MMRCDISCUSSION PAPER SERIES

MMRC-F-20

The Architectural Attributes of Auto Parts andTheir Transaction Patterns in Japan’s Automobile Industry
Manufacturing Management Research Center, University of Tokyo
Ge Dongsheng and Fujimoto Takahiro
December 2004

21COE, University of Tokyo

MMRC Discussion Paper No. 20

The Architectural Attributes of Auto Parts andTheir Transaction Patterns in Japan’s
Automobile Industry
Manufacturing Management Research Center,
University of Tokyo
Ge Dongsheng and Fujimoto Takahiro
December, 2004

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Ge Dongsheng and Fujimoto Takahiro

Abstract

In this paper, we make a tentative study on the strategic choice of transaction patterns for thedetailed design drawings of auto parts in the Japanese auto industry. Using the available
taxonomy of transaction patterns from previous studies --- the drawing-supplied (DS) system,
the drawing-entrusted (DE) system and the drawing-approved (DA) system, we further
explore the conditions under which these patterns are chosen to achieve the efficiency ofinter-firm cooperation in the new product development process. The inquiry into why diverse
patterns can still be observed even within a transaction dyad (one auto maker and one
supplier) motivates us to relate the architectural attributes of auto parts to the outsourcing
decision for their detailed design. Results of our empirical study show that the functional
modularity of auto parts had a positive effect on the outsourcing of design drawings.

Key Words:
Outsourcing; Detailed Design Drawing; Transaction Patterns; Architecture; Functional
Modularity; Structural Modularity; Auto Parts; Japanese Auto Industry

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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

1 Introduction
The significance of outsourcing has been widely recognized in the automobile industry,where auto assemblers are trying to be lean and agile. Within this area of research, thepractices of supplier system management in the Japanese auto industry have been
examined from the perspectives of both economics and management science (Aoki, 1988;
Womack et al. 1990; Clark and Fujimoto, 1991; Nishiguchi, 1994; Fujimoto, 1997, 2001). The
Japanese supplier system can be summarized as a triplet of long-term continuoustransactions; fierce competition on capability building among a small number of suppliers;
and the bundled outsourcing of design, manufacturing, quality assurance and other tasks to
suppliers, in which each aspects complements the others (Fujimoto, 1997, 2001).
Nevertheless, based on this widely accepted recognition, more detailed studies of theJapanese auto industry are necessary to provide deeper insights. Problems such as what to
outsource and how to arrange the outsourcing are still high on the research agenda.

In this paper, we attempt to study the Japanese auto industry on a more detailed level by
spotlighting the outsourcing patterns of detailed design drawings of auto parts. The available
taxonomy in previous research --- the drawing-supplied (DS) system, the drawing-entrusted(DE) system and the drawing-approved (DA) system (Asanuma, 1989; Clark and Fujimoto,
1991; Fujimoto, 1997) are used as the subjects of our analysis.

Under the DS system, an auto assembler makes the detailed design of auto part and calls for
suppliers to manufacture according to the design drawing. In contrast, under the DA system,
it is the supplier that makes the detailed design based on general blueprint requirements
received from an auto assembler. In this case, through the procurement of auto parts, anauto assembler in effect buys the design drawings of auto parts, which are embodied in the
final product where design is bundled with other tasks such as manufacturing and quality
assurance (Fujimoto, 1997; 2001). Finally, under the DE system, an auto assembler entrusts
the making of the detailed design to a supplier, but on the other hand, claims the property
right of the design drawings. This system can be considered as an intermediate mode
between the contrasting cases of the DS system and the DA system. By the criterion ofdesign’s outsourcing, the DE system is the same as the DA system in that it is the supplier3

Ge Dongsheng and Fujimoto Takahirothat makes the detailed design. While by the criterion of ownership of design drawings, theDE system is identical with the DS system; since it is the auto assembler which holds theproperty rights in both cases. Therefore, we can define two dimensions of the taxonomy oftransaction patterns --- the boundary lines of design task assignment and ownership ofdesign drawings. As shown in the Figure 1, the three patterns can be put into a 2X2 table.
The DE system offers an interesting case in that it shows that with design outsourcing, thedesign task fulfillment and the ownership allocation do not always go hand in hand.

Figure 1 about here. Taxonomy of Transaction Patterns

Previous research has empirically shown that the overall performances of development
projects in the auto industry has differed significantly between the US and Japan (Clark andFujimoto, 1991). Whereas the DS system dominated in the US, the DA system was the majortransaction pattern adopted in Japan. Although the gap has been narrowing in 1990s due tothe widespread learning of Japanese auto assemblers’ supplier management practices(Kamath and Liker, 1994), the strategic choice of transaction patterns remains an importantresearch theme. The advantages of design outsourcing are evident in shortening lead-time,
improving quality by design-for-manufacturing and achieving cost reduction; however theconditions under which the alternative patterns should be chosen still needs to be clarified.

In this paper, we carry out our analysis in a specific setting --- a dyadic transaction between afixed pair of one auto assembler and one supplier in the Japanese auto industry, in which thecollaborative inter-firm relationship has already been established. This setting specification
stems from an intriguing case study made by Fujimoto in which diverse transaction patterns
were observed between a single supplier (company A) and Toyota for the transactions of four
representative auto parts (Fujimoto, 1997, p. 215). A longitudinal case study from 1970 to1990 reveals that the steering wheel has maintained its dominant role as a DA part, andinterior parts are stable as DS parts. In contrast, the transaction patterns of other auto parts
have changed over the twenty-year period. Weather strip has evolved from being a DS partto a DE part, while vibration proof rubber, originating in the same DS parts category, hasturned into a DA part. What factors are contributing to the variety of patterns observed insuch a problem setting? This question pushes us to reexamine the issues concerning the4The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

outsourcing of auto parts designs.

The make-or-buy issue has been tackled from multiple perspectives such as transaction costeconomics, the property rights approach and the resource-based view of firms. Transaction
cost economics (TCE) and the property rights approach (PRA) put more weight on theinstitutional solution to the “hold-up” problem, which is caused by contract incompletenessand opportunistic behavior. While TCE emphasizes that vertical integration is more related totransaction attributes such as asset specificity (Williamson, 1979,1985; Klein et al. 1978),
PRA stresses the implications of ownership allocation on the bargaining power of thetransaction parties (Grossman and Hart, 1990; Hart, 1989). Instead of considering thecontractual aspect of an inter-firm relationship, the resource-based view of the firm focuseson the resource endowments and accumulation of capability or knowledge within andbetween the firms (Richardson, 1972; Asanamua, 1989). Especially, Asanuma’s research on
the Japanese automobile and electronics industries classifies the roles played by supplierswith different “relational skill” when transacting with assemblers. Asanuma defines therelational skill as “ the skill required on the part of the supplier to the specific needs of an automaker”. He states that when a supplier’s relational design skill is high, the DA system isadopted, whereas otherwise, the DS system is chosen (Asanuma, 1989).

After examining the previous studies on the make-or-buy issue, we can see that no clear anddirect answer is offered for our inquiry into why diverse transaction patterns of the detailed
design drawings were observed in the dyadic transaction setting. Discussions concerning
asset specificity and contract incompleteness are not pertinent when a long-term
collaborative relationship is assumed as is the case in transactions we target. Similarly, theexplanatory power of “relational skill” is also weakened in our dyadic setting, because
between the same auto assembler and supplier, relational skill can be considered as aconstant. So what may be the possible variables that can explain the choice of varioustransaction patterns? The simple observation that the patterns differ according to the autoparts that are transacted suggests we may relate the attributes of auto parts with theirtransaction pattern choices.

The next question is how we can specify the features of different auto parts. It is on this point5

Ge Dongsheng and Fujimoto Takahirothat the product architecture perspective is introduced into our analytical picture. Defined as“the scheme by which the function of a product is allocated to physical components and bywhich the components interact” (Ulrich, 1995, p.420), the perspective of product architectureoffers a language for bridging technological and management issues. In the remainder of thispaper, we attempt to specify the architectural attributes of auto parts in terms of the degree ofinterdependence between auto parts within the design scheme of the automobile. Aftermaking this concept operationable by establishing some measurable indicators, we attempt
to carry out a tentative hypothesis testing procedure that explores the relationship between
the architectural attributes of auto parts and their transaction patterns.

