slide 1 © carliss y. baldwin and kim b. clark, 2005 unmanageable designs: what some designs need...

© Carliss Y. Baldwin and Kim B. Clark, 2005

Unmanageable Designs: What Some Designs Need from the Economy and How They Get It

Carliss Y. BaldwinHarvard Business School

2005 SDM ConferenceOctober 27, 2005


Three Points Designs “need” to become real

– They become real by creating the perception of “value” Designs act as a financial force

– Perception of value = Incentive to invest– In making the design— “use value”– In making the design better— “option value”

Modular Designs with Option Potential– Create hurricane-type forces– Will change their economic “space”– Unmanageable and dangerous (unless you understand

them)


Metaphor— “Selfish Designs” “Selfish” designs want to become real Their tool is human motivation

– A user perceives use-value => willingness to make or willingness-to-pay

– Designers and producers estimate willingness to pay

– The result is an asset => financial value

Humans move mountains for financial value– Value operates “as a force” in the economy

– Some designs have so much of this force that we work for them…


Strong value forces can change the shape of an industry

Andy Grove described a vertical-to-horizontal transition in the computer industry:

“Modular Cluster”

“Vertical Silos”


Andy’s Movie

Stack View in 1980Services S

PSystems Integration E

RR

Applications Layer Y D CVCMiddleware Layer U H E

Operating Systems IBM N P CS

Hardware Y XRCSAMP

ComponentsTI Intel

Top 10 Public Companies in US Computer Industry

Area reflects Market Value in Constant US $


Andy’s Movie

Stack View in 1995SPERRY D CVCU H E

IBM N P CSY XRCSAMP

TI Intel



ServicesFirst Data

Systems Integration EDSOracle

I CAApplications Layer B MSFTMiddleware Layer M

Operating Systems

Hardware: Printers HPHardware: Servers IBMHardware: Routers Cisco

Components IntelMicron


Andy’s Movie—the Sequel

Stack View in 2002SPERRY D CVCU H E

IBM N P CSY XRCSAMP

TI Intel



ServicesFirst Data

Systems Integration EDSOracle

I CAApplications Layer B MSFTMiddleware Layer M

Operating Systems

Hardware: Printers HPHardware: Servers IBMHardware: Routers Cisco

Components IntelMicron

Services First DataADP

Systems Integration

OracleApplications Layer IBM

Middleware Layer MSFT

Operating Systems

Hardware: Printers HPHardware: PCs Dell

Hardware: Servers IBMHardware: Routers Cisco

Components Intel TI


Turbulence in the Stack

Departures from Top 10: Xerox (~ bankrupt) DEC (bought) Sperry (bought) Unisys (marginal) AMP (bought) Computervision (LBO)

Arrivals to Top 10: Microsoft Cisco Oracle Dell ADP First Data

Sic Transit Gloria Mundi … Sic Transit


Value Migration: 1950-1996

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ADRsIBM

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Significant Option-Rich Modular Design Architectures

IBM System/360

DEC PDP 11; VAX

IBM PC

Sun 2; 3; Java VM

RISC

Internet Protocols (end-to-end principle)

Unix and C; Linux

HTML; XML(?)


This was the puzzle Kim Clark and I began to tackle in 1987

Where was the value shown in the slide coming from?

Designs, yes, but what part and why?


After studying the designs and correlating their changes with value changes

We concluded that modularity was part of the answer…


IBM System/360

First modular computer design architecture (1962-1967)– Proof of concept in hardware and application

software– Proof of option value in market response and

product line evolution– System software was NOT modularizable

» Fred Brooks, “The Mythical Man Month”

» Limits of modularity


1965—IBM wanted to be the sole source of all of System/360’s Modules

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

1 SLT architecture and standard circuits2 Erich Bloch - August 19613 New Processor Line Architectural Ground Rules4 SPREAD Task Group - 12/28/615 New Processor Line control, product and programming standards6 Corporate Processor Control Group (CPC) - 4/1/62

7 SLT Transistors8 SLT Modules9 SLT Cards

10 SLT Boards and Automatic Wiring11 Processor 1 - Endicott, New York12 Processor 2 - Hursley, England13 Processor 3 - Poughkeepsie, New York14 Processor 4 - Poughkeepsie, New York15 Processor 5 - Poughkeepsie, New York16 Main memories, Corporate Memory Group (1)17 Internal memories, CMG18 Read-only memories for control, CMG19 "Binary-addressed" Random Access Files20 Corporate File Group (2)21 Tape devices running at 5000+ char/sec22 Corporate Tape Group (3)23 Time-multiplex system for switching I/O devices24 DSD Technical Development Group

