Experience curve effects
Encyclopedia
Models of the learning curve effect and the closely related experience curve effect express the relationship between equations for experience and efficiency or between efficiency gains and investment in the effort.
according to the difficulty of memorizing varying numbers of verbal stimuli. Subsequent learning about the complex processes of learning are discussed in the Learning curve
article.
The experienced learning rates for exploratory discovery and development processes, for individuals and organizations, is more the focus of the main Learning curve
article.
The rule used for representing the learning curve effect states that the more times a task has been performed, the less time will be required on each subsequent iteration. This relationship was probably first quantified in 1936 at Wright-Patterson Air Force Base
in the United States
, where it was determined that every time total aircraft
production doubled, the required labour time decreased by 10 to 15 percent. Subsequent empirical studies from other industries have yielded different values ranging from only a couple of percent up to 30 percent, but in most cases it is a constant percentage: It did not vary at different scales of operation.
Learning curve theory states that as the quantity of items produced doubles, costs decrease at a predictable rate. This predictable rate is described by Equations 1 and 2. The equations have the same equation form. The two equations differ only in the definition of the Y term, but this difference can make a significant difference in the outcome of an estimate.
1. This equation describes the basis for what is called the unit curve. In this equation, Y represents the cost of a specified unit in a production run.
For example, If a production run has generated 200 units, the total cost can be derived by taking the equation below and applying it 200 times (for units 1 to 200) and then summing the 200 values. This is cumbersome and requires the use of a computer or published tables of predetermined values.
where
2. This equation describes the basis for the cumulative average or cum average curve. In this equation, Y represents the average cost of different quantities (X) of units. The significance of the "cum" in cum average is that the average costs are computed for X cumulative units. Therefore, the total cost for X units is the product of X times the cum average cost.
For example, to compute the total costs of units 1 to 200, an analyst could compute the cumulative average cost of unit 200 and multiply this value by 200. This is a much easier calculation than in the case of the unit curve.
where
In the late 1960s Bruce Henderson
of the Boston Consulting Group
(BCG) began to emphasize the implications of the experience curve for strategy.
Research by BCG in the 1970s observed experience curve effects for various industries that ranged from 10 to 25 percent.
These effects are often expressed graphically. The curve is plotted with cumulative units produced on the horizontal axis and unit cost on the vertical axis. A curve that depicts a 15% cost reduction for every doubling of output is called an “85% experience curve”, indicating that unit costs drop to 85% of their original level.
Mathematically the experience curve is described by a power law
function sometimes referred to as Henderson's Law:
where
, learning generally begins with making successively larger finds and then successively smaller ones. The equations for these effects come from the usefulness of mathematical models for certain somewhat predictable aspects of those generally non-deterministic processes.
They include:
The reasoning is increased activity leads to increased learning, which leads to lower costs, which can lead to lower prices, which can lead to increased market share, which can lead to increased profitability and market dominance. According to BCG, the most effective business strategy was one of striving for market dominance in this way. This was particularly true when a firm had an early leadership in market share. It was claimed that if you cannot get enough market share to be competitive, you should get out of that business and concentrate your resources where you can take advantage of experience effects and gain dominant market share. The BCG strategists developed product portfolio techniques like the BCG Matrix (in part) to manage this strategy.
Today we recognize that there are other strategies that are just as effective as cost leadership so we need not limit ourselves to this one path. See for example Porter generic strategies
which talks about product differentiation
and focused market segment
ation as two alternatives to cost leadership.
One consequence of the experience curve effect is that cost savings should be passed on as price decreases rather than kept as profit margin increases. The BCG strategists felt that maintaining a relatively high price, although very profitable in the short run, spelled disaster for the strategy in the long run. They felt that it encouraged competitors to enter the market, triggering a steep price decline and a competitive shakeout
. If prices were reduced as unit costs fell (due to experience curve effects), then competitive entry would be discouraged and one's market share maintained. Using this strategy, you could always stay one step ahead of new or existing rivals.
that it is impossible to separate the two. In theory we can say that economies of scale are those efficiencies that arise from an increased scale of production, and that experience effects are those efficiencies that arise from the learning and experience gained from repeated activities, but in practice the two mirror each other: growth of experience coincides with increased production. Economies of scale should be considered one of the reasons why experience effects exist. Likewise, experience effects are one of the reasons why economies of scale exist. This makes assigning a numerical value to either of them difficult.
