The Experience Curve argues that the more experience a business has in manufacturing a product, the more it can lower costs. As a company gains un know-how, it also gains in terms of labor efficiency, technology-driven learning, product efficiency, and shared experience, to reduce the cost per unit as the cumulative volume of production increases.
Understanding the experience curve
The Experience Curve was developed in the 1960s by The Boston Consulting Group who observed the phenomenon in the manufacture of semiconductors.
They found that the value-added production cost declined by as much as 20 to 30% each time the total manufacturing output doubled.
In this context, manufacturing output was directly related to experience. In theory, experience then allows a company to further reduce production costs and gain a competitive advantage in the process.
In terms of the fundamental core processes that power the Experience Curve, consider the following:
Employees who perform the same job repeatedly will naturally become more skilful and efficient. Confidence also grows and as a result, they make fewer errors which increases productivity.
Standardization and specialization – skilled employees with experience then contribute to standardizing processes.
They also streamline the use of required tools, techniques, and materials.
When a company has enough experience to bulk produce goods and services, they achieve product and thus cost efficiency.
Shared experience effect
This potentially shortens the learning curve and fast tracks their ability to reduce costs with experience.
Examples of the Experience Curve
Perhaps the most well-known example of the Experience Curve can be seen in the development of the Model T Ford.
With the benefit of 11 years of assembly experience, Ford cut production costs of the Model T and increased its market share from 10% to 55%.
This was achieved by modernizing plants, vertical integration and eliminating model changes.
Ford even went as far offering the Model T in black only, since black paint dried the quickest and therefore increased the speed of production.
Contact lens maker Bausch & Lomb consolidated their market position by computerizing lens design and expanding their plant to facilitate greater productivity.
Arc welding supply company Lincoln Electric also encouraged experienced employees to create policies that would increase efficiency.
Limitations to the Experience Curve
The Experience Curve does suffer from limitations, particularly if certain aspects of the business are mismanaged.
Potential limitations include:
- A lack of mentors or skilled employees who can contribute their experience to improving company processes.
- Mistaking the Experience Curve with future potential. While the curve does lead to reduced costs, it does not make any guarantees. Companies with poor management who suffer from negative external factors may find it difficult to reduce costs significantly.
- Reliance on product relevancy. When a product becomes obsolete or falls out of favour with consumers, any cost reduction the company previously enjoyed will be eroded due to falling sales and lower profits. The company must then start the process again.
Further experience curve examples
Texas Instruments (TI) is an American manufacturer of semiconductors and various integrated circuits that was founded in 1930 by Eugene McDermott, J. Erik Jonsson, Patrick E. Haggerty, and Cecil Howard Green.
When Texas Instruments entered the market and implemented the strategy in 1972, calculator unit costs dropped from a number in the thousands to under $10 in around a decade.
In response, pent-up demand caused sales to skyrocket and, since the company was an experienced-based cost leader, its competitive advantage was impossible to overcome.
The example of Texas Instruments shows that experience curve strategies are particularly effective when there is extreme demand sensitivity to fluctuations in price.
Once the company was able to lower prices, the additional demand accelerated progress along the curve and enabled TI to rapidly increase output.
This output then decreased manufacturing costs further, which caused calculator prices to decrease and demand to increase in a positive feedback loop.
Oil and gas exploration
The effect of the experience curve has also been studied in the context of oil and gas exploration companies.
During the early years of the shale boom which began in the United States in the 1950s, the number of wells that were drilled with no resources discovered was as high as 45%.
Cost reduction improvements were driven by several factors:
- Incremental advances in technology.
- Increased familiarity with crews and engineering, and
- Reduced geologic uncertainty.
Using shale oil and gas development as an example, researchers were able to estimate an acceptable range of marginal costs for geothermal field development.
These costs were then combined with development cost estimates for specific enhanced geothermal systems (EGS) projects. In the process, researchers wanted to know the levelized cost of electricity (LCOE) for various project based on the total number of wells drilled.
The study concluded that there was significant cost reduction potential for EGS projects as a whole.
Taking into account reasonable cost assumptions and a multi-stage completion well design, researchers determined the unsubsidized LCOE for various projects at different stages of maturity.
The results showed that the initial costs relative to market prices were high. However, the experience curve defined a clear path to developing cost-competitive EGS projects without having to rely on technological breakthroughs.
In markets where electricity prices were low, the study admitted that cost-competitiveness may take hundreds of wells to achieve.
But in favorable markets characterized by expensive electricity and an established carbon market, the experience curve would allow new ESG projects to become cost competitive in just a few iterations.
This, researchers suggested, would help dispel the myth that the costs of geothermal and ESG projects did not decrease reliably to a point where they could compete with other resources.
In fact, the reduced exploration risk of ESG projects enabled a manufacturing approach to project development where scale, learning, and innovation factors eventually resulted in impressive cost and efficiency improvements.
- The Experience Curve refers to the graphic representation of the inverse relationship between the total value-added cost of a product and the experience the company has in manufacturing it.
- The Experience Curve is powered by at least five fundamental mechanisms that emanate from a skilled and experienced workforce.
- The Experience Curve has several limitations because it relies on a skilled workforce and favourable product sales.
- The Experience Curve: The Experience Curve is a concept that asserts that as a business gains more experience in manufacturing a product, its production costs decrease. This reduction in costs is driven by various factors associated with accumulated experience.
- Origin of the Concept: The Boston Consulting Group developed the Experience Curve in the 1960s while observing the semiconductor manufacturing industry. They noticed that as production volumes doubled, the value-added production cost declined significantly, often by 20 to 30%.
- Mechanisms Behind the Experience Curve:
- Labor Efficiency: Employees become more skilled and efficient through repetitive tasks, leading to reduced errors and increased productivity.
- Standardization and Specialization: Experienced workers contribute to standardizing processes and optimizing tool usage.
- Technology-Driven Learning: Improved processes are integrated with technology, enhancing manufacturing experience.
- Product Efficiency: Bulk production leads to increased product and cost efficiency.
- Shared Experience Effect: Experience gained in manufacturing one product can be applied to related products, accelerating cost reduction.
- Examples of the Experience Curve:
- Model T Ford: Ford’s 11 years of assembly experience enabled them to cut production costs, increase market share, and streamline operations, e.g., offering the Model T in black for faster drying.
- Bausch & Lomb: The contact lens maker used computerization and plant expansion to boost productivity.
- Lincoln Electric: The welding supply company encouraged experienced employees to develop policies for increased efficiency.
- Lack of Skilled Mentors: A lack of experienced mentors can hinder the application of the Experience Curve.
- No Guarantee of Success: While cost reduction is likely, it doesn’t guarantee success, especially if external factors are unfavorable.
- Product Relevancy: If a product becomes obsolete, cost reductions may not lead to sustained profits.
- Additional Examples:
- Texas Instruments: Implemented an experience curve strategy in the calculator market, significantly reducing unit costs and dominating the industry.
- Oil and Gas Exploration: Experience curve effects observed in the reduction of dry wells due to advancements in technology and reduced geological uncertainty.
- Applicability in Geothermal Energy: The Experience Curve can be applied to geothermal energy projects, showing a path to cost-competitive projects through scale, learning, and innovation, particularly in markets with high electricity prices and established carbon markets.
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