Int. J.

Production Economics 131 (2011) 736746

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Int. J. Production Economics

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Assessing performance of utilizing organizational modularity to manage supply chains: Evidence in the US manufacturing sector
Liang-Chieh (Victor) Cheng n
Department of Information & Logistics Technology, College of Technology, 230E Technology Building, University of Houston, Houston, TX 77004-6020, USA

a r t i c l e i n f o
Article history: Received 3 May 2010 Accepted 18 February 2011 Available online 24 February 2011 Keywords: Supply chain design Modular design Performance metrics Outsourcing

a b s t r a c t
Recent competition and customization have motivated manufacturers to institute modular organizations to manage supply chains. Proclaimed as a paradigm shift, organizational modularity manifests agility and exibility to diversify product offerings, utilize production capacity, and allocate network capital and assets. Whereas studies have conceptualized the impacts of modular organizations, largescale research that examines modularitys impacts on performance are lacking. The study assesses the impacts of organizational modularity in the US manufacturing sector. A set of hypotheses proposes that higher level of modularity is associated with higher efciency and protability. I found modularity to negatively affect product specialization and positively impact capacity utilization, ROI and ROA. The ndings help to determine the robustness of utilizing the modularity for complex supply chain coordination. & 2011 Elsevier B.V. All rights reserved.

1. Introduction In current global competition, managing a complex, extensive network has become an inevitable challenge for supply chain partners (Hoogeweegen et al., 1999; Tu et al., 2004). According to a recent PRTM survey, nearly 60% of 79 enterprises from multiple industries (e.g., electronics, communications, commodities, etc.) acknowledged the increasing complexity in managing a supply chain (Hoole, 2006). Researchers further suggested that a highly complex network usually displays inexibility in product proliferation, capacity utilization, and resource allocation and eventually incurs high operational costs (Hoole, 2005; Novak and Eppinger, 2001). Traditionally, two paradigms dominated the construction for supply chains: vertical integration and market mechanisms, or the make-or-buy decisions (Williamson, 1975). Since the mid-1980s, a new way for structuring the supply chain, organizational modularity, has emerged and become a prominent alternative to vertical integration and market mechanisms (Pires, 1998; Schilling and Steensma, 2001; Sturgeon, 2002). The footprints of this innovative strategy have been found in major regions around the world: contract manufacturing industries in China (Rajmanohar, 2007), auto industries in Europe and South America (Salerno, 2001; Van Hoek and Weken, 1998), and electronics industries the US and East Europe (Holloway and Hoyt, 2005; Lee and Hoyt, 2001).

Tel.: +1 713 743 1524; fax: + 1 713 743 4032. E-mail address: lcheng6@uh.edu

In the present paper, organizational modularity is dened as a strategy through which organizations utilize autonomous, yet interrelated, sub-systems to institute a complex system (Ernst and Kamrad, 2000; Schilling and Steensma, 2001). As supply chain members apply modularity at the organizational level, this new supply chain replaces the complex, systemic processes and systems with autonomous, loosely coupled sub-systems (Doran et al., 2007; Ethiraj, 2007; Fine, 2000). Instead of managing complex details, the focal rm coordinates fewer sub-systems and interfaces, thus streamlining the network structure and simplifying the management for a supply chain. For industry practice, Schilling and Steensma (2001) and Ketchen and Hult (2002) specify three aspects to construct modular organizations: extensive use of contract manufacturing, utilization of external human resources, and establishing alliances. Organizational modularity can be viewed as a hybrid approach to coordinate complex supplies, workforce, and partnerships (Tu et al., 2004). It synthesizes the efciency advantages of vertical integration and the exibility of the market coordination (Ethiraj and Levinthal, 2004). Specically, whereas vertical integration, or the make strategy, can display strong scale economies, the high level of systemic complexity constrains rms agility to coordinate internal resources and adapt to external changes (Dyer, 1996). On the other extreme of the organizational spectrum, the buy strategy, i.e. market mechanisms, essentially do not integrate complex supply chain processes. In contrast, a modularity strategy utilizes collaborative, contractual relationships to integrate supply chain processes without cross-ownerships (Schilling and Steensma, 2001; Tiwana, 2008a). A salient application of the

