Experience Curve Effect
Experience is a very important component for the success of a business organization. Out of experience, executives learn and adapt how to deal with turbulent situations and crises. On the other hand, lack of experience, which is a common attribute of new firms, can be the start of downfall. This hapless situation makes young organizations susceptible to an array of challenges, some of which could be preventable and manageable. Most importantly, a company reduces its costs when it has experience in producing a given product in the market. In this essay, we shall discuss experience curve effect, which denotes the relationship between the performance of a firm and its experience in the field.
Boston Consulting Group developed experience curve effect in 1960s. BCG consultants observed that companies register lower cost of production per unit with and increase in the volume of production. While working with a leading manufacturer of semiconductors, they noted that the firm registered a 25% drop in cost of production whenever it doubled its production volume. This is what they coined as the experience curve. It states that the higher the experience of a company in producing a particular product, the lower the cost of production. According to the experience curve effect, costs of production will always decline, after factoring out inflation, which usually has influence on cost and overall production.
Even though experience curve effect appears to apply on every industry, a fundamental economic law to predict the curve does not exist. Thus, experts have only proven the truth of the curve through inductive methods and not deductive. If this law applies in the service industry, it is vital to note that the low cost of production does not mean that there are costs passed on to customers.
The application of the idea was in being even before BCG expounded it. For example, it was known by the end of WWII and was used in estimating direct labor costs. Here, less labor was required for similar results, depending of the experience of those delivering the services. During that time, labor costs in aircraft manufacturing fell by 10-15% whenever the experience of the labor force was considered.
Nonetheless, experience curve effect almost shattered the world. For instance if production cost fell with high experience, and if experience had close bearing on market shares, them the market player with the highest share would get the highest cost advantage over other competitors. This was the basis of the growth share matrix, which was later developed. The experience curve explained why it was necessary to make huge allocation for businesses out of the company’s portfolio but had the potential of becoming market giants in their respective sectors. This was not healthy as it posed hard times for firms, which did not have the capacity to become market champions.
Business experts further found out that the experience curve effect was not accurate when developing business plans for future performance of the firm. In appreciating how the experience curve effect works, it is worthy noting that different products will always have a different curve gradient and varying origins of cost reduction. For example, not all the products showed a downward slope as BCG had observed at a semiconductor manufacturing plant in 1960s.
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