The option value of modularity in design
Subtitle: an example from Design rules, volume 1 : the power of modularity
By: Carliss Y. Baldwin, Kim B. Clark
Contributors: Harvard Business School. Division of Research
Series: Working paper / Division of Research, Harvard Business School -- 02-078; Working paper (Harvard Business School. Division of Research) -- 02-078
Publisher: Division of Research, Harvard Business School
Published: 2002
Place of publication: Boston
Language: eng
Number of pages: 14
Other titles: Design rules.
Description: When the design of an artifact is "modularized," the elements of the design are split up and assigned to modules according to a formal architecture or plan. Some of the modules are "hidden," meaning that design decisions in those modules do not affect decisions in other modules; some of the modules are "visible," meaning that they embody "design rules" that hidden-module designers must obey if the modules are to work together. Modular designs offer alternatives that non-modular ("interdependent") designs do not provide. Specifically, in the hidden modules, designers may replace early, inferior solutions with later, superior solutions. Such alternatives can be modeled as "real options." In Design Rules, Volume 1: The Power of Modularity (MIT Press, 2000) we sought to categorize the major options implicit in a module design, and to explain how each type can be valued in accordance with modern finance theory. This paper provides an example of the valuation of the modular options "splitting" and "substitution." We show that the key drivers of the "net option value" of a particular module are (1) its "technical potential" (labeled ơ, because it operated like volatility in financial option theory); (2) the cost of mounting independent design experiments; and (3) the "visibility" of the module in question. The option value of a system of modules in turn can be approximated by adding up the netoption values inherent in each module and subtracting the cost of creating the modular architecture. A positive value in this calculation justifies investment in a new modular architecture.
Notes: Includes bibliographical references.