Modularity for Value Appropriation--How to Draw the Boundaries of Intellectual Property

by Carliss Y. Baldwin & Joachim Henkel

Overview — Many firms have adopted models of "open innovation," in which they seek ideas from external sources such as university labs, independent entrepreneurs, customers, and other companies. While such a business model has the potential to create value, the inherent intellectual property issues can be sticky. This paper discusses how companies can address these issues by adopting a system of modularity, wherein innovation in one part of a project will not require changes in all the other parts. Research was conducted by Joachim Henkel of Technische Universität München and Harvard Business School professor Carliss Y. Baldwin. Key concepts include:

Controlling too much of the system's intellectual property will deter outside innovation, but controlling too little can prevent a firm from capturing value.
A system can use different, incompatible forms of intellectual property and still be IP-modular, provided that the incompatible chunks of knowledge are associated with different modules within the whole system.
The optimal modular structure for capturing value is not necessarily the same as the optimal structure for creating value.

Author Abstract

The existing theory of modularity explains how modular designs create value. We extend this theory to address value appropriation. A product or process design that is modular with respect to intellectual property (IP) allows firms to better capture value in situations where knowledge and value creation are distributed across many actors. We propose a theory of IP modularity based on value maximization net of transaction and agency costs. We then use case examples to extend the theory into practical settings and derive strategic recommendations and empirical predictions.