The structure of this paper is as follows. In section 2, the related literatures on the
make-or-buy issue are reviewed. Then, in section 3, we attempted to formulate the conceptof the architectural attributes of auto parts. In section 4, we put forward some hypotheses on
the choice of the outsourcing patterns from the perspective of architectural attributes of autoparts within a theoretical framework. In Section 5, an empirical hypothesis testing study isundertaken. Finally, after the empirical results are discussed in Section 6, conclusions,
implications and future study directions are addressed.

2 Literature Review
2.1 Organization Economics on the Make-or-buy Problem:
The make-or-buy problem is generally considered as identical with the specification of afirm’s boundaries from the perspective of organization economics. As the two representative
approaches, transaction cost economics (TCE) and the property rights approach (PRA) both
recognize the nature of the firm as “a nexus of contracts” (Jensen and Meckling, 1976). Withtransactions as the unit of analysis, their core proposition is that the boundaries of the firm
are determined at the point where external contracts fail to govern the market exchanges.

Under what conditions are external contracts not efficient compared to vertical integration?
Both TCE and PRA emphasize contract incompleteness in the face of the existence ofrelationship-specific investment. Since all possible contingencies cannot be written into the6The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

formal contracts ex ante and the specific investments are not verifiable to resort to thirdparty arbitration, market exchange is likely to be costly since renegotiations and bargaining
at the ex post stage is inevitable. Nevertheless, each theory has its own distinct logic on how
to resolve this contractual problem with different implications for empirical predictions(Holmstrom and Roberts, 1998).

2.1.1. Transaction Cost Economics (TCE):
In his classical paper of 1937, Coase asserts that the boundary of the firm is determined by
the trade-off between “the cost of using the price mechanism” and the diminishing returns tomanagement. Afterwards, Williamson further develops the Coasian insight in his
comparative institutional analysis (CIA) framework. Two rudimentary behavioral assumptions--- bounded rationality and opportunism, and three dimensions of transaction attributes--asset specificity, uncertainty and frequency of exchange, form the analytical framework.
Especially when asset specificity is substantial, transaction costs incurred in the ex poststage tend to be high.1 Since the contracts are only the incomplete kind, the party who
invests in the specific assets will be vulnerable after investing. If the other party threatens toterminate the contract prematurely, the specific investment will be at stake since it has limited
alternative use. Although market procurement can attain a high-powered incentive and avoid
the bureaucratic disabilities of the prospect of production cost control, under such a situation,
the “hold-up” problem caused by the specific investment and opportunistic behavior makes
vertical integration a more efficacious governance structure. A high degree of uncertainty
and frequency of transactions are also predicted to be positively associated with vertical
integration.

Klein, Crawford and Alchian (1978) also predict that the advantages of increased vertical
integration grow as assets become increasingly specialized. Their logic is that the quasi-rentvalue of the specific asset --- “the excess of its value over its salvage value, that is its value
in its next best use to another renter”, is vulnerable to appropriation through renegotiations
and therefore makes vertical governance a preferred choice.
1

Ex post transaction costs include: “ ①’the maladaption costs’ incurred when transactions drift out of the flexible
field of agreement, ② ‘the haggling costs’ incurred if bilateral efforts are made to correct ex post misalignments,③ the set up and running cost associated with the governance structures (often not the court) to which disputes
are referred, and ④ the bonding costs of effective secure commitments” (Williamson, 1985, p. 21).

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Ge Dongsheng and Fujimoto Takahiro

Empirical evidence supporting the theoretical hypotheses drawn from TCE has been
provided in several seminal studies on the auto industry. Monteverde and Teece (1982a)
made an investigation of 133 auto components manufactured by GM and Ford and foundthat the “specialized, nonpatentable technical know-how” associated with the developmentof any given auto component, which is measured by engineering efforts, positively affects thevertical integration of component production. Masten et al. (1989) extended the study ofMonteverde and Teece by examining both physical and human capital’s effects on 133 autoparts in the U.S. auto industry. Their findings show that the physical capital does not have as
strong an influence on vertical integration as does specialized technological know-how. In
the Walker and Weber (1984) empirical study on the U.S auto industry, comparative
production costs between buyer and supplier, volume uncertainty and supplier market
competition (an indicator of asset specificity) are shown to have positive effects on vertical
integration.

2.1.2. Property Rights Approach:
Beginning with the recognition that contracts are incomplete for relationship-specificinvestments, PRA addresses the likely inefficient investment of the specific assets in thefollowing logic. Because of contract incompleteness at the ex ante stage of the transaction,
renegotiations on the division of the payoff gained from the investments are inevitable at theex post stage. As a result, with only limited bargaining power during the market transaction,
the party which invests in the specific assets cannot get the full benefits of the investment.
With the expectation of this consequence, the incentive for the investing party is impaired
and the investment cannot be efficient. The solution offered by PRA to this investment
problem is the common ownership of the specific assets, that is, vertical integration.

In this framework, ownership is defined as the “ex post residual right of control” (Grossman
and Hart, 1986), which is when the “right to choose the missing aspects of usage resides
with the owner of the assets” (Hart, 1989). As a device to deal with contract incompleteness,ownership allocation directly affects the ex post bargaining power and the division of therealized payoffs, and can therefore, affect the investment incentives for the specific assets.

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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

In comparison, with the TCE framework, the property rights approach has several different
points. First, specific physical assets, or non-human capital, is the only subject of discussion,
while in TCE, four types of assets are categorized. In PRA, it is believed that human capitalcan be affected indirectly through the control of physical assets because of the impossibilityof people being owned by others (Hart and Moore, 1990). Second, there is no prediction on
the effect of the magnitude of asset specificity on the firm’s boundary. Additionally, there is no
detailed discussion on the transactional attributes. Therefore, though having conceptual
explanatory power for the make-or-buy problem, PRA opens less opportunity for empiricaltesting (Holmstrom and Roberts, 1998). Thirdly, instead of speaking simply of vertical
integration, the PRA framework shows that the party in the transaction which claims
ownership of the specific assets is important. It states that the party whose investment cangenerate more added-value should own more assets.

In summary, both TCE and PRA provide the conditions for analyzing the boundary of the firmfrom the contractual perspective. The discussions focus on a dichotomy of markets and firms
which is considered oversimplified in the real world.

As Williamson acknowledges that“transactions in the middle range (between market and vertical integration) are much morecommon” (1985, p.83), the subcontracting practices in the Japanese auto industry actuallyprovide a good example. Quite a few studies in the field of economics have been done on
the “governance processes” that contribute to the competence of the Japanese auto
assemblers, however all of these discussions have been made under the premise of how notto vertically integrate but rather outsource (Williamson, 1985; Aoki, 1988; Imai and Komiya,
1989; Richardson, 1993; Holmstrom and Roberts, 1998). The problem concerning theconditions under which the make-or-buy decisions are made is unclear in these studies. To
answer this question, literatures on outsourcing management from the management sciencefield offer some different insights.

2.2 Resource-based View of the Firm’s Boundary and the Taxonomy of Transaction
Patterns:
Differing with the view of the firm as a nexus of contracts, the resource-based view (RBV)
recognizes the firm as a bundle of resources, which embrace anything that could be termed
as strengths or weaknesses of a given firm (Wernerfelt, 1984; Barney, 1986; Kogut and9Ge Dongsheng and Fujimoto Takahiro

Zander, 1992). In stead of discussing the contractual difficulties (transaction costs) inmarkets caused by asset specificity, RBV attempts to explore the sources of the
distinctiveness and the sustainable competitiveness of firms (Dierickx and Cool, 1989).
Therefore, the nature of the firm is not the governance structure, but an entity endowed by aset of skills, complementary assets and organizational routines for coordination and learning(Dosi, Teece and Winter, 1990).

