Strategic Management: Formulation and Implementation

Learning Curves

It is when the product life cycle is put together with the learning curve that inferences are drawn which have major strategic implications.

The learning curve (also know as an experience curve) can often play role is determining a firm's long-run success of failure and therefore also lays an important role in competitive strategy.

The learning curve was adapted from the historical observation that individuals performing repetitive tasks exhibit an improvement in performance as the task is repeated a number times.

Empirical studies of the phenomenon yielded three conclusions on which the current theory and practice is based:

* The time required to perform a task reduce as the task is repeated. Put another way, business organizations, like individuals, learn from repetition and this learning works to make production more efficient (Hayes and Wheelwright 1984)

* The amount of improvement decreases as more units are produced.

* The rate of improvements has sufficient consistency to allow its use as a prediction tool.

The learning curve phenomena affects average cost in a way similar to that for any technological advance that improves productivity efficiency. Both involve a downward shift in the long-run average cost curve at all levels output.

That is, learning through production experience permits the firm to produce output more efficiently at each and every output level. Increased labor, management, and material productivity are associated with learning-curve effects.

The experience curve shows that the cost of doing a repetitive task decreases by a fixed percentage each time the total accumulated volume of production (in units) doubles (Figure 4-3). For example, the total cost might drop from 100 when the total production was 10 units, to 80 (= 100 x 0.80) when it increased to 20 units, and to 64 (= 80 x 0.88) when it reached 40 units. In the horizontal axis is the accumulated volume of production (in units), and in the vertical axis we have the deflated direct cost per unit (the actual cost corrected for inflation). Every time the accumulated volume of production doubles, the cost per unit decreases to 80% of the previous level.

This relationship between the accumulated volume of production and the deflated direct cost can be expressed in a log-log graph as a straight line, which is easier to work with.

The accumulated volume of production represents the total number of units delivered since the very beginning of the production activity, and it should not be confused with the production rate, which corresponds to the number of units delivered in a stated period.

Typical learning curve slopes are 90 percent, 85 percent, and 80 percent. Table 4-1 shows the costs for cumulative volume and different learning percentages.

The cost predicted by the experience curve effect can be obtained from a simple negative exponential relationship of the following type:

In the 80% curve, the constant 'a' can be obtained by recognized that doubling the production reduces the cost to 80% of its initial value. This corresponds to introducing the the expression: The resulting solution is a = 0.322

Other values of this constant for different slopes of the experience curve can be figure. For example, the manufacturing of integrated circuits approaches a 70% slope, air conditioners show a 80% slope, and primarily magnesium exhibits 90% slope, cement manufacturing 70% slope, power tools 80%, and industrial truck 90% slope.

The actual significance of the experience effects for a given industry depends not only on its inherent slope, but also on the speed at which experience accumulates, measured by the rate of growth in the market.

The potential for cost reduction is greatest in industries with string experience effects and fast growing markets, like the semi-conductor and computer industries in recent years.

The experience curve provides important insights for strategic planning, particularly of pricing decisions. There are at least two different pricing strategies based on the experience curve:

* A firm can follow a short-run profit pricing strategy, in which the firm reaps large profits by keeping its prices high while its marginal cost of production declines with increased volume.

This is shown as Period A in the left of Figure 4-6. If led too long, such a strategy encourages competitors to enter the market, which may result in a steep price decline or a competitive shakeout.

This is shown as Period B in the left part of Figure 4-6. As a result of the competition, profit margins remain thin in Period C.

* The firm may follow a barrier pricing strategy in which it aggressively lowers prices as its costs decline with increased cumulative volume. Such lowered prices act as a barrier to market entry and keep the firm's market share high- another strategic implications.

Although firm's profits margin may be modest, but long-term profits tend be to relatively stable. Such a pricing strategy is shown in the right half of Figure 4-6.

The most important factors for a systematic decrease in cost with accumulated volume are:

* Learning. In repeating a task over and over, a person develops skills allow him to do the work more efficiently.

* Specialization and Redesign of Labor Tasks. The increased volume leads to a division of labor that allows for specialization and standardization both contributing to improved productivity.

* Product and Process Improvements. As volume increases, many opportunities open up to improve the product and process and thereby achieve higher productivity and cost reductions.

* Methods and Systems Rationalization. Opportunities increase for improving the performance of a firm by introducing more up-to-date technology for handling operation. Also, adopting a policy of standardization allows coordination of different activities in the various steps of the value-added chain.

* Economies of Scale. Economies of scale can affect nearly every function, and many technological factors combine to produce the downward trend of the cost-curve as volume increases. The dominant factors are:

- Improved technological processes for high volume production;

- The resources that can be profitability used together only in large operations;

- The possibility of integrating manufacturing processes for the various business activities of very large firms operating in stable environments;

- The sharing of resources, mainly those managed at the corporate level, that is possible for diversified firms with businesses in related product markets.

* Organizational "tune-up,". A subtle result of experience is the "tune-up" achieved by the organization after a long history of production, which is reflected in technological know-how and well developed formal systems that provide guidelines for smooth relationships among individuals responsible for different tasks in the production process.

The learning curve concept is useful for a variety of managerial decisions, particularly in turn pricing decisions and production strategies. Thus, the learning curve has significant strategies implication.