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modularity strategy is the emerging Original Equipment Manufacturers-Contract Manufacturers production network in industries such as electronics, automobile, computer, aerospace, bicycle, apparel, toy, etc. (Geref et al., 2005; Plambeck and Taylor, 2005; Rossetti and Choi, 2008). The organizational changes in these industries have transformed pertinent global  industrial outlooks and intensied their supply chain vis-a-vis supply chain competition (Cheng and Grimm, 2006). The prior examples of modular networks have prompted industry experts to proclaim a paradigm shift in managing complex supply chains (Chandra and Grabis, 2004; Sturgeon, 2002). The modularity strategy has the potential to overcome inexibilities exhibited in complex systems through product proliferation, capacity utilization, and resource allocation (Doran, 2005; Fine et al., 2005). In existing modular supply chains, business partners focus their core competences in respective supply chain processes, e.g., research and development, manufacturing, or marketing, and outsource parts or all supply chain processes to specializing rms (Geref et al., 2005; Prahalad and Hamel, 1990). That said, modular organizations entail endeavors to coordinate a broader capital and assets pool in the entire network. Specically, focal rms will need to account for larger scale of supply chain operations in purchasing, logistics, and distribution (Cavinato, 1989; Wang and Yu, 2006). Therefore, assessing organizational modularitys impacts on performance is critical for rms to ensure the effectiveness of this organizational strategy and to prevent its negative effects on network efciency (Tu et al., 2004). While there are abundant conceptual discussions and anecdotal evidences on the growing modular networks in the manufacturing sector, interestingly, empirical studies explicitly examining modular organizations at the industry-level are few in numbers (Daft and Lewin, 1993; Schilling and Steensma, 2001). Furthermore, among extant modularity research, there is nearly no research that empirically investigates the performance of this organizational strategy. As a result, the lack of metrics makes it challenging to determine the performance implications of selecting modularity to coordinate a supply chain (Hui et al., 2008; Pil and Cohen, 2006). The present research performs an industry-level study regarding modularity strategies applied in manufacturing organizations. Specically, this paper addresses the following research questions: What operational and protability performance measures should be utilized to assess the organizational modularity impacts on the product development, manufacturing capacities, and resource allocation? To what extent can modularity affect these performance metrics? By addressing the questions, this paper extends the industry-level research on industrial performance by Ravenscraft (1983), DAveni and Ravenscraft (1994), and Sashi (2004), to name a few. This study uses a large-scale, 1997 US Census data set of the entire US manufacturing sector to attest whether organizational modularity can lead to higher performance. The studied performance indicators are: product specialization, capacity utilization, return on investment, and return on assets. This paper contributes to modularity literature in the following aspects: (1) developing objective performance metrics for organizational modularity; (2) implementing industry-level operationalization of organizational modularity to assess manufacturers performance; and (3) validating prediction on modularitys impacts on protability and efciencies. Section 2 theorizes performance indicators and their relationships with organizational modularity. Testable hypotheses are developed based on literature in operations management, strategy, and economics elds. Section 3 details a method for hypothesis testing. Sections 4 and 5 report regression analyses and provide discussions for modularity practice and research. Section 6 concludes with a summary and directions for future research.

2. Literature review and hypothesis development 2.1. Functions and measures for modularity applications Modularity has been applied at product design, process, and organization levels (Baldwin, 2008). At the design level, supply chain members establish standard interfaces to modularize an integrative system into functional, usually swappable modules. Standard interfaces and modules together facilitate coordination for module developments as well as system innovations (Garud and Kumaraswamy, 1995). The advancement in information system has helped supply chain members apply design modularity to process and organization levels (Fine, 2000). As a result, the modularized design architecture and technological systems are embedded in modular production networks. Not surprisingly, when instituting a complex production system, organizational modularity has emerged as an often-considered strategy (Ernst and Kamrad, 2000). A body of literature documents research measuring modularity application at various levels. Fine et al. (2005) calculate component modularity as a function of module tasks and coupling interfaces. At the product level, Hsuan (1999) proposes a formula on the scope of modularization to measure the sensitivity of modularization for developing a new product. Mikkola (2006, 2007) develops a modularization function to assess product architecture modularity in automobile component and elevator manufacturing. Interestingly, no research has measured product modularity at higher observation levels, e.g., plant, rm, or industry. A supplementary research establishes methods to assess process and organizational modularity. Worren et al. (2002) in their study of international appliance companies develop survey items to measure constructs on modular process and structure. Tu et al. (2004) present an alternative measure for process modularity in their study for US manufacturing rms. Hoetker (2006) utilizes a dichotomous variable to investigate laptop manufacturers determinants for instituting a modular organization. Finally, Schilling and Steensma (2001) develop a measure for organizational modularity that consists of three dimensions: contract manufacturing, temporary employment, and alliance formation. This measure is the rst operationalization using objective data to quantify modularity at the organization level.

2.2. Impacts of modularity applications Researchers have debated as to how modularity in general will inuence the current knowledge-based competition. Arguably, modularity may lead to a change in the type of learning about the components (component-level learning) to learning about using the components (architectural level learning). Dibiaggio (2007) recently argues that product modularity and knowledge modularity may not share the same boundary divisions. A stream of research indicates that modularity allows for concurrent and autonomous learning among the components (Sanchez and Mahoney, 1996), and enables rms to develop new product variations quickly and at lower cost (Sanchez and Collins, 2001). Contrastingly, others suggest that modularity may cause organizational inertia among modular rms and reduce the level of inter-organizational learning (Langlois and Robertson, 1995; Mikkola, 2003). Overall, modularity may shift the transferred knowledge to a more tacit and less explicit form (Grunwald and Kieser, 2007). Three salient efciencies serve as cornerstones for modularitys cost advantages. Modularity displays economies of substitution since rms can efciently swap or upgrade modules of a

