Modularity has recently become an important concept in economics and management science alike (Ulrich 1995; Baldwin and Clark 2000). However, it is not always clear what is meant by modularity as formal treatments are rare. The aim of this paper is threefold. First, we want to provide a rigorous treatment of modularity. To this end we use Kauffman"s (1993) NK-model and some variations recently developed in the field of biology (Altenberg 1994, 1994), economics (Frenken et al. 1999; Marengo et al. 2000) and management (Levinthal 1997). Second, we derive a number of propositions regarding the optimal modularity in complex systems. An optimal level of modularity generally exists because ultra-modular systems are not easy to optimise as one has to choose the right interface standards, while systems without any modularity are difficult to optimise because all elements are interdependent. A system with optimal modularity balances both sources of difficulty by using relatively few interface standards such that a relatively high level of modularity is achieved. Third, since finding the optimal modularity of a complex system is too difficult a task for boundedly rational agents, we develop and compare adaptive heuristics for modularising a system by simulation
