The limits of modularity in innovation and production

Modularity has gained recently a growing attention in the management literature as a key to explain the contemporary trends of industrial dynamics, according to which external «market-based» economies have become predominant over internal «bureaucracy-based» economies. Nowadays global supply-networks play a key role for a large share of material and immaterial inputs in many sectors, and the diffusion of modular architectures for products, in connection with flexible production systems, is often indicated by the literature as the main driver for this change. In order to analyze better this connection, in this paper a model is presented which tries to focus on the factors that influence the competitive performance of internal versus outsourced production when the two options are subject to a trade-off with respect to the kind of innovation strategies they can use. In particular through a set of exploratory agent-based simulations we verify two hypotheses. The first one is the existence of a trade-off between decentralized search and complexity, as suggested by a recent strand of literature which has modeled innovation as a discovery process on complex fitness landscapes. The second one is a comparative advantage of centralized search, which occurs, for all levels of complexity, when the returns of innovation are lower. When the conditions just described occur in a competitive context, the limits of modularity become apparent.