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system in compliance with modular architecture and interfaces (Garud and Kumaraswamy, 1995). The second efciency is economies of scope through which combined resources among modular organizations can lead to innovations in design and processes, thus augmenting rms diversication and product variations (Helfat and Eisenhardt, 2004). The third efciency, economies of scale, is derived since modular designs help vertical disintegrated rms dene the division of labor and focus on streamlined production processes (Sturgeon, 2002). The three efciencies reinforce one another and sustain the modularity phenomenon. 2.3. Selection of performance metrics for organizational modularity This paper examines four objective performance indicators documented in empirical, industry-level literature: product specialization, capacity utilization, return on investment (ROI), and return on assets (ROA) (Banker et al., 1996; Bettis, 1981; Brush and Karnani, 1996; Coelli et al., 2002; Novak and Eppinger, 2001; Randall and Ulrich, 2001). These indicators reect manufacturing industries efciency and protability: Product specialization and capacity utilization are relative to efciency; ROI and ROA, respectively, assess businesses temporary and sustainable protability associated with use of physical resources. Product specialization is dened as the ratio of the primary product dollar value to the total production output dollar value (Brush and Karnani, 1996). It is a proxy of rms production scope and level of diversication. Capacity utilization is dened as the percentage of actual manufacturing output divided by the highest possible output (Banker et al., 1996). This metric assesses business efciencies in using manufacturing capacities. The research denes ROI to be the ratio of prot to the value of investment. This metric captures return relative to organizations short-term investments and temporary commitment for physical resources. This type of resources exists in the forms of R&D investment, IT maintenance, production and supply chain technology upgrades, etc. (Banker et al., 1996). In contrast, ROA is the ratio of prot to the value of assets that assesses rms return on long-term resources (Bettis, 1981; Frigo and Ciecka, 1995; Kousenidis et al., 1998). Assets are long-term commitment, including facilities and equipment to perform value chain processes, e.g., laboratories, manufacturing plants, IT infrastructure, logistics facilities, etc. (Bettis, 1981). The following sections offer rationale to theorize the organizational modularity impacts on the metrics and develop testable hypotheses. 2.4. Organizational modularity vs. product specialization High product specialization reects high level of supply chain exclusivity for producing primary products by an industry. Not only manufacturing but also technologies, R&D, and logistics processes are developed in accordance with the primary product. By comparison, modular organizations, through design modularity embedded in the network, directly impact rms operational diversication and the scope of product varieties. Firms accomplish this through a combination of unique efcient features: economies of substitution and economies of scope. Modularitys economies of substitution directly enable rms to augment product varieties. The modular designs applied in the modular organization enhance the network abilities to swiftly combine and recombine design modules. Autonomous learning on modules in concert with concurrent learning on the product system help OEMs and modular (or turn-key) suppliers increase upgradability for product variations (Sanchez and Collins, 2001; Sanchez and Mahoney, 1996). Firms can accelerate innovations

for individual modules as well (Geref et al., 2005). This modular, exible mechanism translates to higher agility to create more nished product categories and simultaneously expand product varieties (Doran et al., 2007; Plambeck and Taylor, 2005). This is a unique advantage of modular network over vertical integration, where specialized products are manufactured through less exible systems. The advantage of economies of scope helps modular organizations capitalize on supply chain resource and knowledge sharing and increase the scale of diversication. Modular production networks broaden the operational scopes through joint production and services. Since rms consolidate workforce and technologies from external and the focal organizations, they can leverage the knowledge established by network participants to augment the innovation capabilities (Gulati et al., 2000; Spekman et al., 2002). Modular organizations superior R&D capabilities lead to continual innovations that can result in developments outside of the boundary of OEMs industry (Dibiaggio, 2007). Moreover, modular organizations reinforce the degree of diversication through modularized processes and product designs (Helfat and Eisenhardt, 2004). Accordingly, when compared with the vertically integrated rms, which are less exible in development of products, modular organizations will be more diversied (Ernst and Kamrad, 2000; Ethiraj and Levinthal, 2004). In sum, modular organizations are more likely to take advantages of design modularity and richer resource pool that coevolve among rms in the supply chain (Koza and Lewin, 1998). As a result, rms can expand product offerings and, through supply chain collaboration, commit innovations for diversied operations (Schilling, 2000; Tu et al., 2004). Hence, the product specialization will decrease accordingly. I hereby hypothesize the relationship between organizational modularity and product specialization for a focal industry as follows: Hypothesis 1. Higher level of organizational modularity will lead to lower level of product specialization for rms in the focal industry.

2.5. Organizational modularity vs. capacity utilization Supply chain structures have profound impacts on capacity utilization. Applying distinctive organizational strategies will affect the re-allocation for resources in individual rms and accordingly inuence the manner as to how the entire resources embedded in the network are utilized (Galunic and Eisenhardt, 2001; Tiwana, 2008b). While vertically integrated systems utilize internal resources, organizational modularity allows manufacturing resources to be arranged and utilized across rm boundaries. In a vertically integrated system, rms carry out mass production for a narrow scope of systemic products with a goal to attain economies of scale, an approach largely related to the push supply chain strategy (Fine, 2000; Simchi-Levi et al., 2008). After production, rms accumulate nished goods inventories and then push them to the marketplace. In this context, capacity utilization will be determined by internally available capacity, forecast, and production scheduling (Coelli et al., 2002). Furthermore, the push approach may not lead to optimal capacity utilization. Firstly, inefcient use of resources may be caused by forecasting errors, which are augmented by uncertainty in the marketplace (e.g., seasonality and competition dynamics) as well as bullwhip effects (Chopra and Meindl, 2007). Second, the production line is designed to specialize in particular product categories and thus is restrained for swift production changeover (Sturgeon, 2002). In addition, a low level of market responsiveness associated with product specialization may lead to excess inventory that not only