25 Techniques to measure processor performance, system26 throughput and software efficiency, Group Staff27 A unified Input/output Control Structure (IOCS)28 System Software for Configuration I (4)29 System Software for Configuration II (4)30 System Software for Configuration III (4)31 FORTRAN and COBOL compilers32 A unified programming language

33 Announcement and Marketing34 Production, Testing and Integration35 Shipment, Delivery and Installation


IBM System/360

IBM did not understand the option value it had created

Did not increase its inhouse product R&D Result: Many engineers left

– to join “plug-compatible peripheral” companies San Jose labs —> Silicon Valley

“Compelling, surprising, dangerous”


1975—What actually happened: Entry on modules

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

1 SLT architecture and standard circuits2 Erich Bloch - August 19613 New Processor Line Architectural Ground Rules4 SPREAD Task Group - 12/28/615 New Processor Line control, product and programming standards6 Corporate Processor Control Group (CPC) - 4/1/62

7 SLT Transistors8 SLT Modules9 SLT Cards

10 SLT Boards and Automatic Wiring11 Processor 1 - Endicott, New York12 Processor 2 - Hursley, England13 Processor 3 - Poughkeepsie, New York14 Processor 4 - Poughkeepsie, New York15 Processor 5 - Poughkeepsie, New York16 Main memories, Corporate Memory Group (1)17 Internal memories, CMG18 Read-only memories for control, CMG19 "Binary-addressed" Random Access Files20 Corporate File Group (2)21 Tape devices running at 5000+ char/sec22 Corporate Tape Group (3)23 Time-multiplex system for switching I/O devices24 DSD Technical Development Group

25 Techniques to measure processor performance, system26 throughput and software efficiency, Group Staff27 A unified Input/output Control Structure (IOCS)28 System Software for Configuration I (4)29 System Software for Configuration II (4)30 System Software for Configuration III (4)31 FORTRAN and COBOL compilers32 A unified programming language



By 1980, 100s of firms made S/360 “plug-compatible” components

Code Category Definition 1960 1970 1980

3570 Computer and Office Equipment 5 2 93571 Electronic Computers 1 8 293572 Computer Storage Devices 1 6 36 *3575 Computer Terminals 2 5 23 *3576 Computer Communication Equipment 1 1 10 *3577 Computer Peripheral Devices, n.e.c. 3 5 12 *3670 Electronic Components and Accessories 11 7 11 *3672 Printed Circuit Boards 2 19 39 *3674 Semiconductors and Related Devices 8 4 10 *3678 Electronic Connectors 5 15 16 *7370 Computer Programming, Data Processing,

and Other Services 1 9 26 *7371 Computer Programming Services 0 2 12 *7372 Prepackaged Software 0 7 13 *7373 Computer Integrated Systems Design 1 3 167374 Computer Processing, Data Preparation

and Processing 0 5 29 *7377 Computer Leasing 0 10 7 *

41 108 298

* Firms in these subindustries make modules of larger computer systems. Firms making modules = 34 95 244Percent of total = 83% 88% 82%


Short History (continued) Bell and Newell, Computer Structures (1971)

– General principles of modular design for hardware– Basis of PDP-11 design—another ORMDA

Thompson and Ritchie, Unix and C (1971-1973)– Modular design of operating system software (contra

Brooks Law)– Over time, general principles for evolvable software

design (Unix philosophy) Mead and Conway, Intro to VLSI Systems (1980)

– Principles of modular design for large-scale chips


Short History (continued) IBM PC (1983)

– DEC PDP-11 minimalist strategy (exclude and invite) – + Intel 8088 chip– + DOS system software – + IBM manufacturing – + Lotus 1-2-3– A modular design architecture with a mass market

Visions of $$$ dance in your heads!


As scientists, we can visualize and measure modularity in design— after the fact

DSMs, Design Hierarchies

Methods are tedious, non-automated

Mozilla just after becoming open source Linux of similar size

Coord. Cost = 30,537,703Change Cost = 17.35%


Comparison of different software systems with DSM tools

Mozilla just after becoming open source Linux of similar size



Conway’s Law: Different organizations deliver different architectures

One Firm, Tight-knit Team, RAD methods

Distributed Open Source Development

Mozilla April 98 Mozilla Dec 98Location On left On rightSize 1684 1508Coordination Cost 30,527,703 10,234,903 Change Cost 292.0932 41.8561Change Cost % 17.35 2.78

Mozilla Before Redesign Mozilla After Redesign

!!


