead to increases in the directly affected activities, which through a web of complementarities then lead to increases in a set of related activities as well. Although the costs of flexible machinery and data communication and processing surely have fallen substantially in recent decades, an analysis that takes these changes as exogenous does not constitute a full explanation of the pattern of change that we observe. One must ask: Why are these particular costs falling relative to others? Here we enrich the Milgrom-Roberts analysis by adding a dynamic to it: innovations in the manufacture of basic inputs both arise in response to a growing market for those inputs and simultaneously encourage that growth. This reflects a fundamental complementarity between the level of any activity and investments that reduce its marginal * Department of Economics (Milgrom and Qian) and Graduate School of Business (Roberts), Stanford University, Stanford, CA 94305. We thank Avner Greif for his helpful comments on an earlier draft. Financial support from the National Science Foundation (Milgrom and Roberts) and the Robert and Anne Bass Faculty Fellowship (Roberts) is gratefully acknowledged.