The experience curve effect in strategic marketing planning - Marketing Management

In 1925, the commander of the Wright Patterson Air Force Base in the USA observed that the number of direct labour hours required to build an aeroplane decreased as the number of aircraft previously assembled increased. Eventually this phenomenon was explored across a wide range of industries and was found to be present in most of them. The phenomenon came to be termed the ‘experience curve’. It has significant implications for the determination of marketing objectives and strategy.

Basis and definition

Experience curve Analysis in Strategic Management

The experience curve effect are relatively easy to understand, and are encapsulated in the name of the phenomenon itself. Put simply, experience curve effects are derived from the fact that the more times we repeat an activity, the more proficient we become: in other words ‘practice makes perfect’. In the case of the Wright Patterson Air Force Base, the commander noticed that this led to a reduction in the time it took to assemble an aircraft as cumulative production increased. The assembly workers simply became more adept at assembling an aircraft because over time they had assembled increasing numbers.

In the 1960s, the Boston Consulting Group,3 whose work we look at in more detail later in this chapter, observed that the experience curve effect was not confined to assembly operations, or even simply to direct labour costs, but encompassed almost all cost areas of a business.

The experience curve effect is observed to encompass all costs – capital, administrative, research and marketing – and to have transferred impact from technological displacements and product evolution. (Boston Consulting Group: 1970)

Furthermore, not only was the experience curve effect found to encompass more than just production, even more importantly, the effect was found to be predictable (Abell and Hammond).

Personnel from the Boston Consulting Group and others showed that each time cumulative volume of a product doubled, total value-added costs . . . fell by a constant and predictable percentage.(Abell and Hammond: 1986)

It is this predictable relationship between costs and experience that constitutes the experience curve effect.

Specific sources of experience curve effects

We have observed that experience curve effects are based on the old adage ‘practice makes perfect’.

We can now isolate five specific major sources:

  1. increased labour efficiency, e.g. learning short cuts, improved dexterity and greater familiarity with systems/procedures;
  2. greater specialization/redesign of working methods;
  3. process and production improvements, e.g. design of more effective plant and increased automation;
  4. changes in the resources mix, e.g. substitution of initially highly qualified labour by less qualified personnel;
  5. product standardization and product redesign.

The important point to note about these sources of experience curve effects is that many of them are not ‘automatic’, i.e. in order to achieve experience curve effects management must undertake the necessary steps and exercise initiative.

Experience effects provide the opportunities to lower costs, but appropriate strategies are required to grasp them.

Calculating experience curve effects

Understandably experience curve effects differ between industries and between companies. The basic formula for the experience curve is:

Cq = Cn _qn_–b
q = the experience (cumulative production) to date
n = the experience (cumulative production) at an earlier date
Cq = the cost of a unit q (adjusted for inflation)
Cn = the cost of a unit n (adjusted for inflation)
b = a constant depending on the learning rate.

Experience curves are normally expressed in percentage terms, e.g. an ‘85 per cent’ experience curve or a ‘70 per cent’ experience curve. Expressing the experience curve in this way tells us the expected reduction in costs for each doubling of cumulative production. An ‘85 per cent’ curve means that the unit cost of producing (say) 2,000 cumulative units of production will be only 85 per cent of the unit cost when cumulative production had reached only 1,000 units. It is important to note that evidence shows that this percentage impact in costs is the same across the whole range of cumulative experience i.e. doubling experience from four million to eight million units results in exactly the same percentage cost reduction as doubling experience from 100 to 200 units in the company. This too, has important strategic implications.

A typical experience curve. Note how the curve shows that the higher the level of cumulative production the lower the cost per unit will be.

Strategic implications of the experience curve effect

In industries where curve effects are present (and this is in most industries) and particularly where these are substantial, a significant competitive edge can be gained by adopting a strategy aimed at moving down the experience curve more rapidly than competitors.

In effect, this means being the dominant firm in an industry, with strategies aimed at being the early leader and capturing market share.

Remember that the experience curve effect is based on cumulative production and not scale of production. This means that in the early stages it is simple to, for example, double market share at relatively low volumes. Early leadership can thus ensure that the leaders’ costs can be reduced relatively quickly and often before competitors have time to enter the market. By the time these competitors are able to do this the early market leader has established an unassailable cost advantage and competes on price leadership. Owing to the experience curve effect, high market share undoubtedly becomes a prime objective in marketing strategies. When considering this strategy the following points need to be borne in mind:

  • Achieving high market shares can be expensive. In the short term we need to consider if we can finance the capture of market share.

A typical experience curve

A typical experience curve

  • Market share – and hence cumulative volume – is easier to achieve in high growth markets where experience can be gained by taking a disproportionate share of new sales.
  • The pursuit of market share in order to lower costs – and hence competing through price leadership – assumes that the market is price sensitive. Not all markets are; it often makes more sense to compete on superior products or service rather than price.

Experience curve effects are much greater and therefore more relevant in industries such as Aerospace than they are in many service product industries. This explains why the European Consortium which has produced the ‘Eurofighter’ aeroplane was reliant on securing market share. Only major orders from the defence departments of different governments enabled the venture to succeed.

In short, the pursuit of competitive advantage based on experience curves is not a certain solution for success in an industry. The experience curve concept is a useful adjunct to the strategic market planner’s portfolio of ideas and is particularly useful for market share and pricing decisions. Like the product life cycle concept, it has in part provided the impetus to the development of more comprehensive planning tools. The first of these is the Boston Consulting Group’s growth/share matrix, but before this we need to consider the nature of these modern tools of strategic marketing planning.

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