Constructive Conflict, Uncertainty and Real Options

Technology Strategy Red Hat and the Linux Revolution Microsoft’s take on Linux • OSS poses a direct, short-term revenue and platform threat to Microsoft, particularly in server space • the intrinsic parallelism and free idea exchange in OSS has benefits that are not replicable with our current licensing model and therefore present a long term developer mindshare threat. • …commercial quality can be achieved / exceeded by OSS projects • OSS is long-term credible threat FUD tactics can not... combat it. • Linux outperforms many other UNIXes • Linux can win as long as services / protocols are commodities. • OSS projects have been able to gain a foothold in many server applications because of the wide utility of highly commoditized, simple protocols. By extending these protocols and developing new protocols, we can deny OSS projects entry into the market. • OSS evangelization scales with the size of the Internet much faster than our own evangelization efforts appear to scale Modularity is becoming more prevalent, increasing value creation, challenging value capture • Falling costs of co-ordination make modularity easier • Modularity, where it can be employed effectively, can accelerate value creation – once dominant design established, hence stable architecture and modular interfaces – and ultimate performance is not critical – autonomous or modular innovations, in this context • Very challenging for value capture – loss of control for leaders – rapid, diverse innovation – revenues and value widely dispersed Modularity 1. the use of individually distinct functional units, as in assembling an electronic or mechanical system1 2. designed with standardized units or dimensions, as for easy assembly and repair or flexible arrangement and use2 Modularity Æ decoupling • “When a product or process is ‘modularized,’ the elements of its design are split up and assigned to modules according to a formal architecture or plan.” • “From an engineering perspective, a modularization generally has three purposes: – to make complexity manageable – to enable parallel work – to accommodate future uncertainty” Product Architecture Integral FUNCTIONAL ELEMENTS COMPONENTS Modular FUNCTIONAL ELEMENTS COMPONENTS Protect cargo from weather Upper half Protect cargo from weather Box Connect to vehicle Lower half Connect to vehicle Hitch Minimize air drag Nose piece Minimize air drag Fairing Support cargo loads Cargo hanging straps Support cargo loads Bed Suspend trailer structure Spring slot covers Suspend trailer structure Springs Transfer loads to road Wheels Transfer loads to road Wheels Interfaces Modular Interdependent/ Systemic/Integral • Customer understands and can specify key parameters • Can be measured and tested reliably and unambiguously • Understand how variation affects system performance • Market can function effectively • Codified knowledge • Difficult to protect • Associated with optimizing design for ultimate performance • Unstructured technical dialogue • Necessary information for market does not exist • Management and integration most efficient coordinating mechanisms IBM System/360 • First modular computer, conceived as a family of computers – different sizes suitable for different applications – same instruction set – standard interfaces for peripherals • Design rules and decentralized development – Central Processor Control Office defines rules – each team full control over hidden elements • Wildly successful, drove other players out of the market • BUT undermined IBM’s dominance in the long run through emergence of plug-compatible modules There are six modular operators that together enable a very wide range of system designs Separating systems into modules that interact across well defined interfaces Substituting Switching between components that perform the same function Augmenting Adding a module to increase the functions of the system Excluding Removing a module to reduce the functions the system can perform Inverting Making an embedded function into a stand-alone module Porting Moving a module from one system to another The resulting systems can exhibit several different types of modularity Slot Component Swapping Direct Component Sharing Bus Bus Strategic options Architect • For system innovations, may require broad scope of activities at the outset • Create design rules, define visible information • Convince people this architecture will prevail • As modularity established, lead the evolution of the business ecosystem Module player • Conform to the architecture, interfaces and test protocols established by others • Master the hidden information involved • Rely on superior execution Key to value capture is focus on locus of value • “… the virtuous virtuals have carefully nurtured and guarded the