Summary Prepareb for 2004 AIB Farmer Dissertation Award

STRATEGIC MODULARIZATION AND PERFORMANCE IMPLICATIONS IN THE BRAZILIAN AUTOMOTIVE INDUSTRY Dissertation Advisor: Masaaki Kotabe

Ronaldo Parente Temple University Dissertation Defended: June 26th , 2003 Ph.D. Degree Granted: August 29th, 2003 27962 Craven Ct. Salisbury, MD 21801 Phone: +1(410) 341-0128 Email: Ronaldo@Parente.com

STRATEGIC MODULARIZATION AND PERFORMANCE IMPLICATIONS IN THE BRAZILIAN AUTOMOTIVE INDUSTRY Abstract The present research examines the trend toward modularization and the evolution of sourcing strategies. The focus revolves around strategy implications of modular productiona production method that has been increasingly adopted by global manufacturing firms. In-depth interviews were conducted and a conceptual framework to explain the dynamics of modular strategy in a global manufacturing industry was developed. In addition, the conceptual framework was tested using data from questionnaire survey of the automobile industry in Brazil. Our findings indicate that strategic modularization will improve firms positional advantage by reducing the cost of managing tacit knowledge. The adoption of modularization also influences the nature of relationships with major suppliers, further blurring the boundaries of the firm. In addition, suppliers physical proximity and the degree of face-to-face communication seem to have a moderating effect on the relationship between modularization and firm performance. Finally, this study provides important theoretical contributions while offering guidelines to executives in making the right decisions on modularization and providing managers a better understanding for implementing modular production in todays global business context.

1 STRATEGIC MODULARIZATION AND PERFORMANCE IMPLICATIONS IN THE BRAZILIAN AUTOMOTIVE INDUSTRY

This research deals with a very important topic in international management and strategy, which revolves around strategy implications of modular production a production method that has been increasingly adopted by global manufacturing firms. Recently, the Brazilian auto industry has received investments from new entrants, such as: Honda, Renault, Peugeot, Kia, Audi, Chrysler, Navi Star, Nissan, Rover, and Iveco. In addition, early entrants have opened or are building new factories. The existence of so many new factories and investments in Brazil reflect its importance for its local market potential and as an export platform to other international markets. Consequently, Brazil provides an excellent environment in which to examine the determinants and outcomes of strategic modularization in the design and production of automobiles. Being the only country that hosts all the global car manufacturers in the world, Brazil has been identified by automakers as an environment offering the right conditions for the applications of alternative and innovative methods of production. Global automakers and suppliersfrom the United States, Europe, and Japan setting up factories in Brazil have emphasized the concept of modularity in the design and production of their cars since 1996, when Volkswagen opened its modular truck-manufacturing facility.

The purpose of this study is to examine modularization as a competitive strategy in the global manufacturing industry. The objective is to examine how foreign automobile manufacturers operating in Brazil have implemented and benefited from strategic modularization. Since the focus was theory construction (i.e., elaboration of constructs and propositions), it was important to explore a wide range of approaches and perspectives in the context of implementing modularization. In the first phase of empirical investigation, a

grounded theory1 approach was used to develop the conceptual framework based on case studies
1

Grounded theory is invaluable when conducting theoretical research as this qualitative analysis approach allows the data to communicate, through rigorous analysis and coding of concepts conveyed in interviews (Strauss and Corbin, 1990).

2 and in-depth interviews with executives from several automobile manufacturers in Brazil. Then, in the second phase, the theoretical model described in Figure 1, which simultaneously incorporates the antecedent conditions leading to modular production as well as the performance implications of various dimensions of strategic modularization, was tested with data collected through a large sample survey.

Figure 1: Strategic Modularization Conceptual Framework

Level of Supplier Involveme nt & Codesign

Customer Requireme nts Stage of Product Developme nt

Supplier Physical Proximity & Collocation

Strategic Positional Advantage

STRATEGIC MODULARIZATION Mutual Partial Ownership

Supply Chain Integration Tacit Knowledge Isolation Modular product

Architecture Face-to-Face Communicatio n for Knowledge Sharing

Market Economic Performan ce

Collaborati ve Experience

Strategic modularization was defined as a multidimensional construct. It is a method of production that goes beyond the physical and functional dimensions of the module2 in that it is a competitive strategy used to reduce the cost of managing tacit knowledge in the assembly process.
2

Therefore, strategic modularization helps assemblers of final products remain

Modules are subassemblies that reduce complexity and time taken in the plant for assembly, but that do not necessarily comply with a standard interface. It can be defined in the context of the auto industry as a physically proximate chunk of components, which can be assembled into the vehicle as one unit where common interfaces and standardization of specifications are not mandatory, and components are the building blocks of modules.