The well travelled road effect
may lead people to over-estimate the effect of the experience curve.
Learning curve and learning curve effect
The experience of "learning curves" was first observed by the 19th century German psychologist Hermann EbbinghausHermann Ebbinghaus
Hermann Ebbinghaus was a German psychologist who pioneered the experimental study of memory, and is known for his discovery of the forgetting curve and the spacing effect. He was also the first person to describe the learning curve...
according to the difficulty of memorizing varying numbers of verbal stimuli. Subsequent learning about the complex processes of learning are discussed in the Learning curve
Learning curve
A learning curve is a graphical representation of the changing rate of learning for a given activity or tool. Typically, the increase in retention of information is sharpest after the initial attempts, and then gradually evens out, meaning that less and less new information is retained after each...
article.
The experienced learning rates for exploratory discovery and development processes, for individuals and organizations, is more the focus of the main Learning curve
Learning curve
A learning curve is a graphical representation of the changing rate of learning for a given activity or tool. Typically, the increase in retention of information is sharpest after the initial attempts, and then gradually evens out, meaning that less and less new information is retained after each...
article.
The rule used for representing the learning curve effect states that the more times a task has been performed, the less time will be required on each subsequent iteration. This relationship was probably first quantified in 1936 at Wright-Patterson Air Force Base
Wright-Patterson Air Force Base
Wright-Patterson Air Force Base is a United States Air Force base in Greene and Montgomery counties in the state of Ohio. It includes both Wright and Patterson Fields, which were originally Wilbur Wright Field and Fairfield Aviation General Supply Depot. Patterson Field is located approximately...
in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, where it was determined that every time total aircraft
Aircraft
An aircraft is a vehicle that is able to fly by gaining support from the air, or, in general, the atmosphere of a planet. An aircraft counters the force of gravity by using either static lift or by using the dynamic lift of an airfoil, or in a few cases the downward thrust from jet engines.Although...
production doubled, the required labour time decreased by 10 to 15 percent. Subsequent empirical studies from other industries have yielded different values ranging from only a couple of percent up to 30 percent, but in most cases it is a constant percentage: It did not vary at different scales of operation.
Learning curve theory states that as the quantity of items produced doubles, costs decrease at a predictable rate. This predictable rate is described by Equations 1 and 2. The equations have the same equation form. The two equations differ only in the definition of the Y term, but this difference can make a significant difference in the outcome of an estimate.
1. This equation describes the basis for what is called the unit curve. In this equation, Y represents the cost of a specified unit in a production run.
For example, If a production run has generated 200 units, the total cost can be derived by taking the equation below and applying it 200 times (for units 1 to 200) and then summing the 200 values. This is cumbersome and requires the use of a computer or published tables of predetermined values.
where
-
is the number of direct labour hours to produce the first unit -
is the number of direct labour hours to produce the xth unit -
is the unit number -
is the learning percentage
2. This equation describes the basis for the cumulative average or cum average curve. In this equation, Y represents the average cost of different quantities (X) of units. The significance of the "cum" in cum average is that the average costs are computed for X cumulative units. Therefore, the total cost for X units is the product of X times the cum average cost.
For example, to compute the total costs of units 1 to 200, an analyst could compute the cumulative average cost of unit 200 and multiply this value by 200. This is a much easier calculation than in the case of the unit curve.
where
-
is the number of direct labour hours to produce the first unit -
is the average number of direct labour hours to produce First xth units -
is the unit number -
is the learning percentage
The experience curve
The experience curve effect is broader in scope than the learning curve effect encompassing far more than just labor time. It states that the more often a task is performed, the lower will be the cost of doing it. The task can be the production of any good or service. Each time cumulative volume doubles, value added costs (including administration, marketing, distribution, and manufacturing) fall by a constant and predictable percentage.In the late 1960s Bruce Henderson
Bruce Henderson
Bruce Doolin Henderson was the founder of the Boston Consulting Group . Henderson founded BCG in 1963 in Boston, Massachusetts.- Biography :...
of the Boston Consulting Group
Boston Consulting Group
The Boston Consulting Group is a global management consulting firm with offices in 42 countries. It is recognized as one of the most prestigious management consulting firms in the world. It is one of only three companies to appear in the top 15 of Fortunes "Best Companies to Work For" report for...
(BCG) began to emphasize the implications of the experience curve for strategy.