But modularity is only half the story—options matter, too

“Creates” vs. “Frees up” Designs have “option potential”, denoted varies by system and by module

Modularity in the absence of option potential is at best breakeven, at worst an expensive waste of time


Modularity without (enough) option potential

Auto front-end modules (Fourcade)– Much experimentation, leading nowhere

Mobile computers (Whitney-Weinstein)– Power management favors more integral designs

Semiconductors (Strojwas)– IDMs vs. Fabless-Foundry pairs

– Competing types of option potential

– Both forms seem viable for now


Stack View of the Semiconductor Industry (Strojwas, 2005)

Top 10 Firms:

1994 and 2004


What is this elusive property that gives rise to option value?

Where does it arise?

Can we measure it?


Global Design Rules v.1

Version 1.0Version 1.2

Version 1.5Version 1.8

Low Medium Zero High

Measuring Option Potential Successive, improving versions are evidence of

option potential being realized over time—after the fact

Designers see option potential before the fact What do they see?


Major challenge in research and practice right now

Science may not be able to deliver tools to measure ex ante option potential reliably

But ex ante estimates are what’s needed


Sources of option value 1 Physics—

– Whitney: VLSI is different, more splittable– But there is also Moore’s Law

» Dynamics of miniaturization

» Virtuous cycle in mfr. cost and power consumption as chips get smaller

» Explained by Mead and Conway in 1980

– Option value lies in seamless, asynchronous upgrading

» Modeled in Design Rules


Sources of option value 2 Users—new perceptions => new preferences

– Perceptions of desires emerge through use – Value of discovery, direct experience, play– Unexplored preferences = option potential

Kim Clark (1985): Evolving design hierarchies create new preferences w.r.t. each module

Case studies of vertical disintegration driven by search/discovery of new preferences – Frozen food in the UK– Mortgage banking in the US (IO vs. PO)


Sources of option value 3

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Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05

System Availability Date

tpmC and Spec CInt

Key Pfister TPC-C v.3 TPC-C v.5 Spec CPU 95 Spec CPU 2000


Sources of option value 3 Pfister’s Observation (in my language)

– Recombining modules in new ways has more option value than the modules themselves

Amdahl’s Law “Make the frequent case fast”—– First architecture is not the best – Fred Brooks: “Build one and throw it away” – Value of architectural experimentation/optimization

present in all complex systems Not what we model in Design Rules

– Architecture should be a (process) module– Stage in the value chain, node in the network


Where we are in the argument: Designs “need” to become real

– They become real by creating the perception of “value” Designs act as a financial force

– Perception of value = Incentive to invest– Use value– Option value = Potential to improve

Modular Designs with Option Potential– Create hurricane-type forces– Will change their economic “space”– Unmanageable and dangerous (unless you understand

them)


Next questions

What do option-rich modular designs do to the economy?

How do you manage something inherently unmanageable?

Will you always get a modular cluster of firms?


QUICK Answers What do option-rich modular designs do in the

economy?– Attract entry with a promise of lots of $$$

How do you manage something inherently unmanageable?– At first, you don’t– Then, small footprints yield high ROIC– Then, lead firm M&A

Will you always get a modular cluster of firms?– Yes, almost certainly


Faced with this value proposition, what should you do?

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One module or many?

In each module you chose, how many design searches?

Which modules are most attractive?


Lots of stories They all make sense When you see them play out, the moves are

logical and in some cases “inevitable” But our strategic advice for managers and

financiers today comes down to: – “plunge in,”

– “get lucky,”

– “watch out for Microsoft,” and

– “get bought by HP”


Our research strategy—Look for

Stable patterns of behavior involving several actors operating within a consistent framework of ex ante incentives and ex post rewards

==> Equilibria of linked games with self-confirming beliefs (Game theory)


How a “stable pattern” works

Anticipation of $$$ (visions of IPOs) Lots of investment Lots of design searches Best designs “win” Fast design evolution => innovation Lots of real $$$ (an actual IPO)

“Rational expectations equilibrium”


Three Stable Patterns (not quite Equilibria…)

“Blind” Competition– PCs in the early 1980s

High ROIC on a Small Footprint – Sun vs. Apollo– Dell vs. Compaq (and HP and …)

Lead Firm Competition– Monopoly—MSFT– Mergers & Acquisitions—Cisco, Intel …

“Blind” Competition

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

4.00-6.00

2.00-4.00

0.00-2.00

-2.00-0.00

-4.00--2.00

-6.00--4.00

-8.00--6.00

-10.00--8.00

All Zeros

All Ventures All Fighters

ESS (1/8, 3/8, 4/8)