3 competitive by managing complexity, technology, and knowledge flow; becoming more flexible; reducing capital investments; and satisfying increasing customer demands. Thus, the degree of strategic modularization was measured as the degree to which the concept of modularity was implemented at both the product- and process-levels throughout the supply chain in all of its three dimensions: modular product architecture, supply chain integration, and tacit knowledge isolation. According to O Grady (1999), firms that adopted modularity as an strategic approach have increased product variety and strategic flexibility, achieved economies of scale, reduced order lead-time, lower capital costs, lower overall costs, simplified control mechanisms, increased feasibility of product/component change, and are finding easy to perform product upgrade, maintenance, repair and disposal. Therefore, a major theoretical contribution of this research is that it advances the existing theories of strategy and international management to incorporate modularity as an efficient method of production in manufacturing. Research findings suggest that strategic modularization may help improve a firms positional advantage by reducing the cost of managing tacit knowledge. In addition, the adoption of modularization seems to influence the nature of relationships with major suppliers, further blurring the boundaries of the firm. Moreover, leveraging capabilities through the integration of the supply chain facilitates the diffusion of technology and expertise among buyers and suppliers, which help these extended enterprises to achieve competitive advantage.

Theoretical Foundation and Literature Review Resource-based theory (Teece, 1987; Barney, 1991) suggests that it is important to consider complex sets of organizational resources in understanding how strategic flexibility may result in competitive advantage. For example, the strategic value of modular production may be linked to the presence of other organizational resources such as the firms ability to develop flexible structures, processes, and efficient collaborative relationships that allow for effective knowledge exchange. In addition, the adoption of strategic modularization implies having or acquiring advanced architectural knowledge about relevant components and/or activities and their interactions and interdependencies (Sanchez & Mahoney, 1996). Worren, Moore, and Cardona (2002), suggested that strategic modularization can be seen as a set of principles involving modular product and process architectures that provide the organization with strategic flexibility and the ability to manage complexities. In the 1980s Toyota brought a revolution to manufacturing that moved away from Fords mass production and toward the adoption of a production method based on the concept of lean production (Womack, Jones, & Roos, 1990), which focuses on eliminating waste and inventory from the supply chain and aggregates value in every step of the production process. Recently, the concept of modularization has gained much attention, since it has been linked more specifically to the design and/or assembly strategies of large multinationals. The emergence of modularization is being accompanied by new knowledge management strategies (Grant, 1996), which allow firms to develop products more effectively through flexible, modular organization structures (Sanchez & Mahoney 1996). Thus, modularization goes beyond the idea of

subassembly delivery practiced in lean manufacturing. It includes an organizational and managerial system linking module integrators and module suppliers to reduce fixed costs, costs

5 of managing tacit knowledge, and their vulnerability to external factors. According to OGrady (1999), modularity is argued to help organizations to achieve mass customization3, shorten product development cycles, speed technological change, and lower costs. Baldwin & Clark (1997) suggested that by delegating the manufacturing process to many separate suppliers, each one of which adds value, the assembler gains flexibility and cuts costs. Clearly, we need to better understand the recent developments in manufacturing. The literature suggests that there are no empirical studies at the firm level of how the adoption of modularization affects performance outcomes with the exception of a recent study by Worren, Moore, and Cardona (2002), which examined the impact of product modularity to strategic flexibility in the home appliance industry. Therefore, there seems to be a theoretical gap in the management literature on modularization that can be filled by developing and testing a normative framework integrating the antecedents of the decision to adopt modularization and its impact to performance outcome at the firm level. Research Methodology The first phase of the research consisted of plant visits and in-depth interviews with several plant managers, manufacturing supervisors, supply-chain managers, and purchasing managers working in the automobile industry in Brazil. The sample selection was decided by making sure that it included strategy as well as manufacturing managers of several automakers adopting innovative modular arrangements in the Brazilian market. Of the 34 individuals interviewed, 19 were either plant managers or manufacturing supervisors from Ford (Sao Bernardo do Campo, So Paulo), DaimlerChrysler (Sao Bernardo do Campo, So Paulo), General Motors (Gravatai, Rio Grande
3