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negatively affect capacity utilization but also offset the advantages of scale economies (Thomas and Warsing, 2007). In contrast, modular organizations may enhance capacity utilization by applying a pull strategy. Instead of relying on forecasting as in the push strategy, the pull systems supply chain processes are triggered, or pulled, by the actual demand (Van Hoek, 2001). The pull strategy is designed to tailor outputs with individual orders for high level customization and responsiveness (Pil and Cohen, 2006). Prevalent applications of modularity have facilitated the pull strategy. For example, the focal rm can implement design modularity at product and process levels and exercise postponement approaches that delay nished good production and assemble modular components against custom orders (Ernst and Kamrad, 2000). Modular organization participants jointly adjust necessary capacities to implement the pull system and swiftly respond the heterogeneous demands and supplies. The goal of operating the entire modular network is aimed at maximizing the benets of production exibility for customization and simultaneously exploiting individual partners scale economies (Hoetker et al., 2007; Langlois and Robertson, 1995). By concentrating on generic module design and/or production processes, suppliers reach efciency by specializing in module productions. On the system level, the focal manufacturer coordinates the value-added processes by facilitating multiple product lines (Garud and Kumaraswamy, 1995; Helfat and Eisenhardt, 2004). In sum, capacities in the exible, modular organizations will be utilized in a more effective manner in that rms may display high capacity utilization at module and system levels demonstrated by integrative systems and in the meantime achieve customization (Sturgeon, 2002). Enabled by the pull strategy, a modular production network has the potential to harvest scale economies at both module and system levels (Geref et al., 2005). The modular network as a whole thus may be able to operate the network facilities to the nearly optimal level (Ethiraj and Levinthal, 2004). Consequently, capacity utilization will likely be higher in the presence of organizational modularity. The foregoing discussion is summarized as the hypothesis below: Hypothesis 2. Higher level of organizational modularity will lead to higher level of capacity utilization for rms in the focal industry. 2.6. Organizational modularity vs. ROI and ROA Trading partners in a modular organization are joint stakeholders of physical resources (Galunic and Eisenhardt, 2001). A modular supply chains value creation depends on combining and re-combining resources residing in the network (Collins et al., 1997; Hoetker et al., 2007; Van Hoek and Weken, 1998). As integrative systems drifts to modularity, coordinating shortterm investments and long-term assets becomes critical for the entire supply chains performance (Ethiraj, 2007). To enhance ROI and ROA for short-term and long-term physical commitment, respectively, rms will need to minimize costs, maximize prot margins (i.e. returns), or simultaneously achieve the prior two. In order to minimize costs on temporary and long-term physical commitments, modular organizations focus on respective core competences and execute non-asset based supply chain strategies (Sturgeon, 2002). In doing so, rms can re-direct capital and assets toward core competences in innovation and/or marketing, thus limiting the scope of non-core commitment (Prahalad and Hamel, 1990). Rened deployment of resources in plants, marketing channels, and logistics, can help minimize capital and asset expenditure (Jacobides, 2008). Non-core capital and assets and redundant resources can be omitted from individual rms.

Finally, cost advantages can also be attained by the three aforementioned efciencies. Efciencies derived by module substitution, broader operational scope, and scale economies lead to less wastes and help modular organization minimize operational costs (Langlois, 2002). Modular systems also exhibit advantages in prot maximization because of richer capital, assets, and knowledge assembled in the network (Grunwald and Kieser, 2007; Schilling and Steensma, 2001). Modular organizations, facilitated by modularized design and inter-organizational learning, can explore more re-combination and re-design opportunities for product development (Sanchez and Mahoney, 1996). This is an advantage in marketing for continual product upgrades, new product introduction, and branding (Langlois, 2002; Tiwana, 2008b). Furthermore, modular organizations collective strength in expanding production scopes and diversied operations surpass the collection of disintegrated rms advantages (Koza and Lewin, 1998). Specically, shared resources in the network can generate synergy to create values for focal products and those beyond rms operational boundaries (Galunic and Eisenhardt, 2001). This is advantageous for modular organizations to operate in multiple industries to generate revenues. Ultimately, these features help modular organizations differentiate against competitors and translate into higher return (Brusoni and Prencipe, 2001; Pil and Cohen, 2006). In electronics, computer, and semiconductor industries, global rms have extensively utilized outsourcing strategies that consolidate capital and assets across rms in modular networks. By leveraging overseas contract manufacturers strength in design and/or manufacturing processes, rms can drive down supply chain costs and raise prots (Geref et al., 2005; Sturgeon, 2003). Conclusively, the modularity strategy is capable of reducing excessive commitments for capital and assets for the entire network; in the meantime, the strategy enhances the return of the combined resources. Based on the preceding reasoning, the impacts of organizational modularity on ROI and ROA are hypothesized as follows:

Hypothesis 3a. Higher level of organizational modularity will lead to higher level of ROI for rms in the focal industry.

Hypothesis 3b. Higher level of organizational modularity will lead to higher level of ROA for rms in the focal industry.

3. Data and operationalizations for variables 3.1. Sample The scope of the present research is the entire US manufacturing sector. The 1997 Economic Census by the US Census Bureau is the most recent data source that includes all required data items for hypothesis testing (U.S. Census Bureau, 2006). The North American Industry Classication System (NAICS) developed by the US Census Bureau is used to categorize industries (U.S. Census Bureau, 2008). Table 1 presents 3-digit NAICS industries and pertinent descriptions in the entire manufacturing sector. The unit of observation is an industry in the year of 1997. The sample includes all 473 manufacturing industries at the 6-digit NAICS level. The industries examined in the present study are at the most disaggregate level in the NAICS system. The original data set has 473 industry-year observations. The eventual sample for hypothesis testing contains more than 400 observations that have complete data items.

