the pricing and profitability of modular clusters carliss y. baldwin modularity mini-conference...
TRANSCRIPT
The Pricing and Profitability of Modular Clusters
Carliss Y. Baldwin
Modularity Mini-ConferenceLondon Business SchoolOctober 2, 2003
Slide 2 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
5055
60
65
70
75
80
85
90
95
0
20
40
60
80
100
120
140
160
180
YearSIC Code or Company
This is an emergent modular cluster
Slide 3 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Another View Showing Dramatic Increases in Aggregate Market Value even as the Number of Firms Grows
0
100
200
300
400
500
600
700
800
900
1000
50 55 60 65 70 75 80 85 90 95
Slide 4 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Can it last? Chandler-Abernathy-Utterback-Klepper theory of
industry evolution says “no”
Predictions of consolidation have occurred in every downturn since 1980– Larry Ellison of Oracle in 2003
Is the Modular Cluster form of industrial organization sustainable as a long-term equilibrium?– Pricing holds the key– If firms kill each other in product markets, consolidation will
occur
Slide 5 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Quick review of price theory Price competition among imperfect substitutes
– Prices go down as number of firms goes up – Cournot quantities, Hotelling beach…
Vertical price externality among complements– Prices go up as number of firms in a vertical supply
chain or a system of complements goes up – “Double marginalization”—Intuition
Slide 6 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
YesHow?
Read the paper!
Executive Summary
Can imperfect price competition and the vertical pricing externality offset one another in a large cluster?
Slide 7 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Our Thought Experiment Beach resort vacation
– Travel, hotel, restaurants, sports, tours, taxis… – Equipment supply, laundry, maid service,
furniture, food wholesale…– Hospital, police, roads, buildings, electricity…
Large number of primitive production components—– All essential to the system– Many variants of each
Slide 8 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Our Thought Experiment Symmetric modular partitions Divide the complements and variants up in
different ways– 1x1 = One Big Firm– Jx1 = J Module Monopolies– 1xN = N Full-span Oligopolies– JxN = N firms competing in J module markets
One BigUpstream NU SU
FirmDownstream ND SD
One Big Firm Full-span Two Module ModularDuopolists Monopolists Cluster
North
South
Slide 9 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Our Thought Experiment
One BigUpstream NU SU
FirmDownstream ND SD
One Big Firm Full-span Two Module ModularDuopolists Monopolists Cluster
North
South
One Big Firm Five Full-Span Ten Module Fifty Firms in aOligopolists Monopolists Modular Cluster
Our model aims to look at an unlimited number of alternate “configurations”
Slide 10 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
The Key Assumption The representative firm perceives its demand
function to be:qi = i(pi ; …) Q[P(pi ; …)]
where pi is its own price.
i(pi ; …) is “market share” and depends on the prices in its “own market”.
Q[P(pi ; …)] is “system demand” and depends on the average prices of goods in the other “module markets”.
This decomposition makes analysis of symmetric JxN clusters feasible. Otherwise, combinatorial explosion!
Slide 11 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
The “array of configurations” We solve for the pricing equilibrium in each cell
and compute aggregate profitMore Firms in Each Market
1x1 1x2 1x3 1x4 … 1xM 1xN …
More 2x1 2x2 2x3 2x4 … 2xM 2xN
Module 3x1 3x2 3x3 3x4 … 3xM 3xN
Markets 4x1 4x2 4x3 4x4 … 4xM 4xN
…
Jx1 Jx2 Jx3 Jx4 … JxM JxN
Kx1 Kx2 Kx3 Kx4 … KxM KxN
… …
Slide 12 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Results—Prices Along the edges of the array
13
57
911
1315
1719
13
57
911
1315
1719
0
200
400
600
800
1000
1200
1400
1600
1800
2000
Equilibrium System Price
Number of Modules (J =1 - 20)
Number of Firms Per Module Market
(N = 1 -20)
1xN Configurations
One Big Firm1x1 ConfigurationJx1
Configurations
Slide 13 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Results—Aggregate Profit Along the edges of the array
13
57
911
1315
1719
13
57
911
1315
1719
0
100
200
300
400
500
600
700
800
900
1000
AggregateProfit
Number of Modules (J =1 - 20)
Number of Firms Per Module Market
(N = 1 -20)
Jx1 Configurations
One Big Firm1x1 Configuration 1xN
Configurations
Slide 14 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Results—Prices Full array
135791113151719
1357
911
1315
1719
0
200
400
600
800
1000
1200
1400
1600
1800
2000
Equilibrium System Price
Number of Modules (J =1 - 20)
Number of Firms Per Module Market
(N = 1 -20)
Cluster System Price EqualsOne Big Firm System Price
Slide 15 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Results—Aggregate Profit Full array, reverse view—Note “sweet spots”
13
5 7 9 11 13 15 17 19
13
57
911
1315
1719 0
200
400
600
800
1000
1200
AggregateProfit
Number of Modules (J =1 - 20)
Number of Firms Per Module Market
(N = 1 -20)
Slide 16 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Implications for strategy Cluster form is sustainable in theory Financiers’ payoff vs. a firm’s payoff Disintegration can pay… Financiers can use M&A to approach the industry
sweet spot, but… Can a decentralized
cluster find thepricing equilibriumat the sweet spot?
13
5 7 9 11 13 15 17 19
13
57
911
1315
1719 0
200
400
600
800
1000
1200
AggregateProfit
Number of Modules (J =1 - 20)
Number of Firms Per Module Market
(N = 1 -20)
Slide 17 © C. Y. Baldwin, K. B. Clark, and C. J. Woodard 2003
Further implications for strategy Two kinds of clusters
– “Federated” clusters: all modules compatible– “Portal” clusters: Platform firms with captive module
complementary module suppliers – Both appear to exist in the real world
Portal clusters priceas 1xN, need smallnumbers
Can a cluster evolve from “portal” to “federated”by increasing thetechnical compatibilityamongst modules? 1
35 7 9 11 13 15 17 19
13
57
911
1315
1719 0
200
400
600
800
1000
1200
AggregateProfit
Number of Modules (J =1 - 20)
Number of Firms Per Module Market
(N = 1 -20)
Thank you!