As for the boundary of the firm, it is said that the tacit skills, routines and other kind ofresources that are hard to access through the market are accumulated within the firm. Theseso-called “core competence” is distinguished with the “non-core competence” which can beprocured via open market (Prahalad and Hamel, 1990; Venkatesan, 1992). Make-or-buy
decision making, therefore, depends on the attributes of resources. Besides the distinction ofcore and non-core resources, Richardson argues that the “similar” and “complementary”
activities are generally integrated within the firm (1972). The former refers to the “activities
that made demands on the same capabilities”, and the latter means activities “that had to bematched in level or specification”. Furthermore, Richardson goes beyond the dichotomous
discussion of market and vertical integration and proposes that the inter-firm cooperationbuilds on “complementary but dissimilar” activities.

Extending the discussion beyond the dichotomy of market and vertical integration andtackling more details of the intermediate mechanism such as supply chains is one of theimportant contributions of RBV approach. Since our focus here is on the transactions ofdetailed design drawings of components in the assembly industry, we limit our survey to thescope of a supplier’s involvement in the earlier stage of an assembler’s product development
process and review the taxonomy of transaction patterns.

Asanuma (1989) made a seminal study on the make-or-buy decision in the Japanese auto
industry. Between spot market transaction and in-house making, two other ways oftransacting --- the drawing-approved (DA) system and the drawing-supplied (DS) system arefurther explored. Asanuma asserts that “relation-specific skill” 2 is the underlying force to
2

In his later work, Asanuma changed the term to “relational skill” which adapts the concept to theopen network transaction setting (Asanuma, 1997).
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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

drive the classification, which is defined as “ the skill required on the part of the supplier tothe specific needs of auto maker.” According to the product development process in the auto
industry, Asanuma divides relation-specific skill into four factors and arrays them in a vector
presentation (X1, X2, X3, X4). In detail, the four capabilities required by auto assemblers are:
X1: development capability in response to the specifications from an auto assembler andthe ability to make proposals on specification improvement,
X2: process development capability and cost reduction capability through value
engineering efforts,
X3: quality and timely delivery assurance capability, andX4: cost reduction capability in the production stage.
(1989, pp.22-24)
Therefore, with respect to the choice between the drawing-approved system and thedrawing-supplied system, whether suppliers are equipped with capabilities related to theearly stage of the development process is the central explanatory variable. Represented by
the relational skill vector, the DS system corresponds to (0, X2, X3, X4), the DA systemcorresponds to (X1, X2, X3, X4) and the “gray zone” corresponds to (X1, 0, X3, 0) where“some parts that can properly be characterized as quasi DA parts. For them, core firms
provide only rough drawings, entrusting completion of details to the suppliers concerned.
These parts therefore share some elements of DA parts, although they retain the basic
character of DS parts ”(Asanuma, 1989, p.14).

Clark and Fujimoto (1991) offered a similar classification of auto parts and transaction
patterns. The three kinds of auto parts are the supplier proprietary parts, the detail-controlled
parts and the black-box parts. They use this taxonomy to compare the practices of productdevelopment on the project basis across the Japanese, American and European regions.
Their empirical results showed that in the mid- to late 1980s, the black box parts amounted to
62% of the overall transactions between auto assemblers and their suppliers in Japan, whilein U.S., the detail-supplied parts had the dominant share of 81%. This difference wasmapped to a gap in lead time of four to five months between the two regions.

In the Fujimoto’s later works (1997), the black-box parts are further divided into two
categories: the drawing-approved (DA) parts and the drawing-entrusted (DE) parts. The
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Ge Dongsheng and Fujimoto Takahiro

latter is a refinement of the “gray zone” using the classification scheme of Asanuma.
Nevertheless, rather than simply being a naming work, Fujimoto’s research further clarifies
another dimension of the classification: the ownership allocation of design drawings. So theoutsourcing issue of detailed design drawings of components contains the designtask-assignment dimension and the drawing’s ownership dimension. In the cases of the DA
and DS systems, the two outsourcing aspects of the detailed design are together in the same
package. But under the DE system, the two aspects are separated. That is, assemblers
outsource the detailed design tasks but claim the property right of the design drawings.
Furthermore, Fujimoto reveals that design fees are always paid to suppliers once the designtasks are completed and supplier switching is possible at the following manufacturing stage.

Recent studies illustrate several other ways of categorizing suppliers and transaction
relationships. Kamath and Liker (1994) classified suppliers into four types: partners, mature,child and contractual suppliers. Differing in capabilities, partner suppliers and mature
suppliers are close to the black-box parts suppliers. While partner suppliers work jointly with
OEMs from the very start of the development stage --- the concept development, mature
suppliers usually wait for rough specifications from OEMs and complete the sequential tasks.
“Child suppliers” are similar to the “detail-controlled parts suppliers” in that they only
manufacture after OEMs provide them detailed specifications. Finally, contractual suppliers
is identical with the proprietary parts suppliers in that they supply standard parts through acatalogue.

Commenting that the Clark and Fujimoto’s taxonomy provides a sparse taxonomy, rather
than a systematic typology, Kaufman, Wood and Theyel (2000) propose a strategic supplier
typology in another 2x2 table. With the discrete measure of “low” and “high” along bothtechnology and collaboration dimensions, commodity supplier (L,L), technology specialist(H,L), collaboration specialist (L,H) and problem-solving supplier (H,H) are distinguished.
Compared with Clark and Fujimoto’s classification, collaboration specialist corresponds tothe detail-controlled parts supplier, technology specialist corresponds to proprietary parts
supplier and the problem-solving supplier can be viewed as the black-box supplier.

In comparison with these classifications, the transaction pattern based on the works of
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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

Asanuma, Clark and Fujimoto has several advantages and is therefore adopted as the objectof analysis in this paper (shown in the 2X2 table in the previous section). Firstly, the nature of
the transactions between assembler and supplier is explicitly specified as the make-or-buy
decision on detailed design drawings. Although the idea has been implicitly embodied in theprevious studies, the explicit recognition of this point is believed capable of establishing more
systematic logic and offering new insight into the inter-firm relationships. Secondly, twodimensions of detail design outsourcing --- ownership allocation of design drawings anddesign task assignment is clarified to make the taxonomy systematic.

Having reviewed the literatures related to the make-or-buy decision from both theorganizational economics and RBV fields, we return to the central inquiry of why diverse
patterns were observed between a fixed pair of one auto maker and one supplier. It isinteresting that no previous studies have addressed this problem. First, it is clear that theincomplete contract and asset specificity concepts have no explanatory power in our setting.
Secondly, the relational skill embedded in the fixed pair of firms can be considered constantat a single point in time when the observation is made. Furthermore, even taking theevolution of the relational skill into account, we still find that the transaction patterns exhibit
no tendency to converge. Therefore, the answer to our key question should be sought alongsome other logic. As mentioned in introduction, an intuitive answer can be obtained byrelating the characteristics of auto parts to the transaction patterns. In order to specify thecharacteristics of auto parts, we borrow insights from the product architecture literature.

3 The Architectural Attributes of Auto Parts
3.1. Product Architecture Literature:
Product, defined as an artifact that is purposefully and deliberately designed, can be viewed
as a system of components that performs specific functions (Simon, 1962; Ulrich, 1995;
Baldwin and Clark, 2000). Product architecture, then, is recognized as a system designconcept referring to the configuration or layout of how the components are arranged within asystem (Henderson and Clark, 1990). Defined in more rigorous terms, product architecture is“the scheme by which the function of a product is allocated to physical components and by13

Ge Dongsheng and Fujimoto Takahiro

which the components interact” (Ulrich, 1995, P420.). The definition of product architecturereflects the two phases of the general design process --- “analysis” and “synthesis” assuggested by design theory (Suh, 1990; Liedtka, 2000). In the analytical phase, thedecomposition of the design problem into subsets is carried out. In the ensuing stage ofsynthesis, the individual subsets are grouped and integrated to be a coherent harmonious
whole. Therefore, the product architecture concept can be further specified in detail as
proposed by Ulrich (1995). First, it contains the arrangement of functional elements. Second,
it reflects the mapping from these functional elements or design parameters to physicalcomponents. Third, it defines the interfaces among interacting physical components, which
specify how they fit together, connect, communicate and so forth (Baldwin and Clark, 2000).