Footprint Competion 1980—IBM provided few PC Modules

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

1 Intel 80882 Instruction Set3 IBM PC Technical Reference Manual4 for Hardware and Software —published5 Microsoft DOS6 Application Programmer Interfaces (APIs)

78 PC Hardware Components9

10111213 Intel 8088 Microprocessor14151617 Japanese DRAMs181920 Outsourced Floppy Disk Drives2122 Tape drives 2324 Time-multiplex system for switching I/O devices

25 Techniques to measure processor performance, system26 throughput and software efficiency, Group Staff27 IBM BIOS28 Microsoft DOS29 Microsoft Basic30 Lotus 1-2-331 Word Perfect32 Other Applications



But then … Compaq reverse engineered the BIOS Chips and Technologies made “chipsets” Taiwanese clones had cheaper/better

manufacturing Intel refused to second-source 80386 Microsoft sabotaged OS/2


1990—IBM PC is the standard, but IBM makes no money

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

1 Intel 80882 Instruction Set3 IBM PC Technical Reference Manual4 for Hardware and Software —published5 Microsoft DOS6 Application Programmer Interfaces (APIs)

78 PC Hardware Components9

10111213 Intel 8088 Microprocessor14151617 Japanese DRAMs181920 Outsourced Floppy Disk Drives2122 Tape drives 2324 Time-multiplex system for switching I/O devices

2526 Magazines rate components' quality and compatibility27 Clones28 Microsoft DOS29 Microsoft Basic30 Lotus 1-2-331 Word Perfect32 Other Applications

33 Announcement and Marketing34 Clones Production, Testing and Integration35 Shipment, Delivery and Installation


Footprint Competition—Apollo1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42

1 O Processor chip—CPU2 Outsourced—Motorola 680x0 Key:3 O Floating Point Accelerator x= transfer of material or information from column4 Outsourced task to row task;5 O Memory chips DRAMs, ROM T= transaction: sale of good by column owner to row6 Outsourced—Commodity owner;7 O Storage—Disk Drives O= outsourced task blocks;8 Outsourced D= downstream or complementary task blocks;9 O Storage—Tape Drive highly interdependent task blocks with many iterations

10 Outsourced and high within-block mundane transaction costs;

11 O Printed circuit boards Apollo's footprint (tasks performed inhouse).

12 Outsourced—Commodity13 O Display Monitor14 Outsourced15 O Keyboard, Cabinet, Fans16 Outsourced

17 x x x x x x x x x x x x x x x x Aegis proprietary18 Inhouse Operating System19 Design20 x x x x x x x x x x x x x x x x OS DOMAIN proprietary21 Network Network Architecture2223 x x x x x x x x x x x x x x x x Hardware Design24 DN series = 3-4 boards incl.

25 Hardware IO and Display controllers,26 Power supply27 T T T T T T T T T T T T T T T T x x x x Purchase Components28 Component Test x x x x x29 Kits x x x x x x Inhouse30 Board stuff and Solder x x x x x x Manu-31 Test Boards x x x x x x facturing32 Board Assembly x x x x x x33 System Assembly x x x x x x34 System Test x x x x x x35 Quality Assurance x x x x x x36 Consolidate and Ship x x x x x x

37 x x x x x x D38 x x x x x x Many Software Applications D39 x x x x x x D40 x x x x x x x x x x T D41 x x x x x x x x x x Many OEMsT D42 x x x x x x x x x x T D

Keeps Design Control


Then Sun came along…Apollo Computer

Aegis proprietaryInhouse Operating SystemDesignOS DOMAIN proprietary

Network Network Architecture

Hardware DesignDN series = 3-4 boards incl.

Hardware IO and Display controllers,Power supply

x x x x Purchase ComponentsComponent Test x x x x x

Kits x x x x x x InhouseBoard stuff and Solder x x x x x x Manu-

Test Boards x x x x x x facturingBoard Assembly x x x x x x

System Assembly x x x x x xSystem Test x x x x x x

Quality Assurance x x x x x xConsolidate and Ship x x x x x x

And did even less!

How?

x x x x x Customize Unixx x x x x Inhouse Proprietary MMU

x x x x x Design Internal busx x Single Board Layout

T T T T x x x x Purchase ComponentsComponent Test x x x x x O

Kits x x x x T Manu-Board stuff and Solder x x x x x O facturing

Test Boards x x x x TBoard Assembly x x x x x

System Assembly x x x x xSystem Test x x x x x

Quality Assurance x x x x xConsolidate and Ship x x x x x


Then Sun came along…Apollo Computer

Aegis proprietaryInhouse Operating SystemDesignOS DOMAIN proprietary

Network Network Architecture

Hardware DesignDN series = 3-4 boards incl.

