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MBA Help - Strategy

The Experience Curve

The concept of the experience curve was first quantified in the 1960s, when The Boston Consulting Group demonstrated that there was generally a consistent relationship between the marginal cost of producing a unit of a good and the total number of units the company had produced prior to this unit. This relationship showed that the real marginal cost of production tended to fall by around 25 % every time the total number of units produced doubled. This demonstrated that, even for processes that are not particularly labour intensive, a company would become more cost efficient as production continued. Indeed, such is the strength of the relationship predicted by the experience curve that a lack of an experience curve effect in a company is often argued to be a signal of mismanagement. For example, sometimes a firm will withhold further capital investment from a production facility, thus failing to maximise the productivity of that facility. As such, the experience curve is argue to be a combination learning, investment, scale and specialisation.

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As the experience curve has been observed over almost all industries, it has important strategic implications. In particular, should a firm obtain more market share than any of its competitors; it will produce more units, hence gaining greater experience effects and ultimately a cost advantage. This provides additional support to the use of penetration pricing and mass production strategies, as well as significant marketing investments in the early stages of a product, to maximise its demand and hence benefit from rapid experience effects.
 
However, when a company plans to use the experience curve in developing its strategy, it needs to consider potential competitor reactions to this. For example, if all firms follow a penetration strategy no one will gain market share and will only be able to sell a few more units as the market grows. As such, there will only be a small experience effect, which will be outweighed by the excessive production levels and low prices. In addition, if technology diffusion rates are high in the industry, competitors may benefit from some of the company’s experience effects without having to make the same level of investment, thus maintaining a similar cost base. Finally, new technologies may effectively start a whole new experience curve starting from a lower initial cost. As such, new entrants who embrace the new technology may obtain a cost advantage over more experienced incumbents using older technologies.

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