31 Mar 2010Working Paper Summaries

When Open Architecture Beats Closed: The Entrepreneurial Use of Architectural Knowledge

by Carliss Y. Baldwin

Entrepreneurial firms rich in knowledge but poor in other resources can use superior architectural knowledge of a technical system to gain strategic advantage over larger and better endowed rivals. This paper presents a model and provides examples showing that architectural knowledge can be applied strategically to change a firm's scope and boundaries, make innovations more or less autonomous, and change the span of problems it must solve. Key concepts include:

Architectural knowledge is knowledge about the components of a complex system and how they are related.
Architectural knowledge includes knowledge about how the system performs its functions; how the components are linked together; and the behavior of the system, both planned and unplanned, in different environments.
For a small entrepreneurial firm with limited financial resources facing larger rivals, the most valuable architectural knowledge pertains to bottlenecks and remodularizations that isolate the bottlenecks. Such knowledge can form the basis of a small footprint technical architecture that delivers an ROIC (higher return on invested capital) advantage.
Technical systems that are susceptible to remodularization around bottlenecks are strategic targets of opportunity for entrepreneurial firms. Incumbents risk being displaced by smaller rivals with superior architectural knowledge leading to an ROIC advantage.

Author Abstract

This paper describes how entrepreneurial firms can use superior architectural knowledge to open up a technical system to gain strategic advantage. The strategy involves, first, identifying "bottlenecks" in the existing system, and then creating a new open architecture that isolates the bottlenecks in modules and allows others to connect to the system at key interfaces. An entrepreneurial firm with limited financial resources can then focus on supplying superior bottleneck modules, while outsourcing and allowing complementors to supply non-bottleneck components. I show that a firm pursuing this strategy will have a higher return on invested capital (ROIC) than competitors with a less modular, closed architecture. Over time, the more open firm can drive the ROIC of competitors below their cost of capital, causing them to shrink and possibly exit the market. The strategy was used by Sun Microsystems in the 1980s and Dell Computer in the 1990s. Keywords: architecture, innovation, knowledge, modularity, dynamics, competition, industry evolution.