Modularity-in-Design: An Analysis Based on the Theory of Real Options

Abstract

This paper investigates the economic role of modularity in the design of new products and processes. We construct a formal model of the design process based on the financial theory of options, and analyze the benefits and costs of breaking apart a complex design into independent modules linked by pre-established interfaces. The model provides a rigorous framework for dealing with the effects of uncertainty, and shows how modular designs, independent experiments and testing technologies interact to create economic value. The model also shows how modularity rests on and contributes to the knowledge and organizational structure of a company.

JEL Classification: G31, M10, O32