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Experience Curve Profit


It is common for the terms experience curve and learning curve to be used interchangeably. They do, however, have different meanings. According to definitions by Hall and Starr, the experience curve is an analytical tool designed to quantify the rate at which experience of accumulated output, to date, affects total lifetime costs. Melnyk defined the learning curve as an analytical tool designed to quantify the rate at which cumulative experience of labor hours or cost allows an organization to reduce the amount of resources it must expend to accomplish a task. Experience curve is broader than learning curve with respect to the costs covered, the range of output during which the reductions in costs take place, and the causes of reduction.

Organizational learning is complex in that we learn at many levels simultaneously. In organizations, procedures, norms, rules, and forms store knowledge. March states that managers of competitive organizations often find themselves in situations where relative position with regard to a competitor matters. This possible competitive advantage through enhanced learning is the essence of the study of experience and learning curves.

The analytical use of the concept for business purposes first surfaced in 1936 during airplane construction, when Wright observed that as the quantity of manufactured units doubled, the number of direct labor hours needed to produce each individual unit decreased at a uniform rate. The variation of labor cost with production quantity is illustrated by the following formula: F = log F /log N where F equals a factor of cost variation proportional to the quantity N. The reciprocal of F represents a direct percent variation of cost versus quantity.

This insight shows that experience-based learning is closely correlated with cumulative output, extending beyond changes in design and tooling. Wright found empirical evidence that as unit volume increases there are predictable corresponding reductions in cost. These data become central concepts for strategic and operational planning. There has been much discussion on the role of learning in business organizations. A seminal work in learning theory is the 1963 A Behavioral Theory of the Firm by Cyert and March. These authors viewed firms as adaptively-rational systems. This means that the firm learns from its experience. In its basic form, an adaptive system selects preferred states for use in the future. With experience, management uses decision variables that lead to goals and shuns those that do not lead to goals.

Following a strategy of increasing market share, the experience curve focuses on cost leadership. Management attempts to increase market share while simultaneously reducing costs. This is a detriment to market entry as the firm can lower its price, which may further increase its market share and place added pressure on potential competitors, as found in a study by Lieberman. Learning through experience becomes an important component of the increased market share strategy.

Use of a cost leadership strategy based on the experience curve implies several assumptions, according to Amit:

The formula for the learning curve model is commonly shown either as a margin-cost model or as a direct-labor-hour model. The direct-labor-hours formula is more useful, as hourly compensation typically changes over time and there may be inflation considerations as well. However, both derivations will be presented here for clarity. Also, direct-labor hours may be easily converted into costs if necessary, according to Yelle. By convention, we refer to experience curves by the complement of the improvement rate. For example, a 90 percent learning curve indicates a 10 percent decrease in per-unit (or mean) time or cost, with each doubling of productive output. Experience and learning curves normally apply only to cost of direct labor hours.