Mass customization (Pine 1993 and Kotha 1995) emphasizes the need to provide outstanding service to customers in providing products that meet customers needs (through maximizing individual customization) at a low cost (through modular components). In addition, mass customization is the process by which consumers can order, and have delivered quickly, custom-designed products, but at mass-market prices (OGrady 1999).

6 do Sul), Volkswagen (Resende, Rio de Janeiro), and Troller (Maracanau, Fortaleza). In addition, one professor at the University of So Paulo who is currently studying the recent developments of the automobile industry in Brazil was also interviewed. Four of those interviewed were executives at Anfavea and Sindipecas. A total of five automakers (i.e., Volkswagen, Ford, DaimlerChrysler, General Motors, and Troller) were included in the sample, and multiple individuals were interviewed. The companies interviewed were from different countries,

including one Brazilian, two Europeans, and two from the United States.4 In the second phase of the study, firms were chosen from the automobile industry in Brazil to test the conceptual model. The final sample was composed of 493 business units, including manufacturers of cars, motorcycles, buses, trucks, and tractors and their suppliers. A questionnaire was developed with Likert-type measurement scales for the constructs described in the strategic modularization normative framework. Wherever possible, items were reused, or the general question format from existing scales was maintained. When necessary the development of the new items was informed by the field studies, which included semistructured interviews. The construct validation followed the usual steps in exploratory factor analysis and created indices summarizing the items. The survey was mailed to managers at the plant/divisional level, who were asked to respond based on the products and characteristics of their division. After the initial mailing and two follow-up letters a total of 103 valid questionnaires were received with a final response rate of 23 percent.

At this stage of this research, no Japanese company was interviewed. Japanese companies are newer entrants than U.S. and European firms in the Brazilian auto industry, so they have not yet fully established modular structure in their plants.

7 Hypotheses were developed based on literature review and supported by qualitative findings from the fieldwork in Brazil. The hypothesized relationships indicated in the conceptual framework were tested with the General Linear Model (GLM) procedure. An important point is that the distinction among the three dimensions of strategic positional advantages (low cost, speed, and quality) discussed in this study has begun to diminish (Lanctot, 1995; Lanctot & Swan, 2000). Our data also confirmed this. Therefore, relative strategic positional advantage construct (POS_ADV) was calculated by collapsing SPEED, QUALITY, and LOW COST into one product performance index. Moreover, strategic modularization is a multidimensional construct calculated as the mean of its three dimensions identified in the factor analysis. The initial correlation coefficients among these three factors (supply chain integration, tacit knowledge isolation, and product modular architecture) were all above 0.5. The coefficients were all statistically significant justifying the use of the mean strategic modularization index (MODULAR) as the dependent variable in the GLM procedures. Research Results & Analysis Hypothesis 1 states that where the level of customer requirement is high, assemblers will be more likely to adopt a high degree of strategic modularization. The results of the GLM procedure strongly support this hypothesis. This indicates that the greater the level of customer requirements, the more likely a firm is to adopt a higher level of strategic modularization. Hypothesis 2 states that in industries where there is a high level of unpredictability of product specifications (i.e., markets where products are still in the earlier stages of product development), the assemblers will be more likely to adopt a high degree of strategic modularization. Results of the GLM did not support this hypothesis indicating that the stage of