Hardware IO and Display controllers,Power supply

x x x x Purchase ComponentsComponent Test x x x x x

Kits x x x x x x InhouseBoard stuff and Solder x x x x x x Manu-

Test Boards x x x x x x facturingBoard Assembly x x x x x x

System Assembly x x x x x xSystem Test x x x x x x

Quality Assurance x x x x x xConsolidate and Ship x x x x x x

And did even less!

x x x x x Customize Unixx x x x x Inhouse Proprietary MMU

x x x x x Design Internal busx x Single Board Layout

T T T T x x x x Purchase ComponentsComponent Test x x x x x O

Kits x x x x T Manu-Board stuff and Solder x x x x x O facturing

Test Boards x x x x TBoard Assembly x x x x x

System Assembly x x x x xSystem Test x x x x x

Quality Assurance x x x x xConsolidate and Ship x x x x x

Design Architecture for performance

Public Standards for outsourcing


Result: ROIC advantage to SunAverage over 16 Quarters: Apollo Sun

Computer MicrosystemsInvested Capital Ratios (Annualized)Net Working Capital/ Sales (%) 29% 15% Low is goodEnding Net PPE / Sales (%) 24% 13% Low is goodInvested Capital/Sales (%) 57% 31% Low is good

ProfitabilityNet Income/Sales 0% 6% High is good

ROICROIC (excl Cash, Annualized) 2% 20% High is good

Sun used its ROIC advantage to drive Apollo out of the market


Compaq vs. Dell Dell did to Compaq what Sun did to Apollo …

Dell created an equally good machine, and Used modularity-in-production to reduce its

footprint in production, logistics and distribution costs– Negative Net Working Capital– Direct sales, no dealers

Result = Higher ROIC


Higher ROIC always wins!1997 Compaq Dell

Computer ComputerInvested Capital Ratios (Annualized)Net Working Capital/ Sales (%) -2% -5% Low is goodEnding Net PPE / Sales (%) 8% 3% Low is goodInvested Capital/Sales (%) 8% -2% Low is good

ProfitabilityNet Income/Sales 8% 7% High is good

ROICROIC (excl Cash, Annualized) 101% -287% !!!

Dell started cutting prices; Compaq struggled, but in the end had to exit.

Like Apollo, they were acquired by HP!


Lead Firms vs. Others

“Blind” competitors – don’t know others exist

“Footprint” competitors – Don’t expect to influence others—just compete

“Lead firms”– Must influence the beliefs of their competitors– FUD — “Fear, uncertainty and doubt” – Others cannot be blind!


Monopoly or M&A?

Monopoly needs to deter all potential entrants with threats of price war– Very fragile equilibrium

– Potentially expensive to create “enough” FUD

M&A Lead Firm does not try to deter all entry in the design space– Expects to buy most successful entrants ex post

– More robust equilibrium

– Maybe more advantageous, when you count the cost of FUD


Industry Outcomes

“Blind” competition – Cluster (entry everywhere in the architecture)

“Footprint” competition – Cluster (small footprint => vertical

disintegration) M&A Lead Firm

– Cluster (lead firm does not deter all entry) Monopoly

– One Big Firm


Designs as an object of economic analysis—Remember

Designs “need” to become real– They become real by creating the perception of “value”

Designs act as a financial force– Perception of value = Incentive to invest

Modular Designs with Option Potential– Create hurricane-type forces– Will change their economic “space”– Unmanageable—cannot be confined in one firm or a

supply chain – Dangerous (unless you understand them)


One more story before we close—

5053

5659

6265

6871

7477

8083

8689

9295

737773747373

7372 ex Microsoft

Microsoft

737173703678

3674 ex Intel

Intel3672367035773576357535723571

3570 ex IBM

ADRsIBM

0

20

40

60

80

100

120

140

160

180

$ billion

Significant Option-Rich Modular Design Architectures

IBM System/360

DEC PDP 11; VAX

IBM PC

Sun 2; 3; Java VM

RISC

Internet Protocols (end-to-end principle)

Unix and C; Linux

HTML; XML(?)


The Bright Side of the Option-rich Modular Designs

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But there was The Dark Side …

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$ 2.5 trillion appeared then disappeared in the space of four years!


Bubble followed by a Crash

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A failure,

not of the Internet’s design architecture,

but of the economic institutions built on that architecture


Ultimate unmanageability

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$ billion


A reason—if we need one—to try to turn our stories into science…


Thank you!

slide 1 © carliss y. baldwin and kim b. clark, 2005 unmanageable designs: what some designs need...

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