Modularity is a dimension to measure the way of decomposition and interface specification in
the design process. It is a continuum describing the mapping structure of the functionalparameters to the physical components and the degree to which components are
independent from each other. The typical modular product is characterized as (1) eachcomponent implements a single function (the so-called “one-to-one mapping”), and (2) theinterfaces between the components are well defined or standardized. As a result, the productsystem tends to be of the loosely coupled kind and the mixing and matching of components
can be carried out (Schilling, 2000). In contrast, a product with extremely low modularity has
the properties that (1) its components always implement multiple functions (function sharing)or a single function requires multiple components working together to be achieved (theso-called “complex mapping”), and (2) interfaces among tightly coupled components are ill
defined (Ulrich, 1995; Sanchez and Mahoney, 1996).

The notion of product architecture has inherent linkage with management issues because
the decomposition and interface specification of product design are naturally related to theprocess of the division of labor and coordination in which design ideas are transformed into
real products 3 . Especially, modular architecture has attracted much attention in the
management science field recently.

3

Using the terminology offered by Baldwin and Clark, design structure and task structure are“isomorphic” (2000, p. 46).
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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

Sanderson and Uzumeri (1990), Garud and Kumaraswamy (1995) and Schilling (2000)
suggest that the feasibility of mixing and matching can offer more product variation and newcomponents can be substituted into a new configuration with little loss of functionality. Ulrich(1995) further proposes several implications of modular architecture on the engineering
management issues, such as product change, product variety, component standardization,
product performance and product development. Sanchez and Mahoney (1996) argue thatthe standardized interfaces of modular architecture enable embedded (or autonomous)coordination and facilitate effective learning. Furthermore, a loosely coupled system canreduce the cost and difficulty of adapting to a changing environment and thus increase thestrategic flexibility of an organization (Sanchez, 2000). Langlois and Robertson (1992)
discuss the implications of a modular system on both the supply and demand sides. On the
supply side, a modular system can breed autonomous innovation and achieve rapid
trial-and-error learning. On the demand side, it can increase product differentiation andblanket the product space more completely. Modularity can reduce the communications
overhead on a team and permit reuse of modules from other designs and consequently,
development expenses and cycle time can be reduced. Baldwin and Clark (2000)
summarize the power of modularity as (1) increasing the range of manageable complexity,(2) allowing concurrent work, and (3) accommodating uncertainty. On the other hand, its
potential negative side is also addressed. The standardized interface can act as a bottleneck
for performance and modular architecture cannot achieve the same level of performance asa tightly coupled nonmodular system. In order to accommodate uncertainty in the productdevelopment process, it’s also necessary to allow some degree of redundancy in theinterface design.

As for the inter-firm transaction and outsourcing issue, Sharon and Eppinger (2001) relate
the make-or-buy decision of auto component production to the complexity of automobile
design. By complexity, they mean “(1) the number of product components to specify andproduce, (2) the extent of interactions to manage between these components (parts
coupling) and (3) the degree of product novelty” (p.189). Their results from an empirical
study on the luxury-performance segment of the auto industry show that when complexity ishigh, vertical integration is more attractive. Nevertheless, their focus is on how complexity inproduct design affects production, and they don’t address outsourcing of design. Baiman,
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Ge Dongsheng and Fujimoto Takahiro

Fischer and Rajan (2001) use an agency theory model to examine the relationship between
product architecture and supply-chain performance metrics. They conclude that the“separated architecture”, in which components aredecoupled and there is no function

sharing, can facilitate the performance measure of suppliers and thus relieve the external
contractability problem. Although they offer insights on the measurement aspect of theoutsourcing issue, they do not separate design and production. In this paper, we tackle theoutsourcing of detailed design, which has not been discussed systematically in previous
literatures.

3.2. Formulation of Architectural Attributes of Auto Parts:
We borrow the definition of product architecture of Ulrich (1995) that the mapping fromfunctional elements to physical components and the interface specifications are two
essential aspects. Product, then, can be viewed as the hierarchy of both functionalparameters and physical components (Gopfert and Steinbrecher, 1999). The interactions
among components are clarified here into two types. One is the functional interaction, whichrefers to the relationships among components to implement functions. This is embodied in
the mapping process from functional elements to physical components. The other is the
structural interaction, which refers to the relationship among components reflected in thephysical interfaces.

The architectural attributes of auto parts are defined as the features of both functional andstructural interactions among auto parts. As such, the concept shares the same fundamental
spirit of product architecture and can be regarded as a redefinition of product architecture on
the component level. In particular, the architectural attributes of one auto part are specified torefer to:(1) The degree of interaction with other auto parts to achieve a given function, and(2) The degree of interaction with other auto parts in terms of physical intervention.

Modularity can also be applied here as a dimension to measure the architectural attributes ofauto parts in a continuum manner. Along our logic, modularity can also be decomposed into
two sub-concepts, a functional one and structural one. Auto parts with higher functional
modularity are those parts that implement simple functions and achieve their specified
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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

functions in a manner independent of other parts. Auto parts with higher structural modularity
are the parts with relatively standardized physical interfaces with other parts. Contrarily, autoparts with lower functional and structural modularity are those parts that implement functional
sharing with other parts and with physical interfaces that are tightly coupled and ill defined.

Before establishing a theoretical framework that relates the attributes of auto parts and theoutsourcing of their detailed design, we have some points to clarify. Firstly, although definingarchitecture on the product system level and on the component level share the same
fundamental spirit of functional decomposition and interface specification, in the case of theautomobile, there are some differences according to the observe level. From the productsystem level, the automobile is usually perceived as an integral and complex product. But
from the component level when discussing the architectural attributes, we can observe avariety of interfaces with differing degrees of modularity in the various sections of automobile.
Therefore, contrary to the simple perception of the automobile, the product actually contains
a portfolio of interactions among auto parts.

Secondly, since the architectural attributes of auto parts are endogenous variables during the
product development process, they change over time. This also creates the problem of how
to define the “component” of the product since there are different levels such as parts,
components and subassemblies related to the hierarchical methodology of design (Ulrich,
1995; Simon, 1962). To avoid this problem, we view auto parts in a static way here and baseour discussions on auto parts whose detailed design drawings are actually transacted
between auto maker and supplier.

4. Theoretical Framework and Hypotheses
4.1. Problem Setting:
Again, the key inquiry of our study is why diverse transaction patterns of detailed designs ofauto parts --- the drawing-supplied (DS) system, the drawing-entrusted (DE) system and thedrawing-approved (DA) system --- are observed in a dyadic transaction setting in theJapanese auto industry. There are three main assumptions in this problem setting.
17

Ge Dongsheng and Fujimoto TakahiroFirst, long-term transactions and a collaborative relationship between the auto assembler
and supplier are assumed as the background of this analysis. Therefore, problems caused
by incomplete contracts are not relevant in this study and the discussion is on a different
analytical level from the classic make-or-buy inquiry on the alternative institution choice
between market and vertical integration. The means by which firms can co-operate more
efficiently is the main concern here. Second, the technological capabilities of the auto
assembler and supplier are assumed to be constant at a sufficient level such that they do not
influence the choices of transaction patterns of detailed design. The dyadic transaction
setting supports this assumption. Third, although determined endogenously, the architectural
attributes of auto parts are assumed to be static independent variables since our mainconcern is on the choice of transaction pattern.

4.2. Foundation of the Theoretical Framework:
Despite the difference in the analytical subject and level, the logical structure (not the content
itself) of the transaction cost economics framework is borrowed for understanding theoutsourcing of design in this study.

First, the TCE framework deals with the make-or-buy problem by placing more weight on the
ex post stage of transactions, which is compatible with our make-or-buy concerns fordetailed design of auto parts between a pair of firms. Second, the TCE framework aims tofacilitate the comparative study of alternative institutions by aligning transaction attributeswith various institutional arrangements. Its emphasis on the concept “fit” sheds light on our
attempt to relate the architectural attributes of auto parts with the transaction patterns ofdesigns. Third, the TCE framework makes the transaction the analytical unit, takes bothproduction and transaction costs into consideration and identifies the trade-off between themthat leads to solutions to the problem of institutional choice. This point is also useful forfinding the solutions to our inquiry, although our analytical unit is auto parts design.

Using the basic logical structure of the TCE framework and taking into account of theessential differences in our problem setting, we build our new framework as follows.