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Table 1 3-Digit level NAICS manufacturing industries. Industry categorization NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS NAICS 313 314 316 321 322 324 325 326 327 331 332 333 334 335 Description

NAICS 336 NAICS 337 NAICS 339

Textile mills Textile product mills Leather and allied product manufacturing Wood product manufacturing Paper manufacturing Petroleum and coal products manufacturing Chemical manufacturing Plastics and rubber products manufacturing Nonmetallic mineral product manufacturing Primary metal manufacturing Fabricated metal product manufacturing Machinery manufacturing Computer and electronic product manufacturing Electrical equipment, appliance, and component manufacturing Transportation equipment manufacturing Furniture and related product manufacturing Miscellaneous manufacturing

the ratio between the actual manufactured output dollar value to the maximum output value in 1997. The results are presented as a percentage rate for each NAICS industry, with 100% as full utilization. The data sources are 1997 Annual Surveys of Plant Capacity for the US manufactures (U.S. Census Bureau, 2001). The return on investment (ROI) measure is based on Banker et al. (1996), Frigo and Ciecka (1995), and Kousenidis et al. (1998). ROI is operationalized as the ratio of the pricecost margin to the capital dollar values for a manufacturing industry in 1997. The Census data items used are the total capital expenditure and the pricecost margin (the data item titled value added in the Economic Census) in the year of 1997. The return on assets (ROA) measure is based on Bettis (1981). ROA is calculated as the ratio of the pricecost margin to the asset dollar values for an industry in 1997. The Census data used are the total asset dollar value and the pricecost margin in 1997. 3.2.3. Control variables Since various attributes of manufacturing industries may affect industry performance, this paper controls for scale economies, industry concentration, vertical integration, and capital and labor intensity in hypothesis testing. Specically, scale economies and vertical integration may impact efciency by an industry. The level of industry concentration may also account for the industrys overall protability due to different intensity of competition. Moreover, industry efciency and protability may be a function of capital and labor intensity. Hence, the study controls for these differences by including the prior variables in regression runs. The ratio of minimum efcient scale (MES) to an industrys output value is utilized as a proxy to scale economies (Hennart and Park, 1994; Hladik, 1985; Sashi, 2004). The MES is derived through the following steps. Initially, the Economic Census establishes a 10-class categorization for each industry and grouped manufacturers by their respective production output sizes. The total output dollar value of establishments of the median class and all higher size classes is calculated. A mean output size is then computed by dividing the prior output value by the total establishment numbers in these classes. Finally, this mean of annual output per establishment is divided by the overall output dollar value of the industry. The industry concentration is operationalized as the top four rms percentage of the total output dollar value by an industry (Ravenscraft, 1983; Sashi, 2004). Data is collected from the 1997 Census. The vertical integration operationalization is based on a number of empirical studies in the industrial organization literature (Balakrishnan and Wernerfelt, 1986; Brush and Karnani, 1996) that calculate the ratio of pricecost margin (i.e., the value added data) to sales (i.e., the total output dollar value) per annum to measure this variable. These two items are collected from the 1997 Census. Brush and Karnani (1996) dened the degree of capital intensity as the ratio of capital expenditure to the total employee number per annum. Data on this ratio is derived from the 1997 Census. Schilling and Steensma (2001) measured the degree of labor intensity as the ratio of total number of employees to the industry output dollar value per annum (Schilling and Steensma, 2001). Pertinent data is derived from the 1997 Census.

3.2. Operationalization of variables 3.2.1. Organizational modularity This paper adopts Schilling and Steensmas (2001) method to operationalize the overall organizational modularity, which has been empirically implemented to industry-level research in a manufacturing context similar to the present study. Organizational modularity incorporates three managerial components: (1) contract manufacturing, (2) alternative employment, and (3) alliance formation. The details of the measures of these components are given as follows. The contract manufacturing component is derived as the fraction of dollar value an industry spent on contract works to the dollar value of total materials purchased in a calendar year. The data source is the 1997 US Economic Census. To measure alternative employment, data is collected on the total number of external, short-term workers employed in a manufacturing industry in 1997. The total sum is then divided by the entire employment of the industry (Schilling and Steensma, 2001). The data source for external employment is the Supplement to the 1997 Current Population Survey by the Bureau of Labor Statistics. Total industry employment is from the Economic Census. The alliance formation is operationalized by dividing the counts of alliances and joint venture in an industry by the total rm numbers of the industry. This ratio indicates the degree of industry-level alliance formation for a specic year. Data on alliances and joint ventures is collected from Thompson Financials SDC Platinum system. The number of rms in an industry is gathered from the 1997 Economic Census. Finally, overall organizational modularity is calculated as follows: the value of each prior component is standardized and, in turn, the three standardized values for an industry are combined together with uniform weights. The nal measure is the modularity score for a 6-digit NAICS industry (Schilling and Steensma, 2001). 3.2.2. Dependent variables Brush and Karnanis (1996) operationalization for product specialization was employed to measure product specialization. Product specialization is derived as the percentage of the primary products dollar value to the dollar value of entire industry output in 1997. The data source is the 1997 Economic Census. The paper applies operationalization by Banker et al. (1996) to measure capacity utilization. Capacity utilization is measured as

4. Hypotheses testing procedures and results 4.1. Statistical procedures Table 2 reports the descriptive statistics and correlation coefcients for all variables in original data values. For hypothesized

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Table 2 Descriptive statistics and correlation coefcients for variables. Variables Product specialization Capacity utilization ROI ROA Organizational modularity 6. Contract manufacturing 7. Alternative employment 8. Alliance formation 9. MES 10. Concentration 11. Vertical integration 12. Capital intensity 13. Labor intensity
nn n

Mean 92.141 .706 19.773 1.677 .084 .035 .020 .064 .011 40.960 .507 9.012 .006

S.D. 5.809 .117 13.729 1.080 1.567 .045 .030 .162 .020 21.215 .123 10.782 .003

1. 1 .098** .146** .174** .093

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

1. 2. 3. 4. 5.

