The inexorable rise of the modular economy
The structure of the economy will be quite different in the future from what we see today.Chartered Accountants Australia and New Zealand - Acuity - July 2014
As business leaders consider the future, and what they need to do to prosper in the years ahead, they can readily identify a range of important trends. Developments such as globalisation, increasing connectivity, pervasive use of mobile devices, price transparency, China’s economic growth, ageing populations and many other trends are evident and well discussed.
However, often a critical assumption is made in the planning process: that the structure of the economy will be the same in the future as it is today.
The reality is that the entire nature of value creation is shifting. Traditional economic perspectives built on assumptions of rigidly delineated industry sectors often mislead more than they elucidate.
The modular economy
Perhaps the most useful way to think about the changing economic structure is the idea of the “modular economy”, in which value is created in increasingly small units that are combined in a wide variety of ways across organisational boundaries and between individuals.
The Nobel Prize-winning economist Ronald Coase proposed that organisations exist because of transaction costs: it is more efficient to coalesce economic activities inside a company due to the cost of finding and working with external resources. Yet in a connected, globalised world, transaction costs are now a tiny fraction of what they were in the 1930s when Coase formulated his ideas.
Today, organisations are no longer the locus of value creation. Value is created by orchestrating many smaller elements, sometimes within firms, often beyond organisational boundaries and increasingly between many individuals or micro-businesses.
One example of the modular economy can be found in Chongqing in Western China, where novel approaches have helped the city become the world’s largest centre for motorcycle manufacturing. The manufacturers in Chongqing dramatically overtook the previous industry leaders in Japan by taking a very different approach.
Rather than specifying requirements to their suppliers in minute detail, as the Japanese manufacturers do, they assemble their suppliers to discuss collectively the parameters of the motorcycle they wish to build, and let them work together to identify how the modules they create can fit together to achieve the group’s vision.
However, often a critical assumption is made in the planning process: that the structure of the economy will be the same in the future as it is today.
The reality is that the entire nature of value creation is shifting. Traditional economic perspectives built on assumptions of rigidly delineated industry sectors often mislead more than they elucidate.
The modular economy
Perhaps the most useful way to think about the changing economic structure is the idea of the “modular economy”, in which value is created in increasingly small units that are combined in a wide variety of ways across organisational boundaries and between individuals.
The Nobel Prize-winning economist Ronald Coase proposed that organisations exist because of transaction costs: it is more efficient to coalesce economic activities inside a company due to the cost of finding and working with external resources. Yet in a connected, globalised world, transaction costs are now a tiny fraction of what they were in the 1930s when Coase formulated his ideas.
Today, organisations are no longer the locus of value creation. Value is created by orchestrating many smaller elements, sometimes within firms, often beyond organisational boundaries and increasingly between many individuals or micro-businesses.
One example of the modular economy can be found in Chongqing in Western China, where novel approaches have helped the city become the world’s largest centre for motorcycle manufacturing. The manufacturers in Chongqing dramatically overtook the previous industry leaders in Japan by taking a very different approach.
Rather than specifying requirements to their suppliers in minute detail, as the Japanese manufacturers do, they assemble their suppliers to discuss collectively the parameters of the motorcycle they wish to build, and let them work together to identify how the modules they create can fit together to achieve the group’s vision.
Implications and strategic questions
The forces underlying the rise of the modular economy have been in place for well over a decade. However, the real impact of this shift in the structure of value creation has become evident only over the past few years. This trend has far further to run, and organisations need to address the challenges and seize the emerging opportunities.
The implications will play out very differently depending on issues such as a company’s industry, size and geographical scope. To understand the actions they should be taking, leadership teams should be asking themselves three strategic questions:
- How can we compete with modularised offerings?
- How can we drive efficiencies through modularisation?
- What governance structures are required?
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