Experience Curve Effect

Experience Curve Effects (EC) were first described by BCG consultant Bruce Henderson in 1960. Henderson found that there is a consistent relationship between the cost of production and the cumulative production quantity.
 

Simply put it states that the more often a task is performed, the lower will be the cost of performing it. Each time cumulative volume doubles, value added costs (including administration, marketing, distribution, and manufacturing) fall by a constant and predictable percentage.

Researchers since then have observed experience curve effects for various industries ranging between 10 to 30 percent.

The Experience Curve is a major enabler for a cost leadership strategy. If a company can grasp a big market share quickly in a new market, it has a competitive cost advantage because it can produce products cheaper than its competitors. Provided the cost savings are passed on to the buyers as price decreases (rather than kept as profit margin increases), this advantage is sustainable. If a business could accelerate its production experience by increasing its market share, it could gain a cost advantage in its industry that would be hard to match. The result is many companies try to gain a large market share quickly by investing heavily and aggressively pricing their products or services in new markets. The investment can be recovered later, once the company has become a market leader and has built itself a cash cow.

Some limitations of an experience curve-based strategy include:

• There are also other business strategies than Cost Leadership Strategies (see Competitive Advantage and Value Disciplines).
• Competitors may also pursue a similar strategy, increasing the necessary investment levels while decreasing the returns for both.
• Competitors that copy manufacturing methods may achieve even lower production costs by not having to recover R&D investments.
• Technology breakthroughs may enable even bigger experience curve effects. This is beneficial for later entrants.
   

Compare with Experience Curve Effects: BCG Matrix  |  Return on Investment  |  Organizational Learning  |  Parenting Advantage  |  Core Competence  |  Organic Organization

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