1 .176** 1 .090** .700** .044 .233** .269** .188** .101* .025 .084 .170** .366** .247**

1 .291** .402** .153** .141** .117* .086 .216** .346** .353**

1 .652** .668** .350** .009 .131** .273** .037 .257** 1 .095* .102* .112* .283** .336** .138** .379** 1 .020 .042 .070 .190** .142** .219** 1 .434** .336** .079 .286** .264**

.198** .011 .039 .068 .166** .108* .016 .068* .059 .082 .205** .183** .202** .160** .314** .145**

1 .593** .154** .218** .218**

1 .115* 1 .271** .123** 1 .453** .448** .468** 1

p o.01. p o .05 (two-tailed tests).

variables, the average of product specialization is 92.14 percentage points. Average capacity utilization is around 70.6%. ROI and ROA are highly correlated; however, their mean values are distinctive: ROI19.773 and ROA1.677. In terms of organizational modularity measurements, average contract manufacturing is around 3.5% of total purchased materials, average of alternative employment is around 2% of total employment, and average level of alliance formation is around 6.4% of total number of rms. The mean value of the composite organization modularity index is around .084. The hypothesis testing procedures apply regression methods established in econometrics literature (Greene, 2000; Johnston and DiNardo, 1997). The primary model is specied as follows: Performance indicator of the focal industryk b0 b1 Organizational modularity 6 X bi Control_Variablei disturbance terms
i2

Moreover, the inuence of modularity combines impacts of the three components: contract manufacturing, alternative employment, and alliance formation. I thus decompose organizational modularity and assess each components impacts on performance metrics. Performance indicator of the focal industryk b0 b1 Organizational modularity 6 X bi Control_Variablei disturbance terms Componentj
i2

for the full modularity-capacity utilization model (po.10). These outcomes are indicative of the presence of heteroscedasticity. To correct this effect, the White estimate approach is applied to obtain robust standard errors for regression coefcients (Greene, 2000). The next step is testing the signicance for the inclusion of control variables. Full regressions consistently indicate that adding control variables improves the model t for regression runs, as manifested by higher R2 scores. The F-statistics for all R2 increases are signicant at the .10 level, indicating the necessity of including control variables regression models. Additionally, to test multicollinearity, the variance ination factors (VIF) for explanatory variables in full regressions are examined. All VIF scores fell between 1.13 and 1.92, below the threshold of 10 as suggested in the literature (Bae and Gargiulo, 2004; Wang and Tsao, 2005). Hence, the multicollinearity effect is limited on regressions. I report hypothesis testing results in Tables 36. The tables present full multivariate models that include modularity and all control variables with the White robust standard errors. 4.2. Hypothesis testing result Hypothesis 1 predicts a negative impact of organizational modularity on product specialization. The rst regression in Table 3 shows that the coefcient for organizational modularity is negative and marginally signicant (b1 352, p o.10). This result thus supports Hypothesis 1. In Table 3, the model relative to contract manufacturing has the coefcient of this component negative and signicant (b1 1.501, p o.01), further supporting Hypothesis 1. Hypothesis 2 proposes that high level of organizational modularity is associated with high level of capacity utilization. In Table 4, the coefcient for organizational modularity in the capacity utilization regression is positive and signicant (b1 .005, po.05). Hypothesis 2, hence, is supported. Further, the model relative to contract manufacturing has the coefcient of this component positive and signicant (b1 .008, po.01), further supporting Hypothesis 2. Hypothesis 3a suggests that organizational modularity will lead to positive ROI. In Table 5, the coefcient for organizational modularity is positive and signicant (b1 1.603, p o.05), thus supporting Hypothesis 3a. The model relative to contract manufacturing has the coefcient of this component positive and signicant (b1 3.120, p o.01), further supporting Hypothesis 3a.

In the equations above, k 1, 2, 3, 4, and j 1, 2, 3. Control variables are MES (b2), industry concentration (b3), vertical integration (b4), capital intensity (b5), and labor intensity (b6). According to the Hypothesis 1, it is anticipated that the coefcient of organizational modularity variable (b1) shall be negative and signicant in the product specialization regression. According to Hypotheses 2, 3a, and 3b, coefcients of organizational modularity shall be positive and signicant in respective regression models for capacity utilization, ROI, and ROA. Regression runs are performed using the STATA statistics software. Since the data set is cross-sectional, the disturbance terms of OLS regressions may display heteroscedasticity, which could result in inaccurate standard errors for the coefcients. Additional tests are performed for each OLS regression. The BreuschPagan test statistics for heteroscedasticity for all models are signicant at the p .05 level, except the regression

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Table 3 Least square regression results on product specialization with the White robust standard errors. Product specialization as the dependent variable (Hypothesis 1) Constant Organizational modularity Contract manufacturing Alternative employment Alliance formation MES Concentration Vertical integration Capacity intensity Labor intensity F-statistic R2 Number of observations
nnn nn n

94.069 (1.778)*** .352 (.271)y

93.060 (1.739)*** 1.501 (.505)**

94.063 (1.509)***

.93.964 (1.539)***

.193 (.199) 54.847 (43.753) .002 (.019) 4.392 (3.030)y .036 (.055) 103.700 (101.264) 1.88* .0372 428 51.581 (43.692) .014 (.019) 2.166 (3.176) .037 (.055) 160.184 (96.277)* 3.13** .0826 428 60.834 (36.662)* .001 (.018) 3.950 ( 2.660)y .035 (.052) 72.548 (96.029) 1.57y .0322 448 .133 (.349) 63.215 (41.084) .0005 (.018) 3.805 (2.669)y .038 (.052) 84.402 (94.930) 1.43y .0314 448

po .001. p o.01. p o .05. p o .10 (one-tailed tests). The White corrected standard errors in parentheses.