8 product development does not have any implication in the degree of adoption of strategic modularization. Hypothesis 3 states that in industries where there is a high degree of mutual partial ownership within the buyer-supplier relationship, assemblers will be more likely to adopt a high degree of strategic modularization. Results of the GLM marginally support this hypothesis. This indicates that to the extent to which there are mutual ownership (MUT_OWN) relationships between assembler and suppliers, these relationships seem to have a slight significant effect on the firms degree of adoption of strategic modularization. Hypothesis 4 states that in industries where firms possess a high level of experience in collaborative buyer-supplier network relationships, the assemblers will be more likely to adopt a high degree of strategic modularization. Results of the GLM strongly support this hypothesis. This indicates that the greater the firms experience in collaborative relationships, the more likely a firm is to adopt a higher level of strategic modularization. Hypothesis 5 state that a higher degree of strategic modularization will be positively related to a higher level of relative strategic positional advantage. The GLM results, shows support for this hypothesis. This positive significant relationship indicates that the degree of strategic modularization is positively associated with relative strategic positional advantage. Hypothesis 6 states that a higher degree of strategic modularization will be positively related to a higher level of relative market performance. The GLM results, shows strong support for this hypothesis. This positive significant relationship indicates that the degree of strategic modularization is positively associated with relative market performance. Hypothesis 7a states that the positive relationship between the degree of strategic modularization and relative strategic positional advantage becomes stronger as the level of

9 codesign and early involvement increases. This moderator hypothesis is not supported. Hypothesis 7b states that the positive relationship between the degree of strategic modularization and relative market performance becomes stronger as the level of codesign and early involvement increases. This hypothesis is not supported. Hypothesis 8a states that the positive relationship between the degree of strategic modularization and relative strategic positional advantage becomes stronger as physical proximity increases. This moderator hypothesis is not supported. Hypothesis 8b states that the positive relationship between the degree of strategic modularization and relative market performance becomes stronger as physical proximity increases. This moderator hypothesis is marginally supported. This indicates that, as the degree of physical proximity increases, there will be some positive effect on the relationship between the degree of strategic modularization and market performance. Hypothesis 9a states that the positive relationship between the degree of strategic modularization and relative strategic positional advantage becomes stronger as the level of faceto-face communication increases. This moderator hypothesis is not supported. Hypothesis 9b states that the positive relationship between the degree of strategic modularization and relative market performance becomes stronger as the level of face-to-face communication increases. This moderator hypothesis is strongly supported. This indicates that as the degree of face-to-face communication between assembler and suppliers increases, there will be a positive effect on the relationship between the degree of strategic modularization and market performance. Research Findings, Implications, and Contributions Management literature suggests that organizations must be able to predict the shift of customer preferences toward higher product variation and customization requirements; at the same time

10 managers must develop innovative marketing and supply-chain management strategies to ensure proper commercialization and distribution of their products (Mikkola, 2000). In highly competitive environments, firms must respond to the environments demandsand must do so quickly in order to survive. Thus, in an industry with strong pressures for flexibility, a high degree of competitive intensity will increase the likelihood that the industry will be characterized by greater use of strategic modularization. This line of reasoning is consistent with recent conventional wisdom regarding globalization and changing organizational forms. Several authors have speculated that the globalization of markets has encouraged organizational disaggregation (Snow, Miles, & Coleman, 1992). In essence, globalization increases the level of customer requirements, enhancing firms need for quick response to the demands of their environments. There is evidence in the management literature that firms use alliances to gain technologies (or other capabilities) more quickly than they could develop them in-house (Harbison & Pekar, 1998; Heinsl, 2000; Powell, Koput, & Smith-Doerr, 1996; Schilling & Steensma, 2000). Empirical findings support the above argument and the hypotheses that the degree of customer requirements and the extent of the firms experience in collaborative relationships are positively related to the degree of adoption of strategic modularization. Research results support the idea that manufacturing firms can avoid rigidity and obsolescence by adopting a strategy based on the concept of modularization, which in turn will allow the organization to build a high degree of flexibility, enabling it to adapt to changes on a continuous basis. In general the findings indicate that the degree of adoption of strategic modularization has positive effect on firm success. Moreover, physical proximity and the degree of face-to-face communication seem to enhance the positive relationship between strategic modularization and relative market performance. Although the moderating effects did not come