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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

Behavioral Assumptions and Nature of Design:
Opportunism no longer plays a critical role in our framework due to the assumption that along-term collaborative relationship has already been established. Instead, the bounded
rationality of human beings is particularly important for the design issues under scrutiny here.
Due to limited knowledge of the cause-effect linkages in a new product, design is said to beconcerned with the contingent state of how things might be (Simon, 1962). Therefore, thenature of design is a searching process in which the hypothesis-driven approach is used forunderstanding what a product is to achieve, the internal fit of its internal components and its
external fit with its contexts (Alexander, 1964; Clark, 1989; Liedtka, 2000). Through iterative
hypothesis generating and testing, new information is acquired and new possibilities arecontinually opened up.

Nature and Sources of Transaction Costs:
As the result of the behavior assumption above and the nature of the design process, in ourframework the inter-firm transactions should not be seen as a governing structure to handle
the problems of opportunism, but as a coordination mechanism to facilitate the development
activities of new products. This point is especially pertinent when practices in the Japanese
auto industry are under examination, since the contractual arrangements are not asemphasized by each party and bargaining at the ex post stage is not one of the main
activities (Imai and Komiya, 1989; MacMillan, 1990). Consequently, transaction costs, in thegenerous sense that is referring to all the “costs of running the economic system” (Arrow,
1969, p.48), are better recognized as coordination costs, rather than as governance costs.
These costs are incurred from both limited cognitive capability on cause-effect relationships
and uncertainty regarding technological and market environment changes. In particular, twokinds of coordination costs can be distinguished. One is the measurement cost, the other isadjustment cost.

The measurement cost refers to the cost incurred to detect the responsibility for design
quality problems when there is failure to achieve the desired performances in the testingstage. Since the division of labor concerning the design activities is carried out across thefirm’s boundary, to identify failures caused by particular parts and then allocate theresponsibility to the supplier is essential to the inter-firm coordination during product19

Ge Dongsheng and Fujimoto Takahiro

development. The adjustment cost refers to the cost incurred by the design changes that are
inevitable during the iterative trial-and-error process of design. Whether the design changes
can be localized in a limited scope so that a chain effect is not triggered and the need forchange does not spread out to the whole development agenda is important to inter-firmcoordination efficiency.

Having specified the foundation upon which our discussion is made, in the following section,
we build up our theoretical framework along the logical structure of TCE and propose several
hypotheses.

4.3. Theoretical Framework and Hypotheses:
Similar to the hypotheses in the TCE framework, we suggest that the outsourcing of thedetailed design of auto parts ought to be aligned with their architectural attributes in the waythat best economizes coordination costs. Our argument is divided into two parts. First, thechoices of the DS and DA systems are studied as two contrasting cases. Second, using thefirst part of the analysis as a benchmark, we extend the logic to the choice of the DE system,
which is an intermediate mode.

4.3.1. The DS System versus the DA System:
As mentioned before, the DS system and the DA system are two contrasting cases that
correspond to the in-house making and to the outsourcing of the detailed designs of autoparts respectively. As has been shown in the previous studies, the outsourcing of detailed
designs has several advantages for productive efficiency in the product development
process. First, It makes parallel or concurrent product engineering possible, which canshorten lead time (Clark and Fujimoto, 1991; Baldwin and Clark, 2000). Second, it facilitates
design-for-manufacturing (DFM) activities, which can improve quality and cost performance(Whitney, 1988; Ulrich, 1995). By integrating the product and process design process,suppliers can exploit their know-how better to achieve the rationalization of design. Third, it
can promote the front-loading of development tasks, which deal with uncertainty in thedesign process in a more efficient way (Thomke and Fujimoto, 2000). Fourth, it can provide ahigh-powered incentive in the product development process both for suppliers and thedevelopment staffs of an auto assembler (Williamson, 1985).
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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

However, in contrast with these eulogies on outsourcing, we claim that these merits ofoutsourcing in new product development will not be realized without conditions. Whendetailed design tasks are assigned to outside suppliers, the potential costs of coordinationmust be considered. Even if the opportunistic behavior of suppliers can be well controlled, it
is still necessary for an auto assembler to “measure” and “monitor” the activities of its
suppliers. If quality or some other incompatibility problems arise, the auto assembler has to
identify the source of the problems and localize the responsibility to the specific supplier. As
noted before, there is the potential measurement cost. In addition, during the trial-and-error
process of developing automobiles, unavoidable design changes are likely to cause theadjustment costs. While a few studies show the evidence that suppliers are willing tocoordinate with each other such that the adjustment costs can be assumed by suppliers, thecommon perception suggests that the auto maker assumes a substantial proportion ofadjustment costs. Therefore, there is a trade-off between the productivity benefits and thecoordination costs when an auto assembler makes the choice of transaction pattern.

The modularity of auto parts design may be an effective measure for determining thedominant effect in the trade-off between productive efficiency and coordination costs. Whenthe design of an auto part displays high modularity, we would expect the productive
efficiency effect to be dominant as the productivity benefits in design and manufacturing canbe realized with lower coordination costs. In such a case, due to the high functional
modularity between auto parts, the measurement problem can be effectively resolved simply
by requiring that all the parts be developed to conform to standardized interface protocols.4
Also, due to the high structural modularity, design changes can be localized to individual
suppliers with no need for accommodation across several suppliers. The foregoing
discussion leads to the following hypothesis.

Hypothesis 1 (H1): Auto parts with high functional and structural modularity will be more
likely to be transacted under the DA system, with both design tasks and ownership of design
4This statement shares some overlap with agency theory (Jensen and Meckling, 1976; Eisenhardt, 1989), whichputs emphasis on the measurement problem when discussing the incentive mechanism. When tasks areprogrammable and the outcomes are less uncertain, ‘outcome-based’ contracts are likely to be adopted to induce
the high-powered incentive. In the opposite case, ‘behavior-based’ contracts are likely to be used in which payoff
is not related to the outcome and thus has a relatively low incentive effect.

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Ge Dongsheng and Fujimoto Takahiro

drawings going to suppliers, given that the firm’s capability factors remains constant.

In contrast, when the design of an auto part exhibits low modularity, we would expect thecoordination cost effect to be dominant in the trade-off. When auto parts are closelyinterdependent with each other in achieving some particular function of an automobile (i.e.,
low functional modularity), the measurement problem will become severe. Just like thescenario of the “team production” (Alchian and Demsetz, 1972), it is hard to tell which one
should be responsible for a possible problem in quality because whether a part performs itsrole well or not depends on its interaction with other parts. Additionally, adjustment costs will
also increase due to close physical interdependence between auto parts (i.e., the low
structural modularity). Design changes of a part are likely to require extensive
accommodating changes in other interrelated parts. If the part with such attributes istransacted as a DA part, the benefit in productivity cannot be realized without substantial
costs. Therefore, under such situation, the DS system is preferred. An auto assembler will
carry out the detailed design to take the responsibility for handling design problems and only
outsource the manufacturing activities to suppliers. This theoretical logic leads to thefollowing proposition.

Hypothesis 2 (H2): The DS system is more likely to be chosen when the auto part’s design
exhibits both low functional and structural modularity, given that the firm’s capability factor
remain constant.

4.3.2. The Choice of the DE system:
The DE system has been shown to be an intermediate mode that exhibits the hybrid featuresof both the DA and DS systems. While the detailed designing of auto parts is entrusted tosuppliers, the property rights of design drawings belong to auto assemblers. The system alsobears the one-spot nature that there is not necessarily continuity between design andmanufacture. The separation of design task outsourcing and drawings ownership can beconsidered a sort of institutional innovation. As revealed in our research interviews, the main
purpose of this innovation by auto assembler is to take advantage of specialized know-how
in suppliers to tackle challenging and uncertain design problems. As for the conditions for the
choice of the DE system, we attempt to hypothesize from the perspective of auto parts
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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

modularity in the following discussion.

