The impact of modularity on intellectual property and value appropriation

Distributed innovation in open systems is an important trend in the modern global economy. In general, distributed innovation is made possible by the modularity of the underlying product or process. But despite the documented technical benefits of modularity, history shows that it is not always straightforward for firms to capture value in a modular system. This paper brings together the theory of modularity from the engineering and management literatures with the modern economic theory of property rights and relational contracts to address the question of value appropriation. It defines three generic threats to intellectual property (IP) and models the interactive impact of modularity and state-sanctioned IP rights on these threats. It identifies strategies for capturing value in so-called "open systems" in which IP is distributed among several parties. It shows why open systems should be designed as modular systems. Finally, it analyzes in detail the strategy of capturing value by maintaining exclusive control of an essential module in an open system.