internal capabilities that provide the essential underpinnings of competitive advantage… they invest considerable resources to maintain and extend their core competences [because without them] their strategic position in the network would be short-lived” • “Attractive profitability seems to flow … to the point at which unsatisfied demand for functionality, and therefore technological interdependency exists.” Locus 1. a center or focus of great activity or intense concentration 2. a center or source, as of activities or power Amdahl’s Law: “…make the common case fast…” • Amdahl’s Law is concerned with the speedup achievable – from an improvement to a computation – affects a proportion P of that computation – where the improvement has a speedup of S “God grant me the serenity to accept the things I cannot change (much); courage to change the things I can (a lot); and wisdom to know the difference.” The top three players now outsource at least 25% of their volume, and some more than 50% Handset COGS, global, 2005 ($ billions) Foxconn has the RAZR, the W220 and is expected to get the Motofone Nokia Motorola SE Other OEM 18.5 15.2 7.2 26.0 Flextronics 1.5 Elcoteq 1.3 Other Celestica 0.7 26 Other MS 2.7 100% Foxconn 2.0 NOK 19 3.7 Elcoteq 90% 80% Compal made 25% of Motorola’s handsets – but most were low-end, low cost Celestica 70% Fox 0.6 MOT 3.7 FlexSE0.5 Foxconn 15 7 Arima 0.7 Compal 0.2 Compal has little apart from Motorola 1.0 Flextronics 3.2 60% Compal 50% In-house In-house (or unknown) 5.5 40% In-house 1.1 12.6 19.5 30% In-house 7.2 20% 10% 0% 0% Nokia only outsources low end and CDMA 10% 20% 30% 40% 50% 60% 70% Sony Ericsson mostly outsources low end Sources: SinoPac; Nomura; ABN Amro; KGI; Yuanta; Ericsson company reports 80% 90% 100% Sony Ericsson has added Compal in 2006 In ‘05, top tier vendors outsourced a third of CoGS; Foxconn is now #3 manufacturer 7 2. rs he 7 Ot 0. a .3 im 1 Ar l 7 a 1. mp Co a eq ic ot st lc le E ics Ce on tr nn ex o Fl oxc F Handset COGS, global, 2005 Foxconn’s revenue is expected to top $11 billion in 2006, and it is now the world’s #3 mobile phone development and manufacturing business ($ billions) 6.4 In-house 44.8 5.2 4.1 100% NOK 2.0 Taiwan based Foxconn Compal Arima NOK MOT NOK 3.2 3 50% 12.6 MOT 7.2 SE 5.5 Sources: SinoPac; Nomura; ABN Amro; KGI; Yuanta; Ericsson company reports; 2003 COGS based on Citigroup, Nov 2004 MOT 3.7 SE .5 US/Europe based Flextronics Elcoteq Celestica Other OtherOth 1.5 1.3 0% Samsung and LG do not outsource much 19.5 SE 0.6 29% of MS mkt 0% 33% 50% 100% 50% 100% One third of COGs is outsourced – up from 11% in 2003 Despite the importance of collaboration, there are still large differences: Nokia keeps clear leadership Feature set and cost Nokia 1110 Standby time Motorola C138 Up to 380 hours Up to 300 hours Up to 7.5 hours GSM dual band (900/1800) Weight Up to 5 hours GSM dual band (900/1800 and 850/1900 versions) 80g Volume 78cc 94cc 104 x 44 x 17 mm 100 x 45 x 21 mm Talk time Technology Dimension Display 96 x 68 mono MP3 Removable covers, grade, Other features multiple language, speaker SMS, EMS (picture & jack Messaging messaging) Games, polyphonic ring, Personalization speaking alarm, stop watch, icon menu Call management 200 entry phonebook 81g 96 x 65 mono Headset jack SMS, EMS Games, ringtones, alarm clock, calculator, stop watch SIM only Manufacturing cost $29.45 $34.91 Retail price $60 to $75 Around $50 Sources: and Motorola website and company documents, Portelligent, CSFB comparison: • Nokia 1110 phone beats the Motorola C138 on most key measures that matter to customers: 9 27% more standby time 9 removable covers 9 speakerphone 9 polyphonic ringtones 9 200 entry phonebook 9 17% smaller and 20% thinner 8 33% less talk time Nokia has 15% cost advantage from investing in research to lower the costs of three key chips Architecture teardown and cost comparison: Nokia 1110 and Motorola C138 Cost comparison for 3 key chips Motorola $10.58 Nokia $6.90 delta $3.68 Nokia LCD Keypad Flash Tx/Rx switch TI $2.56 Nokia/Infineon $1.56 filter filter GSM transceiver TI $2.3 Audio Power amp 4 Nokia/IST Analog baseban $1.6 3 d process or TI $5.68 Nokia/TI $3.71 Digital baseban d process or Power amp Crystal oscillato r Vibrator Nokia has SRAM built into the digital baseband processor, Motorola does not Microphone Nokia RFMD Crystal Nokia has Tx/Rx switch and power amplifier combined, Motorola’s is separate SIM SRAM Sources: Motorola website and Motorola company documents, Portelligent, CSFB, Endeavour Partners analysis Summary • Modularity when and if: – performance not critical – dominant design established • Accelerates value creation, makes value capture tough • Focus on locus of value – bottleneck, constrains overall system performance – build inimitable capabilities and core competences