First, we suggest that relatively high structural modularity facilitates the outsourcing of designtasks. In a situation where the basic spatial and functional parameters can be specified in thedesign blueprint by auto assemblers, suppliers can conduct their design work in a relatively
independent way to achieve the merits of parallel progressing of the development project.
On the other hand, we suggest that auto parts with relatively low functional modularity leads
to auto maker’s ownership of design drawings. Although structural interfaces may berelatively well defined, the interdependency of auto parts to achieve a certain function
causes uncertainty when localizing the design responsibilities to individual parts. Put in our
specified terms, the measurement costs are high in such a situation. Furthermore, since thedesigns transacted under the DE system are technologically uncertain, design changes arevery likely in the subsequent development process. If design drawings belong to suppliers,
the freedom of auto assemblers to change designs is constrained and negotiations acrossfirms become necessary, which makes coordination costs high. In response to this problem,
an auto assembler changes the transaction of design drawings into a one-shot deal by
paying the design fees to a supplier once the drawings are completed, which eliminates thepossibility of sequential inter-firm interactions. Therefore, in order to utilize the designknow-how of a supplier while at the same time attenuating the coordination problems, anauto assembler entrusts the design task to supplier while internalizing the coordination
among the designs of auto parts.
This point can be better understood by examining an example in a case study by Fujimoto(1997), in which weather strips are transacted under the DE system. Although the spatial
design parameters of the weather strip can be specified ex ante when the specifications of
the body frame and the window glass parameters are determined, there is a highinterdependence among the body frame, window glass and weather strip to fulfill the sealing
function. When a leakage problem occurs, it is hard to tell which part should be held
responsible. However, if the auto maker internalizes this coordination problem by taking the
responsibility for design defects, complicated intervention across firms can be greatly
reduced.

Therefore, as revealed by the theoretical logic and observation outlined above, the choice of23

Ge Dongsheng and Fujimoto Takahiro

the DE system can be hypothesized as follows.

Hypothesis 3 (H3): When the structural modularity of an auto part’s design is relatively high,but the functional modularity of an auto part is relatively low, the DE system is likely to bechosen, given that the firms’ capability factors remain constant.

In the next section, we present a hypothesis testing procedure that can be used to see how
well our hypotheses are supported by empirical data.

5. Research Methodology
5.1. Sample Setting:We specified our sample setting in a way similar to our problem setting in that we focus on
the transactions between auto maker A, and one of its first-tier suppliers, to control for thefirms’ capability factors. Our sample consisted of 33 auto parts, which were chosen by the
respondent.

5.2. Variables and Measures:
5.2.1. Transaction patterns:
Transaction patterns are measured on a nominal scale with three categories: (1) the
drawing-supplied (DS) System, (2) the drawing-entrusted (DE) system, and (3) the
drawing-approved (DA) System. The respondent was asked to identify the transaction
pattern with respect to each auto part in the sample.

5.2.2. Architectural Attributes of Auto Parts:
To make the concept of architectural attribute operational in our empirical study, weconstructed eight indicators to capture both functional and structural interdependence
among auto parts. All of these variables are measured on a 5-point scale, with 1 indicating a“very low” level and 5 indicating a “very high” level.

(1) Functional Integration (FIN) --- the extent to which an auto part can implement its function
24

The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

independently.

(2) Performance Measurability (PME) --- the degree of ease with which design quality
problems caused by the sample auto part can be correctly identified in the testing andassembly process.

(3) Interface Commonality (ICM) --- the extent to which the structural interface design of thesample auto part can be shared across different auto models.

(4) Interface Complexity (ICP) --- the degree to which the structural interface design of thesample auto part is coupled with other parts in terms of the number of joint points.

(5) Design Independence (DIN) --- the extent to which the design of the sample auto part canbe carried out independently and concurrently with other parts. This variable contains both
functional and structural aspects of the auto part design.

(6) Design Commonality (DCM) --- the degree to which the design drawing of the sample
auto parts can be reused in other auto models. DCM can be considered as an indirectindicator of both functional and structural aspects of auto parts design since the more
modular a design is, the more likely the design can be mixed and matched in other models.

(7) Proximity to Core Function Sections of an Automobile (PCF) --- the degree of structural
proximity between the sample auto part and the core functional sections of an automobile
such as the body, engine and chassis.

(8) Proximity to Exterior/Interior Design of an Automobile (PEI) --- the degree of structural
proximity between the sample auto part and the exterior and interior designs of an
automobile.

5.2.3. Control Variables: the internal complexity of auto partsThree indicators were designed to measure the internal complexity of auto parts on a 5-point
scale.
25

Ge Dongsheng and Fujimoto Takahiro(9) Functional Multiplicity (FMU) --- the assessment of how many functions the sample autopart contributes.

(10) Structural Complexity (SCM) --- the assessment of how complex the sample auto parts
are in terms of their internal structure such as the number of parts used and the engineeringhour used for manufacturing.

(11). Technologically Advanced Degree (TAD) --- the assessment of how advanced is thetechnology required to design the sample auto part. TAD also reflects the technologicaluncertainty related to the sample part. The number of patents related to the design andmanufacturing of the auto part is one measure used for this indicator.

5.3. Data Collection:
We relied on an interview and questionnaire survey to collect data on the sample auto parts.
First, a senior manager at the supplier (B) was contacted to seek permission to conduct ourstudy. Once the study was approved, the questionnaire was emailed to the respondent forreview of the question item design. In this way, the accuracy and relevance of the indicatorsand language was evaluated. Three weeks later, we made a visit to the supplier andconducted an interview with the respondent. The question items were once again checked--- ambiguities were removed and the face validity of the measures was examined. After thequestionnaires on the 33 sample auto parts were completed, we obtained the data based ona confidentiality agreement with the respondent. Afterwards, we continued contacting the
respondent via phone calls, faxes, and emails to review the responses, discuss thepreliminary results of the data analysis, and resolve some questions related toinconsistencies between the data and our ex ante expectations.

Using the subjective perceptions of respondents for measurement during a questionnaire
survey is common in the empirical research field (Monteverde and Teece, 1982; Masten etal., 1989; Walker and Webber, 1984; Clark, Fujimoto, 1991; Takeishi, 2001). Although
perceptual measurement may raise concerns about bias and the reliability of the responses,
the judgment of the respondent based on his long career experience and receiving
26

The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

confirmation from other engineers of the validity of the responses to be an appropriate
approximation for the purposes this exploratory empirical study.

5.4. Method:
As the first step, a correlation analysis was conducted and the correlation coefficients matrix
was derived. Second, we carried out a factor analysis on the 11 independent variables andextracted four factors. Finally, based on the results of factor analysis, a logistic regression of
the four explanatory factors on the transaction patterns was conducted. Instead of using thefactor scores directly, the means of the representative variables that have high weights forthe same factor are used as the independent variables in the logistic regression models.

6. Results
6.1. Results of Correlation and Factor Analyses:
Table 1 presents the descriptive statistics and the correlation matrix. A relatively strong
positive correlation exists between FIN and PME. This result supported our intention of using
these indicators as the variables for reflecting the functional interdependence between autoparts. To our surprise, there was no correlation between ICP and ICM which were used tomeasure the physical interfaces between auto parts. This could suggest that there may be
more than one dimension of the interface being measured. Additionally, consistent with our
expectation, an extremely high correlation is observed among the variables indicating theinternal features of auto parts design.

Insert Table 1. Descriptive Statistics and Correlation Matrix about here.

Next, to better understand the latent constructs in the measured variables, a factor analysis
was conducted. Four factors were extracted that accounted for 66 percent of the variance,
as is shown in Table 2.

Insert Table 2. Results of Factor Analysis about there.

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Ge Dongsheng and Fujimoto Takahiro

The first factor consists of the FIN, PME and DIN variables, which captures the functional
independence of the sample part. This factor shows that the auto parts in the sample
implement their functions with few interactions with other parts, that their functional
performance can be well measured and that a higher degree of freedom can be enjoyedduring the design process. Therefore, we label this factor the functional modularity factor.

Factor 2 also contains three variables --- ICP, PCF and DCM. It reflects the complexity of thephysical interfaces between the auto parts and the spatial proximity between the sample
parts and the core functional sections of an automobile like the engine, body and chassis. It
shows that the design commonality of auto parts across different car models is low. We cancall this factor the structural coupling factor.