Research by BCG in the 1970s observed experience curve effects for various industries that ranged from 10 to 25 percent.
Mathematically the experience curve is described by a power law
Power law
A power law is a special kind of mathematical relationship between two quantities. When the frequency of an event varies as a power of some attribute of that event , the frequency is said to follow a power law. For instance, the number of cities having a certain population size is found to vary...
function sometimes referred to as Henderson's Law:
where
is the cost of the first unit of production
is the cost of the nth unit of production
is the cumulative volume of production
is the elasticity of cost with regard to output
Reasons for the effect
The primary reason for why experience and learning curve effects apply, of course, is the complex processes of learning involved. As discussed in the main articleLearning curve
A learning curve is a graphical representation of the changing rate of learning for a given activity or tool. Typically, the increase in retention of information is sharpest after the initial attempts, and then gradually evens out, meaning that less and less new information is retained after each...
, learning generally begins with making successively larger finds and then successively smaller ones. The equations for these effects come from the usefulness of mathematical models for certain somewhat predictable aspects of those generally non-deterministic processes.
They include:
- Labour efficiency - Workers become physically more dexterous. They become mentally more confident and spend less time hesitating, learning, experimenting, or making mistakes. Over time they learn short-cuts and improvements. This applies to all employees and managers, not just those directly involved in production.
- Standardization, specialization, and methods improvements - As processes, parts, and products become more standardized, efficiency tends to increase. When employees specialize in a limited set of tasks, they gain more experience with these tasks and operate at a faster rate.
- Technology-Driven Learning - Automated production technology and information technology can introduce efficiencies as they are implemented and people learn how to use them efficiently and effectively.
- Better use of equipment - as total production has increased, manufacturing equipment will have been more fully exploited, lowering fully accounted unit costs. In addition, purchase of more productive equipment can be justifiable.
- Changes in the resource mix - As a company acquires experience, it can alter its mix of inputs and thereby become more efficient.
- Product redesign - As the manufacturers and consumers have more experience with the product, they can usually find improvements. This filters through to the manufacturing process. A good example of this is Cadillac's testing of various "bells and whistles" specialty accessories. The ones that did not break became mass produced in other General Motors products; the ones that didn't stand the test of user "beatings" were discontinued, saving the car company money. As General Motors produced more cars, they learned how to best produce products that work for the least money.
- Network-building and use-cost reductions (network effectNetwork effectIn economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.The classic example is the telephone...
s) - As a product enters more widespread use, the consumer uses it more efficiently because they're familiar with it. One fax machine in the world can do nothing, but if everyone has one, they build an increasingly efficient network of communications. Another example is email accounts; the more there are, the more efficient the network is, the lower everyone's cost per utility of using it. - Shared experience effects - Experience curve effects are reinforced when two or more products share a common activity or resource. Any efficiency learned from one product can be applied to the other products. (This is related to the principle of least astonishmentPrinciple of least astonishmentThe principle of least astonishment applies to user interface design, software design, and ergonomics. It is alternatively referred to as the rule or law of least astonishment, or the rule or principle of least surprise .The POLA states that, when two elements of an interface conflict, or are...
).
Experience curve discontinuities
The experience curve effect can on occasion come to an abrupt stop. Graphically, the curve is truncated. Existing processes become obsolete and the firm must upgrade to remain competitive. The upgrade will mean the old experience curve will be replaced by a new one. This occurs when:- Competitors introduce new products or processes that you must respond to
- Key suppliers have much bigger customers that determine the price of products and services, and that becomes the main cost driver for the product
- Technological change requires that you or your suppliers change processes
- The experience curve strategies must be re-evaluated because
- they are leading to price wars
- they are not producing a marketing mixMarketing mixThe term "marketing mix" was coined in 1953 by Neil Borden in his American Marketing Association presidential address. However, this was actually a reformulation of an earlier idea by his associate, James Culliton, who in 1948 described the role of the marketing manager as a "mixer of ingredients",...
that the market values
Strategic consequences of the effect
The BCG strategists examined the consequences of the experience effect for businesses. They concluded that because relatively low cost of operations is a very powerful strategic advantage, firms should capitalize on these learning and experience effects.The reasoning is increased activity leads to increased learning, which leads to lower costs, which can lead to lower prices, which can lead to increased market share, which can lead to increased profitability and market dominance. According to BCG, the most effective business strategy was one of striving for market dominance in this way. This was particularly true when a firm had an early leadership in market share. It was claimed that if you cannot get enough market share to be competitive, you should get out of that business and concentrate your resources where you can take advantage of experience effects and gain dominant market share. The BCG strategists developed product portfolio techniques like the BCG Matrix (in part) to manage this strategy.