Table 4 Least square regression results on capacity utilization with the White robust standard errors. Capacity utilization as the dependent variable (Hypothesis 2) Constant Organizational modularity Contract manufacturing Alternative employment Alliance formation MES Concentration Vertical integration Capacity intensity Labor intensity F-statistic R2 Number of observations
nnn nn n

.752 (.025)*** .005 (.003)*

.752 (.024)*** .008 (.003)**

.748 (.023)***

.752 (.023)***

.001 (.004) .573 (.361)y .0003 (.0003) .104 (.043)** .003 (.0004)*** 1.960 (1.260)y 13.58*** .1529 433 .620 (.364)* .0003 (.0003)y .106 (.042)** .003 (.0004)*** 1.816 (1.244)y 13.52*** .1536 433 .410 (.260)y .0004 (.0002)y .098 (.040)** .003 (.0004)*** 2.118 (1.323)y 16.27*** .1655 464 .006 (.006) .254 (.286) .0004 (.0002)y .101 (.040)** .003 (.0004)*** 2.237 (1.297)* 17.07*** .1683 464

p o.001. p o .01. p o .05. po .10 (one-tailed tests). The White corrected standard errors in parentheses.

Table 5 Least square regression results on return on investment with the White robust standard errors. Return on investment as the dependent variable (Hypothesis 3a) Constant Organizational modularity Contract manufacturing Alternative employment Alliance formation MES Concentration Vertical integration Capacity intensity Labor intensity F-statistic R2 Number of observations
nnn nn n

10.751 (3.441)** 1.603 (.706)*

10.938 (3.213)*** 3.120 (1.085)**

8.809 (2.831)**

7.583 (2.777)**

1.269 (1.091) 65.992 (73.200) .163 (.034)*** .419 (5.903) .393 (.087)*** 593.892 (207.858)** 10.89*** .2711 438 81.022 (69.935) .178 (.036)*** 1.051 (5.906) .382 (.083)*** 529.569 (215.472)** 10.73*** .2862 438 29.366 (45.542) .142 (.033)*** 5.936 (4.844) .385 (.082)*** 585.559 (192.814)** 11.75*** .2358 471 .772 (.543)y 51.535 (51.764) .143 (.033)*** 7.490 (4.749)y .382 (.082)*** 612.227 (184.653)*** 11.63*** .2284 471

po .001. p o.01. p o .05. p o .10 (one-tailed tests). The White corrected standard errors in parentheses.

Interestingly, the model relative to alliance formation has the coefcient of this component negative and marginally signicant (b1 .772, p o.10), which is opposite to Hypothesis 3a.

Hypothesis 3b suggests that organizational modularity will lead to positive ROA. In Table 6, the coefcient for organizational modularity is positive and signicant (b1 .191, po.01), thus

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743

Table 6 Least square regression results on return on asset with the White robust standard errors. Return on asset as the dependent variable (Hypothesis 3b) Constant Organizational modularity Contract manufacturing Alternative employment Alliance formation MES Concentration Vertical integration Capacity intensity Labor intensity F-statistic R2 Number of observations 1.272 (.371)*** .191 (.060)** 1.356 (.347)*** .434 (.116)*** .075 (.074) 7.573 (6.224) .011 (.003)*** .326 (.623) .032 (.007)*** 59.804 (20.285)** 18.12*** .2385 438 6.074 (5.574) .013 (.003)*** .030 (.630) .031 (.007)*** 48.609 (18.165)** 20.23*** .2873 438 4.663 (4.127) .007 (.003)* .940 (.531)* .030 (.007)*** 60.378 (21.070)** 18.53*** .1803 468 .022 (.051) 3.984 (4.498) .007 (.003)* 1.024 (.521)* .031 (.007)*** 62.791 (20.333)** 18.21*** .1770 468 1.050 (.316)*** .985 (.315)**

yp o .10 (one-tailed tests). The White corrected standard errors in parentheses.

nnn nn n

p o.001. p o.01. p o .05.

supporting Hypothesis 3b. Among the regressions with modularity components, the model relative to contract manufacturing has the coefcient of this component positive and signicant (b1 .434, po.001), further supporting Hypothesis 3b.

5. Discussions 5.1. Implications for organizational modularity practice The regression results indicate that modularity strategy can make rms more efcient and protable. This is a new insight into organizing complex systems. Conventional wisdom emphasizes modular organizations exibilities and innovation capabilities; however, these features may come with increased costs in integration and additional investments for implementing the modularity strategy. Our ndings otherwise suggest modularity can be a device to construct a supply chain and become protable. The outcomes associated with product specialization suggest crucial advantage relative to current trends in customization. Highly heterogeneous marketplace drives erce competition and stimulates rms to augment operational scopes (Fine, 2000). By applying modularity at the organizational level, rms may capitalize on the agility in product development and resource combination. A number of lead manufacturers demonstrate this agility with a high level of customization. For instance, Volkswagen in Brazil (Salerno, 2001), Smart Car assembly at Hambach, France (Van Hoek and Weken, 1998), and Dell Computers large-scale outsourcing operations (Magretta, 1998) are modular networks with versatile production capabilities. Modular organizations can positively impact operational diversication and help rms meet larger market demands with broader product varieties. Furthermore, instituting modular organizations may enhance efciency in capacity utilization. This is an interesting contrast to conventional wisdom that vertical integration is the primary approach to achieve efciencies. In a modular network, internal resources can be utilized synergistically with those of supply chain members. Perhaps the economies of substitution, scope, and scale help rms and the supply chain as a whole to utilize to the optimal level. With this insight, modularity can alter the vertical integration for cost-minimizing rms. The results pertaining to ROI and ROA strongly suggest that organizational modularity strategy can lead to higher protability for manufacturing industries. Additional investment indeed is a necessity as rms institute the modular network. For example,

