Coordination Costs and the Optimal Partition of a Product Design

The purpose of this paper is to analyze the problem of optimally partitioning a design process of a complex product, and to derive several comparative statics results by utilizing the technique developed by Topkis (1998). By partitioning the product design and assigning each sub-design to a team, there are the benefit of having many smaller real options on the one hand, and the cost resulting from an increased incidence of across-team coordination on the other. Furthermore, by endogenizing the across-team coordination costs, our analysis shows that lower cost of within-team coordination induces coarser partitions and higher costs of across-team coordination, i.e. lower level of information and communication technology (ICT) investment. It is argued that these results may explain the reason for the retarded introduction of the ICT by Japanese firms in the 1970s and 1980s as well as the difference of performance between Route 128 and Silicon Valley in the 1990s. It is also argued that our results are consistent with the empirical finding by Brynjolfsson, Maline, Gurbaxani, and Kambil (1994) that ICT leads to decreases in firm size