IP Modularity: Profiting from Innovation by Aligning Product Architecture with Intellectual Property

by Joachim Henkel, Carliss Y. Baldwin & Willy C. Shih

Overview — Firms increasingly practice open innovation, license technology out and in, outsource development and production, and enable users and downstream firms to innovate on their products. However, while such distributed value creation can boost the overall value created, it may create serious challenges for capturing value. This paper argues that in order to optimize value capture from a new product or process, an innovator must manage the artifact's intellectual property (IP) and its modular structure in conjunction. In other words, each module's IP status needs to be defined carefully and its boundaries must be placed accordingly. Fundamentally, IP modularity eliminates incompatibilities between IP rights in a given module, while permitting incompatibilities within the overall system. This in turn allows a firm to "have its cake and eat it too": It can reap the benefits of an open architecture while at the same time reducing the costs of opportunism on the part of suppliers, complementors, and employees. Key concepts include:

By managing a system's modular structure in conjunction with its IP, firms can overcome intrinsic conflicts between distributed value creation on the one hand, and value appropriation on the other hand.
The details of IP modularization must be determined by engineers and legal experts working together. But beyond the technical and legal concerns, IP modularity affects a firm's strategies for value appropriation in increasingly complex and fragmented technological spaces.
With own IP, IP modularity helps to reconcile distributed value creation with value capture, and to avoid IP "leakage" to suppliers and employees.
With external IP, an IP-modular architecture reduces holdup risk and other transaction costs of licensing, and may allow a firm to establish control over external, originally open IP.
Under conditions of uncertainty, "anticipatory" IP modularity creates option value: it allows a firm to better exploit upcoming opportunities for distributed value creation and to counter threats from inadvertent IP infringement.
Beyond products and processes, the concept of IP modularity also extends to organizations. An example is "Chinese Walls," the virtual barriers between different organizational units that prevent information exchange between these units. These units constitute "IP modules" within the organization, and the Chinese Walls between them are module boundaries.

Author Abstract

Distributed value creation can boost the overall value created, but may create serious challenges for capturing value. In order to draw in external contributors, an innovator often waives legal exclusion rights or reveals formerly exclusive knowledge. But as a result, contributors may appropriate a large share of the jointly created value. In turn, integrating external contributions entails the risk of becoming dependent on outside owners of IP. To address this tension we propose the concept of "IP modularity." We argue that, by managing a system's modular structure in conjunction with its IP, firms can reconcile distributed innovation with value capture.