2. The Experience Curve The “Law of Experience” The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles. Cost per unit of output (in real $) Cumulative Output 19 92 19 94 19 96 19 98 2000 2002 2004

3. Examples of Experience Curves 100K 200K 500K 1,000K 5 10 50 Accumulated unit production Accumulated unit s (millions) (millions) 1960 Yen 15K 20K 30K Price Index 50 100 200 300 70% slope 75% Japanese clocks & watches, 1962-72 UK refrigerators, 1957-71

6. Economies of Scale: The Long-Run Cost Curve for a Plant Units of output per period Minimum Efficient Plant Size: the point where most scale economies are exhausted Cost per unit of output Sources of scale economies: - technical input/output relationships - indivisibilities - specialization

8. Scale Economies in Advertising: U.S. Soft Drinks 10 20 50 100 200 500 1,000 Annual sales volume (millions of cases) Advertising Expenditure ($ per case) 0.02 0.05 0.10 0.15 0.20 Coke Pepsi Seven Up Dr. Pepper Sprite Diet Pepsi Tab Fresca Diet Rite Diet 7-Up Schweppes SF Dr. Pepper Despite the massive advertising b udgets of brand leaders Co ke and Pepsi, their main brands incur lower advertising costs per unit of sales than their smaller rivals.

9. Cost Advantage in Short-Haul Passenger Air Transport Costs per Available Seat-Mile Southwest Airlines United Airlines (cents) (cents) Wages and benefits 2.4 3.5 Fuel and oil 1.1 1.1 Aircraft ownership 0.7 0.8 Aircraft maintenance 0.6 0.3 Commissions on ticket sales 0.5 1.0 Advertising 0.2 0.2 Food and beverage 0.0 0.5 Other 1.7 3.1 Total 7.2 10.5

10. Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES STAGE 2. ALLOCATE TOTAL COSTS PURCH- ASING PARTS INVEN- TORIES R&D DESIGN ENGNRNG COMPONENT MFR ASSEMBLY TESTING, QUALITY CONTROL GOODS INVEN- TORIES SALES & MKITG DISTRI- BUTION DEALER & CUSTOMER SUPPORT

11. Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued) PURCH- ASING PARTS INVEN- TORIES R&D DESIGN ENGNRNG COMPONENT MFR ASSEMBLY TESTING, QUALITY CONTROL GOODS INVEN- TORIES SALES & MKITG DISTRI- BUTION DEALER & CUSTOMER SUPPORT --Plant scale for each -- Level of quality targets -- No. of dealers component -- Frequency of defects -- Sales / dealer -- Process technology -- Level of dealer -- Plant location support -- Run length -- Frequency of defects -- Capacity utilization under warranty Prices paid --Size of commitment -- Plant scale --Cyclicality & depend on: --Productivity of -- Flexibility of production predictability of sales -- Order size R&D/design - - No. of models per plant --Customers’ -- Purchases per --No. & frequency of new -- Degree of automation willingness to wait supplier models -- Sales / model -- Bargaining power -- Wage levels -- Supplier location -- Capacity utilization STAGE 3. IDENTIFY COST DRIVERS