The ppt tells what experience curve is, it's type and in which situations it can be a handy tool for strategy making.

1. Diagnosing the
Experience Curve
Group: Manish Kapgate (13382), ShreyashTade (13738),
Devin Haria (13245), Pawan Maurya (13469), Amit Meena (13098)

2. The Concept of Experience Curve
The experience curve is an idea developed by the Boston Consulting Group (BCG) in the mid-
1960s.
In simple terms it states that “ the more the experience a firm has in producing in a particular
product, the lower it’s cost.”
The usual form of the experience curve is: Cn = C1 n-
where Cn = cost of the nth unit
C1 = cost of the first unit
n= cumulative number of units
= elasticity of unit costs with respect to cumulative volume.

3. The Concept of Experience Curve
The form of the function reflects a constant elasticity  and the cost (price) will fall by
1 - k = 1 - 2-  percent, each time experience doubles.
 For example , If k = 80, then cost will fall by 1 - 80 = 20% as experience doubles and the
experience curve is said to be an 80% curve or have an 80% slope.
 This slope will only be observed if the effects of inflation have been removed and all costs
and prices are stated in real term.
 Also, it should be emphasized that the curves apply to cumulative experience and not to
calendar time. Experience will tend to cumulate faster in calendar time during periods of
rapid growth and relatively early in the product life cycle.

4. Supporting Evidence

5. Sources of the Experience Curve Effect
There are three major sources:
1. Learning by Doing:
• Learning encompasses the increasing efficiency of all aspects of labor input as a result of
practice and the exercise of ingenuity, skill and increased dexterity in repetitive activities.
• Learning includes the discovery of better ways to organize work via improved methods and
work specialization.
• Example:The capacity of a fluid catalytic cracking unit typically "grows" about 50% over a
ten-year period as operators, engineers and managers gain experience in operating the
unit.
• The reason is that with experience workers were more effective in using and maintaining
the equipment and various technical "bugs" were identified and corrected.

6. Sources of the Experience Curve Effect
2.Technological Advances
• Technological improvements also contribute to the experience curve effect. New
production processes, especially in capital intensive industries, often contribute substantial
economies.
• Changes in the resource mix, such as automation replacing labour, also provide a
technology driven basis for the experience effect
3. Scale Effects
• Economies of scale, from the increased efficiency due to size, are another source of the
experience curve effect.
• These scale effects apply to the majority of investment and operating costs

7. Decomposing the Experience Curve
• Most experience curves reflect the joint effects of learning, technological advances and scale.
• Normally it is difficult to distinguish the separate contributions of scale, learning and
technology, in part because the process of learning usually coincides with the expansion of scale.
• Example : In some cases scale effects seem less important, while in other cases it is the major
source of the experience.
• Despite the difficulty of decomposing the experience curve to understand the underlying
sources, the effort is critical to informed strategic application because
1. Cost reductions due to learning and technology are the result of continuous, planned efforts by
management.
2.Where the cost reductions are being achieved primarily from economies of scale through more
efficient, automated facilities and vertical integration , then cumulative experience may be
unimportant to the relative cost position. In these situations a new entrant may be more efficient
than more experienced producers.

8. Company Cost Compression Curves
• It relates changes in the company’s costs to accumulated company experience and
it is derived from internal cost and production records.
• Establishes the cost corresponding to each level of company production experience
with a specific product, service or cost element.
• Short-term discontinuities are found due to revisions in accounting procedures,
changes In product and cost variances from the fluctuations in the level of capacity
utilization.
• Despite that, it is considered as most useful of all the experience curves.

9. Competitive Cost Comparison Curves
• These are cross-sectional experience curves that relate the relative cost
positions of the competitors in an industry(Henderson 1978).
• It shows the current costs of all direct competitors as the function of their
respective levels of cumulative experience at that point in time. Hence, helps to
estimate the profitability of each of the competitors at the prevailing price.
• It is most useful but most difficult to obtain because we know slope of our own
cost curve but we can’t locate each of the competitors on our cost curve
according to relative experience.This overstates the cost differences.
• The slopes of cross-section curve is shallower than other experience curve:-
1) Followers into a market usually have lower initial costs than the pioneer.
2) All competitor should benefit from cost reductions achieved by outside
suppliers of components or production equipment.

10. 3) One competitor may have lower factor costs than another for reasons that are
independent of experience, such as location advantages, benefits of government
subsidies.
4)Whether there is a disadvantage depends on the ability of the diversified firm to
exploit opportunities for shared experience gains through corporate coordination.
5) If there is significant changes in market positions, current market shares may
not be good measures of relative cumulative output.
• Narrowing of Competitive Cost Differentials:-
As markets mature and forces acting on the cross-sectional experience curve
continue to operate, competitive cost differences tend to narrow.This can be
further narrowed by change in industry structure.

11. Industry Price Experience Curve
• This curve describes the behavior of industry prices and average costs as total
industry experience cumulates.
• List prices are unfavorably realistic, given the fluctuating discount structures
that exist to cope the changes in the industry supply picture.
• Another problem is that good industry data are unavailable or can’t be trusted.
This becomes serious when different competitors use different strategies.
• Captive manufacturing issue: In some component markets the process of
vertical integration is so far advanced that more than 50% of total output is in-
fed.This would be dangerous.