The third factor, which includes ICM, PEI and DCM, shows that auto parts are located close
to the exterior and interior design of an automobile and both the interface and configuration
designs of the auto parts are not likely to be shared among different car models. Due to thesubstantially high loading on variable PEI, we name Factor 3, the styling design factor.

Finally, the variables contained in Factor 4 have high positive values for the number offunctions implemented by the sample parts (FMU), on the internal structural complexity ofthe sample parts (SCM) and on the advanced degree of technology required by the design
and manufacturing of the sample parts (TAD). Since the factor apparently indicates thefunctional and structural complexity of the auto parts internally, we define this factor as theinternal complexity factor. It is consistent with our expectation to use the internal features of
the auto parts as a control variable.

6.2. Results of Logistic Regression Analysis:
To test our hypotheses, we use a logistic regression model to examine the relationshipbetween the architectural attributes of the auto parts and the choice of the three transaction
patterns. Instead of using factor scores directly, we use the means of the representative
variables of each factor as the explanatory variables. Meanwhile, since the dependent
variables in the logistic regression model are conventionally of the dichotomous kind, we ran
five models for use in applying the logistic regression technique to analyze the choice of28

The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

three transaction patterns. Table 3 shows the results.

Insert Table 3. Results of Logistic Regression about here.

In Model 1, the DS system is the dependent variable with the DE system and the DA system
combined as the default. According to our logic, this model can be viewed as revealing thedetermination of the detailed design task outsourcing, since the DE and DA systems are theoutsourcing cases while the DS system is case where the designing is done in-house. In
Model 2, the DA system is the dependent variable with the DE and DS systems combined as
the default. In this model, the determination of the ownership allocation of the detailed design
drawings is examined since it is only under the DA system that suppliers claim the property
rights of the design drawings. In Model 3, we left out the auto parts that were transacted
under the DE system and studied the contrasting cases of the DS and DA systems using 22of the sample auto parts. In Models 4 and 5, we focused on the choice of the DE system.
Because of its intermediate nature, the DE system is studied separately first with the DS
system, and then with the DA system as the defaults. The sample size was 25 in Model 4
after deleting the DS parts. In the same vein, 19 sample auto parts were used in Model 5
when the DA parts were left out.

Results of Model 1 show that only the “internal complexity factor” has a significantly negative
influence on the choice of the DS system, when compared with the DE and DA systems (theso-called “black-box” systems). This indicates that the DS system is likely to be adopted
when auto parts are less complex internally. In Model 2, the coefficients of the “functional
modularity factor” and “the internal complexity factor” are positive and significant. The same
results were obtained in Model 3. Both of these results indicate that the choice of the DA
system is positively associated with auto parts that are internally complex and functionallyindependent from other parts.

Predicting the choice of the DE system, Model 4 shows the results when compared with theDA system. The DE system is associated with auto parts for which functional modularity isrelatively low. On the other hand, when compared with the DS system in Model 5, “theinternal complexity factor” significantly influenced the choice of the DE system.
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Ge Dongsheng and Fujimoto Takahiro

In summary, the results of the logistic regression analyses partially support our hypotheses.
First, Hypothesis 1 on the choice of the DA system was partially supported. The coefficient of
the functional modularity factor was positively significant, but the coefficients of both thestructural coupling factor and the styling design factors, which reflect the structuralmodularities of the auto parts, were not significant. Similarly, results on the DS system werealso partially consistent with Hypothesis 2, since only the functional modularity factor
showed a negative significant result. No significant result was shown for the factors reflecting
structural modularity. As for Hypothesis 3 on the choice of the DE system, it was partially
supported in that the functional modularity factor exhibited a negative significant resultcompared with the DA system. Moreover, the structural modularity factors were again
revealed as irrelevant in explaining the transaction pattern choice. Finally, the internal
complexity factor was shown to exert a significant positive influence on the choice of the DA
and the DE systems, but to have significant negative influence on the choice of the DS
system.

7 Discussion
Our results, which only partially supported, make us look back to the taxonomy of thetransaction patterns, in which the design task assignment and the ownership of design
drawings are the two dimensions. When plotting the results of the logistic regression analysis
along the two significant explanatory factors, we can see that the functional modularity factor
significantly influences the ownership of design drawings. When the functional modularity of
auto parts is high, the DA system is likely to be chosen. On the other hand, the “internal
complexity factor” of auto parts is negatively associated with the DS system and is positively
related to the DA system and the DE system. While between the DE and DA system, there isno significant outcome concerning the internal complexity of auto parts. These results
indicate that the internal complexity of auto parts may be a separating line between in-house
design and design outsourcing regardless of the drawing ownership issue.

Insert Figure 2.

Results of the Logistic Regression Analysis about here.
30

The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry(1) Functional modularity and the ownership allocation of design drawings:
The result that functional modularity influences the ownership allocation of design drawings
firstly verifies the logic in our theoretical framework that high modularity between auto partsto achieve a certain functional parameter of an automobile can economize the inter-firmcoordination costs, especially the measurement costs. As design theory shows, thefunctional parameters specification or the establishment of functional structure is the firststep in the design process (Pahl and Beitz, 1984; Clark, 1985; Ulrich, 1995; Baldwin and
Clark, 2000). There reveals also the isomorphic relationship between the functionalparameter determination and the task partitioning (Hippel, 1990; Eppinger, 1991; Baldwin
and Clark, 2000). When the functional interfaces between auto parts are well defined and thefunctional parameters of each part are specified definitely, an auto maker can provide
suppliers with a strong incentive by letting them claim the property right of design drawings.
Under such a situation there is a good balance between a supplier’s incentive andresponsibility for design tasks and the merits of design outsourcing such as lead-time
shortening, cost reduction and quality improvement can be realized. Put differently, thisresult implies that the functional modularity of auto parts and their detailed design
outsourcing should be matched to achieve competence of supply chain.

(2). Why structural modularity had no impact on the transaction patterns?
Results from the empirical study show that the degree to which the physical interfaces
between auto parts can be well defined does not seem to be important in deciding whether tooutsource the detailed designing of auto parts. According to our framework, such anobservation means that the adjustment costs incurred from design modifications may notcause a serious inter-firm coordination problem. This point was confirmed during theinterview with the respondent who commented that the interface complexity of auto parts
seldom posed problems during the design process.

The reasons for this result may lie in our sample setting of the Japanese auto industry, where
the longstanding collaborative relationship between Supplier B and Auto Maker A could beassumed beforehand. Instead of engaging in time-consuming inter-firm negotiations when
design changes need to be done during the development process, Japanese auto makers
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Ge Dongsheng and Fujimoto Takahiro

and their suppliers usually seek to solve the problems together. It should be pointed out that
auto makers generally pay for the die costs to suppliers during the development stage, which
can be considered as important means of alleviating the inter-firm frictions when designchanges occur (Asanuma, 1997). Additionally, long-term communication and the frequentexchange of development staff between auto makers and suppliers also reduces thetechnological barriers to making design modifications. Therefore, given a shared cooperative
attitude and accumulated technological know-how concerning changed in the design of autoparts between Japanese auto makers and suppliers, the adjustment costs incurred in theinter-firm transactions are not meaningful enough to explain the choice of the varioustransaction patterns. This result can further imply that the optimal physical interface design
can be achieved by competitive Japanese auto makers if design changes can be conductedsmoothly.

(3) Internal complexity of auto parts and design task outsourcing:
The result that the internal complexity of auto parts is positively associated with theoutsourcing of detailed designing may be considered as an unusual result at first sight, since
relatively simple parts should generally be outsourced. The reason for the result, however,lies in our data collection method and the design of the survey items. Since we acquired datafrom the supplier and asked how much advanced technology was required or the number ofpatents acquired for designing and manufacturing the auto part, as one of the indicators of
the internal complexity of auto parts, this result actually describes the conditions for utilizing
the supplier’s development capability. This interpretation is compatible with the argument by
Asanuma (1989) that the more know-how suppliers accumulate for designing auto parts, thegreater the likelihood that design outsourcing will be done by the auto makers. It also backs
up the analysis of Fujimoto on the supplier system in Japanese auto industry that “bundled
outsourcing” to suppliers can make them “build a certain integrative capability in the long run”
and increase their likelihood of becoming “system suppliers” (Fujimoto, 2001, p. 23;
Nishiguchi, 1994).

