experience curve

Definition:
A diagrammatic representation of the inverse relationship between the total value-added costs of a product and a firm's experience in manufacturing and marketing it. Experience in this context is measured by the cumulative number of units produced to date. The experience curve for a product depicts the way in which total unit costs will decline due to the combined impact of: ECONOMIES OF SCALE in production, purchasing, sales, distribution, marketing, administration, and research and development, and the so-called experience effect, whereby total value-added costs decline by a fixed percentage (usually 10 per cent to 30 per cent) each time the cumulative number of units produced (experience) is doubled. The experience curve generalizes the learning effects that were originally observed in aircraft manufacture, where the number of direct labour hours required to assemble a plane was seen to decline as the total number of aircraft assembled increased. The work of the Boston Consulting Group has observed the operation of the experience effect in the manufacture and marketing of a wide range of products, including integrated circuits, cars, petrochemicals, synthetic fibres, steam turbines and earth moving machinery. The general form of the experience curve can be represented as follows: Yn = a n-b where Yn is the cost of manufacturing, distribution, selling, etc., the nth item; n is the cumulative production; a is the cost of the first unit (i.e. where n = 0); and b is a parameter representing the learning rate. An 80 per cent learning rate means that each time experience doubles, costs per unit fall to 80 per cent of the original figure; or, in other words, costs per unit decrease by 20 per cent for each doubling of the cumulative production. As the experience curve below shows on linear axes the rate of cost decline is logarithmic (therefore using a log-log scale the decline would be linear).

Cross-References:
[economies of scale]

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