12. Costs, Prices and the Product Life Cycle
• This curve has close relationship to product life.
• Average industry curve frequently does not decline as fast as cost curve in the
early stage of cycle(Hedley 1976).
• Introductory period: During this period, prices are held below current cost in
expectation of lower costs in the future and to expand the market for the
product by increasing the cross-elasticity of demand with existing substitutes.
A steep cost compression curve is more attractive when
1) there is little prospect of creating and maintaining product superiority over
the competitors.
2) when there are few barriers to entry and expansion by competitors, or
3) when the lower price significantly expands the current market.

13. • Growth Period: During growth period, the market leader trades long run
market share for current profits.This is because the current profits are often
needed to fund the still rapid growth in capacity, working capital, R&D and
market development activity.
If market growth is underestimated, the market leader may be forced to give up
further share because of capacity constraints.
• Shake-out period: During this period, the expansion plans come into
production but there is sharp break in price trend.The ensuing excess capacity
puts further downward pressure on prices.
• Maturity and beyond: Competitive cost differentials steadily narrows as
market matures. Also, the cost compression curve flattened. The effect of
experience on real unit costs and prices becomes less evident.

14. Types of Expansion Curve
Within a specific market environment a variety of experience curves can be found, depending on :
• Costs or prices,
• Total cost or elements of cost,
• The effect of industry or company accumulated experience,
• Dynamic or static comparisons.
1. Company Cost Compression Curves
2. Competitive Cost Comparison Curves
3. Industry Price Experience Curve
4. Costs, Prices and the Product Life Cycle

15. Measurement and Interpretation
Questions
The insights gained from the three types of experience curves depend on
numerous judgments as to the treatment of costs, inflation, shared experience
and the definition of the units of analysis. These put significant limitations on
the strategic relevance of experience curve analysis.

16. Costs
Total costs decline from the effect of experience on the cost elements that combine to make up the
product, including components, assembly, packaging, distribution and so on. The amounts of experience
accumulated in each cost element may be very different, as a result of shared experience, and the slopes
of the experience curves may also vary between elements. For these reasons, special attention must be
given to the controllable elements of costs.
• Cost component analysis. When the slopes of the experience curves of major elements are different,
the relative importance of each component changes as experience with the total product
accumulates. This may also lead to a change in the slope of the overall experience curve.The slope of
the total cost curve is increasingly influenced by the cost element which is declining the slowest with
each doubling of total experience .
• Value-added costs. The experience effect is largely felt on those costs that contribute to the value
added during manufacturing or when providing the service. If value-added costs decline faster than
other costs with increasing experience, the industry price experiencecurve is likely to have a smaller
slope than the industry value-added experience curve.

17. • Identifying relevant costs. Most cost accounting systems are designed to serve many
purposes and the resulting costs are often wildly inappropriate for experience curve
analysis.The major problems are with the allocation of costs, the treatment of joint
costs, and the deferred recognition of actual costs until revenue is realized. Cost
allocations may be made of departments or profit centers rather than to specific
products
• Choosing the unit of analysis. When costs are averaged across a broad product line, a
change in the total cost may be observed simply as a result of a change in the sales
mix.

18. Shared Experience
Cost differences between competitors are often less than we would expect from our knowledge of
relative market shares and the slope of the company cost compression curve. A major reason is the
effect of shared experience between two or more products using a common resource.The experience
gained with one of the products can be applied to a reduction of the costs of related products.
For Example:
Textile fiber manufacturers use similar polymerization and spinning processes for polyesters and nylon.
Thus assessment of competitor's shared experience as well as the company's own shared experience is
important to understanding the relative economies of the various competitors. It is necessary to
estimate the unique, shared experience base of each competitor in order to understand relative cost
positions

19. Strategic Relevance
The basic strategic message of experience curve is-
(1) The largest competitor in a particular business area should have the potential for the lowest unit costs
and hence greatest profits. If he is unprofitable he is probably either being "out-segmented" by more
focused competitors or he is defective in experience curve cost control.
(2) Smaller competitors in a business area are likely to be unprofitable, and they will remain so unless a
strategy can be devised for gaining dominant market share at reasonable cost. If achieving overall
dominance is not feasible, then the smaller competitor should seek to identify an economically distinct
segment of the business in which he can dominate the relevant experience bases sufficiently to attain a
viable cost position overall.

20. Conclusion
The simplistic market share dominance prescriptions that marked the early experience curve
applications have been replaced with a growing sensitivity to the complexities of this concept.
While its appeal as an organizing framework remains high, there is a realization that the
experience curve effect is itself a product of underlying scale, technology and learning effects.
Whether the experience curve is strategically relevant depends initially on whether these
three effects are influential features of the strategic environment. Beyond this there is a
growing recognition that there is a family of experience curves, each addressing different
strategic issues, from cost component analyses to price forecasting to competitive cost
comparisons.One consequence is that the earlier broad generalizations have been replaced
with focused applications, where experience curve analysis plays a supportive role as one of a
number of analytical methods.

21. An Agenda for Research
There are significant risks in analyses based on the experience curve concept because the
potential for misleading signals is high.Yet when the insights are valid, they are highly
valuable.These are conditions where the payoff to research is high.The following topics are
judged especially rewarding.
• Theory Development: Both theory and practice would benefit from further research on the
sources of the experience effect.
• Measurement Sensitivity:Consequences of different assumptions, errors in data.
• Model specification and evaluation: Beyond straight lines
A major area for further development is the integration of product life cycle and experience
curve models that incorporate competitive behaviour patterns.

22. ThankYou!