rms incur nontrivial commitments on resources and implementation effort for large-scale communication systems required to integrate inter-organizational processes (Malone et al., 1987). The regression analyses imply that higher return can offset the additional expenses and improve modular organizations protability through the augmented resource pool. The regression results relative to modularity components offer insights into how they affect the performance metrics independently and in conjunction. According to Tables 36, contract manufacturing appears to be the strongest factor to impact metrics. This set of ndings is instructional for practical strategy to operate modular organizations. As documented in the literature (Geref et al., 2005; Sturgeon, 2002), OEMCM relationships are found to be an effective approach to establish a modular production network, where OEMs manage a network of contract manufacturers and apply design and/or process modularity to carry out supply chain operations. Surprisingly, alliances formation is found to negatively affect ROI. Perhaps relationship-oriented arrangements, e.g., alliances, partnerships and joint ventures in the supply chain, require a period of time for successful collaboration. The desirable benets from these relationships will not be immediately realized until trading partners reached a fuller integration. In addition, many collaborative relationships are associated with prot and cost sharing agreements which may in the short-term reduce rms protability. In alliances, rms may be willing to sacrice shortterm performance for long-term gains, so high ROI may be gained in the long run.

5.2. Implications for organizational modularity research Scholars have attested that the modularity phenomenon is not random and this paradigm shift will sustain its pace in the coming years (Baldwin, 2008; Langlois, 2002). Findings of the present research provide a potential explanation relative to earlier emergence of the phenomenon of modular organizations. Namely, higher level of protability and efciency stimulate rms to pursue this exible organizational strategy and maintain organizational modularity to replace complex integration for exibility in the entire value system. High returns will reward the coinvestors of the modular networks and may contribute to the prevalent growth of large-scale, modular production networks (Fine, 2000; Shy and Stenbacka, 2003).

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This paper illustrates that Schilling and Steensmas (2001) measure of organizational modularity can be implemented to study US manufacturers performance at the industry-level. It shall be noted that our applications of this measure focus on tangible forms of agreements. Therefore, our results incline to the impacts by contractual relationships. However, there are other arrangements to construct modular organizations, which may be more temporary or less tangible. For instance, partnerships may be created by verbal, instead of contractual agreements. Researchers (Hoetker et al., 2007) suggest that mutual trusting relationships will help rms establish modular rms. However, trust is not embodied in contracts. As a result, Schilling and Steensmas (2001) operationalization may underestimate the degree of organizational modularity. Future research may need to combine quantitative and qualitative approaches to comprehensively capture an entitys modularity.

6. Conclusion 6.1. Summary and contributions Organizational modularity has constituted a potential paradigm shift in the complex system management. This phenomenon is likely to keep developing in the coming years. Modularity research has vividly asserted that this innovative, exible supply chain form can bring forth higher performance compared to the conventional paradigms: vertical integration and market mechanisms, or the make-or-buy approaches. Given the emergence of modularity research works, it is interesting that little research has objectively examined the performance of this agile form of supply chain. The present study is aimed at lling this gap in the modularity literature. This paper contributes to the literature by quantifying organizational modularitys impacts on objective performance metrics relative to efciencies and protability. Specically, it theorizes a set of metrics assessing organizational modularity effectiveness. Utilizing a large-scale, objective data set, the statistical analyses offer evidence that higher level of organizational modularity is associated with higher level of capacity utilization, ROI, and ROA. Higher degrees of organizational modularity, on the other hand, will likely lead to lower degree of product specialization. The research hence provides insights into the robustness of utilizing modularity as an alternative to conguring complex supply chain networks. 6.2. Limitations and future research The study discerns the following limitations that lead to several future research directions. First, given the close tie between product and organizational modularity, our results imply that product modularity may positively affect rms supply chain performance. Since this is beyond the scope of this research to measure product modularity at the industry-level, this paper has a limitation to observe product modularitys direct impacts on nancial performance as well as its inuences combined with organizational modularity. Thus, future research may need to extend the existing product level modularity measurement to evaluate the design or architecture modularity across industries. The measurement may be a composite index that considers modularity measurements of all product categories in an industry. Furthermore, future research may include additional explanatory variables to provide further validation of the present results, when data is available. For example, IT investments are considered a driving force for supply chain performance; however, data

on IT is not collected in the 1997 Economic Census. The additional variables may not only add insights into theory-building on the modularity phenomenon, but also help overcome the relatively low model t in the present regressions. The R2 scores reported in the present research are comparable to other industry-level studies (e.g., Schilling and Steensma, 2001). With that said, low levels of model t may result from the limitations of available data items as well as cross-sectional nature of the data. As the Economic Census starts to report more industry-level data items for the manufacturing sector (e.g., the 2002 and 2007 data), future studies are encouraged to capitalize on the richer information to develop more comprehensive models with additional variables. In terms of the data point, the cross-sectional study is constrained for investigating the sole impacts of modularity strategy on the entire US manufacturing sector in the year of 1997. Hence, the empirical results need to be interpreted with caution. Specically, key variables, particularly related to capacity utilization, ROI, and ROA, may change from year to year. To the extent that modularity will reward the supply chain as a whole, newer data, ideally including additional performance metrics, will be necessary to explore its long-term impacts. Future studies should conduct longitudinal research relative to the modularity strategies for US manufacturing industries upon future release of the Census data. Finally, rm-level data sets may provide information of strategic variables that are not observable in the present research. Specically, information on R&D expenditures, contract specics, marketing costs, etc., is difcult to capture in industry-level data. As such, disaggregate studies employing primary data collection to examine the interactions between hypothesized variables in the paper are in order.

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