In the 1960’s management consultants at the Boston Consulting Group observed a consistent relationship between the cost of production and the cumulative production quality. Data showed that the real value-added production cost declined by 20 to 30 percent for each doubling of cumulative production quantity:
The concept of experience curve refers to systematic unit-cost reductions that have been observed to occur over the life period of a product. The experience curve concept states that the unit cost declines as a firm accumulates experience in terms of a cumulative volume of production. It implies that larger firms in an industry are likely to have lower unit costs as compared to smaller firms, thereby gaining a competitive cost advantage. The experience curve phenomenon is built on the building blocks of Learning effects, product redesign, economies of scale, and improvements in technology. As a company increases the accumulated volume of its output over time it realizes both economies of scale and learning effect. As a result, unit cost decreases with increases in accumulated output.
The experience curve is significant from strategic choice point of view. It suggests that increasing a company’s product volume and market share will also bring cost advantages over the competition.
The concept of experience curve refers to systematic unit-cost reductions that have been observed to occur over the life period of a product. The experience curve concept states that the unit cost declines as a firm accumulates experience in terms of a cumulative volume of production. It implies that larger firms in an industry are likely to have lower unit costs as compared to smaller firms, thereby gaining a competitive cost advantage. The experience curve phenomenon is built on the building blocks of Learning effects, product redesign, economies of scale, and improvements in technology. As a company increases the accumulated volume of its output over time it realizes both economies of scale and learning effect. As a result, unit cost decreases with increases in accumulated output.
The experience curve is significant from strategic choice point of view. It suggests that increasing a company’s product volume and market share will also bring cost advantages over the competition.
The figure explains that company A down the experience curve has a cost advantage over company B. The concept of experience curve is more relevant in those industries that are engaged in the mass- production of standardized output. If a firm desires to gain more efficiency and attain low cost position, it must ride down the experience curve and achieve cost advantages over its competitors. For example Japanese semiconductor companies used such tactics to ride down the experience curve and gain a competitive advantage over their U.S. rivals in the market for DRAM chips. Companies that go further down the experience curve should not become complacent about its cost advantages. There are three reasons why companies should not become complacent about their efficiency- based cost advantages derived from experience effects.
1. Neither learning effects nor economies of scale go on forever. The experience curve is like to bottom out at some point. Further unit-cost reduction from learning effects and economies of scale will be difficult to derive. Other firms will also be able to reduce their costs and equalize with the cost leader. Therefore, establishing a sustainable competitive advantage must involve strategic factors as better customer responsiveness, product quality, or innovation in addition to the minimization of production costs by utilizing existing technologies. 2. The development of new technologies may turn competitive cost advantages of experience effects obsolete. 3. High volume does not necessarily give a company a cost advantage.
The experience curve has important strategic implications. If a firm gains market share over its competitors, it is able to develop a cost advantage. Penetration pricing strategies, a significant investment in advertising, sales personnel, production capacity, etc. can be justified to increase market share and gain a competitive advantage.
When evaluating strategies based on the experience curve, a firm must think carefully about the reaction of competitors who also realize the significance of the experience curve. Some potential pitfalls of the experience curve are:
1. If all other firms equally pursue the strategy, then no firm will increase market share and will suffer losses from over-capacity and low prices. Larger the number of competitors that pursue the strategy, the higher the cost of gaining a given market share and the lower the return on investment.
2. Competing firms may be able to discover the leading firm’s proprietary methods and replicate the cost reductions without having made the large investment to gain experience.
3. New technologies may create a new experience curve. New entrants building new plants may be able to take advantage of the latest technologies that offer a cost advantage over the older plants of the leading firm.
The experience curve has important strategic implications. If a firm gains market share over its competitors, it is able to develop a cost advantage. Penetration pricing strategies, a significant investment in advertising, sales personnel, production capacity, etc. can be justified to increase market share and gain a competitive advantage.
When evaluating strategies based on the experience curve, a firm must think carefully about the reaction of competitors who also realize the significance of the experience curve. Some potential pitfalls of the experience curve are:
1. If all other firms equally pursue the strategy, then no firm will increase market share and will suffer losses from over-capacity and low prices. Larger the number of competitors that pursue the strategy, the higher the cost of gaining a given market share and the lower the return on investment.
2. Competing firms may be able to discover the leading firm’s proprietary methods and replicate the cost reductions without having made the large investment to gain experience.
3. New technologies may create a new experience curve. New entrants building new plants may be able to take advantage of the latest technologies that offer a cost advantage over the older plants of the leading firm.
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