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The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

8. Conclusions
8.1 Conclusions and Implications:
Choosing a dyadic transaction setting to control factors such as asset specificity andrelational skill, we discussed the make-or-buy decision for detailed design drawings of autoparts in the Japanese auto industry from the perspective of the architectural attributes. We
borrowed the taxonomy of transaction patterns classified by Asanuma (1989) and Fujimoto(1997), but we further clarified two dimensions --- the transactions as the design task
assignment and the ownership allocation of detailed design drawings. The inquiry into why
diverse patterns were observed in the transactions between one auto maker and one
supplier made us turn to the perspective of product architecture. We defined the architectural
attributes of auto parts in terms of functional and structural modularity that reflect the degreeof interdependency among auto parts within the automobile. Results of the hypothesis
testing effort showed that the functional modularity of auto parts had a significantly positiveeffect on the outsourcing of the detailed design when a supplier claims ownership of design
drawings. The internal complexity of auto parts showed a significantly positive effect on theoutsourcing of design tasks to suppliers but was irrelevant with respect to the ownership
dimension.

Our discussion of detailed design outsourcing in the Japanese auto industry can shed lighton both practical and academic issues. First, the functional modularity of the design of autoparts should be taken into account when deciding the outsourcing of design tasks, together
with other factors like asset specificity, capability or know-how, commitments, trust, and soforth. Balance should be secured between providing a high-powered incentive to a supplier,
clearly defining responsibility and coordinating costs during the product development
process. Matching between architectural attributes and the division of labor should beemphasized during decision making on outsourcing.

Second, the results contain some implications on the diverse trends of modularization
occurring in the global automobile industry. So-called modularization as the concept was
proposed during the 1990s mostly by European and American auto makers and suppliers,
means supplying a larger chunk of a composite module with quasi-independent functions
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Ge Dongsheng and Fujimoto Takahiro

from either a first-tier supplier or from an internal sub-assembly line to the main assemblyline (Fujimoto, 2001). From some previous research and our study here, it should be notedthat the delivery of functional modules where the responsibility is clearly defined between theauto maker and suppliers emerged and developed into a systematic practice in Japan muchearlier than the 1990s (Fujimoto, 1997, 2001). When the functional modularity of an auto
part’s design is high so that the scope of the supplier’s responsibility can be clearly defined,
the close communication within the long-term collaborative inter-firm relationships found in
the Japanese auto industry is likely to achieve the optimal modularization that both achieves
functional integration and avoids the redundant interface designs. The blind following of the
global trend towards modularization to make larger chunks without other considerations may
economize the assembly costs for auto makers, but improvements to design quality andconsumer satisfaction cannot be assured. At the same time, profit margins of supplierscannot be enlarged easily simply by incorporating more assembly tasks, and there is doubt
as to the incentive of suppliers to carry out such kind of modularization. Therefore, themodularization decision also needs to be made such that it is compatible with the context ofthe larger supplier system, and furthermore firms in Japan should not conduct
modularization at the sacrifice of the competitive advantage of the Japanese-style suppliersystem (Fujimoto, 2001; Takeishi and Fujimoto, 2002).

8.2. Research Limits and Future Study:
In our specific dyadic transaction setting, although factors such as supplier’s capability andasset specificity are controlled so that the effect of architectural attributes of auto parts canbe examined in an independent way, the likely sampling bias cannot be avoided. In addition,
since the research data was limited in the Japanese auto industry, there is also the difficultyof generalizing of our findings to other industries with products that have a different design
philosophy from the automobile. Furthermore, due to the explorative nature of our study, theconstructs and measurement of the variables were imperfect. Therefore, further refinementson the empirical study method are needed. Finally, going forward the simultaneous
examination of the choices of both architectural attributes and transaction patterns is also achallenging work that needs to be done. Rather than the static analysis of this paper, adynamic viewpoint should be added when the interactions between the effective
modularization and the changes of inter-firm transaction patterns are tackled. With the34

The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

inherent linkage to organizational issues, the perspective of product architecture is believed
to be promising raising new questions and providing new insights to the understanding ofinter-firm relationships in new product development.

35

Ge Dongsheng and Fujimoto Takahiro

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Ge Dongsheng and Fujimoto Takahiro

Figures:Figure 1

Taxonomy of Transaction Patterns of detailed design drawings

Drawing-approved
Supplier

System(DA system)

Ownership
Allocation

Auto Maker

Drawing-entrusted

Drawing-supplied

SystemSystem(DE system)(DS system)

Outsource

Make In-house

Design Task Assignment

Figure 2. Results of Empirical Study

FunctionalHigh

Design-approved
SystemModularity
FactorLow

Design-entrusted
Design-supplied
High

Low

Internal Complexity factor

42

Table 1 Descriptive Statistics and Correlation Matrix
Means

S.D.

FIN

FIN

2.66690.2741

1

PME

4.15150.2

0.3946 *1ICM

2.60610.26450.2267

0.168

1

ICP

2.15150.2

0.14850.0371

0.0967

1

PCF

3.66670.2671-0.03810.1001-0.33640.4172 *1

3.24240.3258-0.3150.2251-0.4128-0.1457

0.2942

1

PEI

ICM

ICP

PCF

PEI

DIN

DCM

FMU

SCM

TAD

*

DIN
DCM

FMU

SCM

TAD

PME

1.93940.19910.18990.4763 *0.1351-0.2461-0.228-0.01691

3.39390.2381

0.09601-0.1053

0.4592 *-0.41 **

-0.6304-0.3466

0.3679

1

**

*

3

3.45450.16280.2503-0.4614-0.4168**-0.28120.1543-0.3574

0.09140.16860.199-0.0904-0.19221-0.42510.04910.16220.30690.3787 *-0.21590.6149**3.5455

0.1986-0.3249

0.2131-0.1254

1

**
0.019

-0.1439

*

Note:
43

0.12890.4234 *-0.07280.47220.8001****1

*: Significant at 0.01 level;**: Significant at 0.05 level.

Sample Size: N=33
Variable Measures:
1: very low; 2: fairly low; 3: average; 4: fairly high; 5: very high.

Table 2

Results of Factor Analysis

Factor1

Factor2

Factor3

Factor4

FIN

0.497

0.128

-0.301-0.298PME

0.881

8.61E-02

0.211

2.09E-02

ICM

7.60E-02-0.17-0.538-0.304

ICP-1.99E-02

0.778-0.301

5.82E-02

PCF

8.57E-02

0.704

0.311

-4.99E-02

PEI

8.04E-02

4.53E-02

0.756

8.87E-02

DIN

0.538

-0.401-4.68E-02

0.37

DCM

5.52E-03-0.761-0.47-0.109FMU-0.4090.115

9.47E-02

0.684

SCM

0.142

7.66E-02

0.251

0.935

TAD

4.51E-02-7.99E-02

0.105

0.881

Loading weight?

0.22389

0.17472

0.13840.13537

44

The Architectural Attributes of Auto Parts and Their Transaction Patterns in Japanʼs Automobile Industry

Table 3 Results of Logistic Regression Analysis

Model 1
The DS System

Functional Modularity Factor

Structural Coupling Factor

Styling Design Factor

Internal Complexity Factor

Constant

Log. Likelihood

Model2Model 3

The DA System

Model 4Model 5

The DA System

The DE System

The DE System(vs. the DS System)(vs. the DA System)(vs. the DS System)

N＝33

N＝33

N＝22

N=25

N=19

-1.9660

0.8714*2.2851*-0.9752

1.2358(1.3551)(0.4830)(1.2888)(0.6017)(1.1688)

2.5081-0.2638-0.6245-0.3367-2.0680(1.8671)(0.8818)(1.1213)(1.0916)(1.6632)-1.1956

0.7132-2.3127-0.47140.3596(1.0504)(0.6512)(1.5956)(0.6648)(1.0788)-2.32110.9381*2.2982*-0.4960

1.6599*(1.1952)(0.501)(1.2717)(0.5129)(1.0015)

6.3799-7.45224.16126.9113-2.1215(5.2143)(5.3052)(4.0620)(5.7777)(5.1748)

22.66634.91614.73129.79119.19945