11 out as expected, the results and possible alternative explanations point toward interesting directions for future research, whereby the implications of codesign, physical proximity, and face-to-face communication can be systematically examined and compared in cross-national strategic relationships. Surprisingly, the empirical data provided no support for a positive relationship between the degree of strategic modularization and firms cost reduction in isolation as suggested by anecdotal evidence and fieldwork. Conversely, the degree of strategic modularization seems to be positively associated with most of the performance indicators such as speed of product development; higher product quality, relative strategic positional advantage, and relative market performance. Many of the factors found to be associated with strategic modularization in the analysis can be controlled or influenced by management decisions and therefore can be altered by managers to improve the probability of success when implementing strategic modularization. Overall, the fieldwork data, conceptual framework, and research results provide managers a comprehensive view of what strategic modularization is, the ways to operationalize it, and how it is likely to affect performance outcomes in global manufacturing firms. Thus, an important recommendation from this research is that managers need to better understand modular production and relationships to better manage the factors associated with how firms continuously improve internal processes to reduce job turnaround times, reduce cycle time, and cut waste. The empirical findings in this study offer knowledge that should allow for quick response to customer demand and changes in the market. In terms of the managerial implications of this study, the findings provide normative guidelines to managers on managing the transition to modular production strategies and

12 relationships. The research findings suggest that strategic modularization is the current technological trend in designing a more efficient global supply chain in the automobile industry and should have direct managerial implications. The complexity of this strategic approach requires managers to develop a good understanding of its antecedents and outcomes to be able to take full advantage of the opportunities. This study can help managers develop a comprehensive understanding of this process and allow them to implement modularization strategically in ways that will lead to firm success. Managers can benefit from the results in this research by developing a set of managerial tools that will help firms become more competitive by offering customers better delivery times, higher quality delivery, and cost savings. Moreover, knowledge exchange practices and strategic modularization may help firms switch from a traditional adversarial relationship with suppliers, so that suppliers become strategic partners and integrate their businesses. Suppliers can then respond faster to product demands, because they can better anticipate the firms needs. The goal should be that suppliers start to see a module integrator as a valued partner and not simply as another sale. At the VW plant each supplier is expected to behave as a partner and bring improvements and process innovation to the production process. As Mr. Luca, the plant manager, noted: Our suppliers working inside our plant can better monitor our production line. Our suppliers can sense demand fluctuations and volatility in the market at the same time we do. Because of this close interaction, they are always willing to sit with us to renegotiate prices and conditions. This gives us a competitive edge when biding for large contracts such as the one we just closed for selling 700 trucks to Saudi Arabia. Researchers have shown increasing interest in generalizing the principal of modularity from the product level to the context of organizational processes (Sanchez & Mahoney, 1996). There seems to be a theoretical gap in the management literature studying modular production in

13 manufacturing industries that this research filled by developing and testing a normative framework integrating the potential drivers of strategic modularization and determining its effect on performance outcome at the firm level. Therefore, a major contribution of this research is that it is broader in scope and takes an in-depth view of the strategic modularization process by looking at its determinants, its effect on the relative positional advantage of the firm, and some of the moderating factors of this relationship. The discussion of strategic modularization and the empirical analysis of the data allow for a better understanding of the strategy implementation and motivations of the ongoing international expansion of global enterprises investing in foreign markets and the understanding of how their global supply chain and production decisions are linked to long-term firm performance. This research represents the first effort to build a foundation for systematic development of a strategic modularization framework for the manufacturing industries that will help researchers understand the technological trend currently underway in these industries. The research contributes to the existing body of literature that has examined the concept of modularity by developing and testing a strategic modularization framework. Thus, the empirical findings of this research should develop the interest of researchers in the importance of modularization and its role as a strategic approach for competitive advantage. As mentioned, the conceptual framework and empirical findings of this research provided important managerial and theoretical insights on applying existing strategy and international management theories to the area of strategic modularization. Notwithstanding this, several limitations should be addressed in this study. First, this study is subject to the usual limitations inherent in cross-sectional research designs employing subjective measures. Second, we must be cautious in drawing conclusions outside the scope of this research, because these results are from

14 an industry-specific research, with data collected in one specific country. Therefore we must be careful in trying to generalize its findings. Finally, when controlled for the type of product produced and delivered, the study results indicate a consistent significant beta coefficient for this control variable, suggesting that module suppliers may not be getting all the promised benefits from strategic modularization relationships. Therefore, future research is warranted and should extend this conceptual model to address this aspect of modular production from the suppliers point of view by trying to understand what suppliers really think about such modular relationships with automakers and how knowledge is exchanged between buyer and supplier and to try to link this modularization trend in the auto sector to supplier performance improvements. Other future research opportunities are also addressed in the study.

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