The consistent relationship between the cost of production and the cumulative production quantity. Explanation of Experience Curve Effect.
The Experience Curve Effects 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 if a task is performed more often, the cost of performing the task will decrease. Each time cumulative volume doubles, the value added costs (including administration, marketing, distribution, and manufacturing) will fall by a constant and predictable percentage.
Researchers since then have observed experience curve effects for various industries ranging between 10 to 30 percent.
Cost Leadership Strategy
The Experience Curve is a major enabler for a cost leadership strategy. If a company can gain 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 company could accelerate its production experience by increasing its market share, it could gain a cost advantage in its industry that would be hard to equal. 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 it has built Cash Cows.
Limitations of an Experience Curve-based strategy
* There are also other business strategies than Cost Leadership Strategies (see Competitive Advantage and Value Disciplines).
* Competitors may also pursue a similar strategy, thus 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 companies that enter the market later.
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