Today we recognize that there are other strategies that are just as effective as cost leadership so we need not limit ourselves to this one path. See for example Porter generic strategies
Porter generic strategies
Michael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope...
which talks about product differentiation
Product differentiation
In economics and marketing, product differentiation is the process of distinguishing a product or offering from others, to make it more attractive to a particular target market. This involves differentiating it from competitors' products as well as a firm's own product offerings...
and focused market segment
Market segment
Market segmentation is a concept in economics and marketing. A market segment is a sub-set of a market made up of people or organizations with one or more characteristics that cause them to demand similar product and/or services based on qualities of those products such as price or function...
ation as two alternatives to cost leadership.
One consequence of the experience curve effect is that cost savings should be passed on as price decreases rather than kept as profit margin increases. The BCG strategists felt that maintaining a relatively high price, although very profitable in the short run, spelled disaster for the strategy in the long run. They felt that it encouraged competitors to enter the market, triggering a steep price decline and a competitive shakeout
Shakeout
Shakeout is a term used in business and economics to describe the consolidation of an industry or sector, in which businesses are eliminated or acquired through competition...
. If prices were reduced as unit costs fell (due to experience curve effects), then competitive entry would be discouraged and one's market share maintained. Using this strategy, you could always stay one step ahead of new or existing rivals.
Criticisms
Some authors claim that in most organizations it is impossible to quantify the effects. They claim that experience effects are so closely intertwined with economies of scaleEconomies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
that it is impossible to separate the two. In theory we can say that economies of scale are those efficiencies that arise from an increased scale of production, and that experience effects are those efficiencies that arise from the learning and experience gained from repeated activities, but in practice the two mirror each other: growth of experience coincides with increased production. Economies of scale should be considered one of the reasons why experience effects exist. Likewise, experience effects are one of the reasons why economies of scale exist. This makes assigning a numerical value to either of them difficult.
The well travelled road effect
Well travelled road effect
The well travelled road effect is a cognitive bias in which travellers will estimate the time taken to traverse routes differently depending on their familiarity with the route. Frequently travelled routes are assessed as taking a shorter time than unfamiliar routes...
may lead people to over-estimate the effect of the experience curve.
See also
- Economies of scaleReturns to scaleIn economics, returns to scale and economies of scale are related terms that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable...
- Hermann EbbinghausHermann EbbinghausHermann Ebbinghaus was a German psychologist who pioneered the experimental study of memory, and is known for his discovery of the forgetting curve and the spacing effect. He was also the first person to describe the learning curve...
- ManagementManagementManagement in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively...
- Marketing strategies
- Porter generic strategiesPorter generic strategiesMichael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope...
- Strategic planningStrategic planningStrategic planning is an organization's process of defining its strategy, or direction, and making decisions on allocating its resources to pursue this strategy. In order to determine the direction of the organization, it is necessary to understand its current position and the possible avenues...
- Gordon MooreGordon MooreGordon Earle Moore is the co-founder and Chairman Emeritus of Intel Corporation and the author of Moore's Law .-Life and career:...
's Law of affordable computing performance growth - Mark KryderMark KryderMark Kryder was Seagate Corp.'s senior vice president of research and chief technology officer.Kryder holds a Bachelor of Science degree in Electrical Engineering from Stanford University and a Ph.D...
's Law of magnetic disk storage growth - Jakob NielsenJakob Nielsen (usability consultant)Jakob Nielsen is a leading web usability consultant. He holds a Ph.D. in human–computer interaction from the Technical University of Denmark in Copenhagen.-Early life and background:...
's Law of wired bandwidth growth - Martin CooperMartin CooperMartin Cooper is an American former Motorola vice president and division manager who in the 1970s led the team that developed the handheld mobile phone ....
's Law of simultaneous wireless conversation capacity growth - Learning-by-doingLearning-by-doingLearning-by-doing is a concept within economic theory. It refers to the capability of workers to improve their productivity by regularly repeating the same type of action...
External links
- Learning curve calculator (Accessed March 24, 2007)
- http://fast.faa.gov/pricing/98-30c18.htm