The Boston Consulting Group, Inc 1968 (cited in Henry 1992, p.21)
”If experience improves performance, it should follow that company that has produced the most widgets will be the most efficient widget producer. This implies that market share is vital in determining potential profitability and that new products, whether developed internally or acquired outside, are doomed to lackluster financial performance unless they capture a dominant market position.”
If you have a little time to consider, you will understand that this is not always true because there are so many prosper companies in terms of financial performance especially in IT domain which did not even exist some years ago.
However, experience curve, which is evolved from learning-curve effect, can be useful for cost control and forecasting, and explaining a relationship for price and profits as well. This is why this blog will focus on this theme.
Learning-curve effect, discovered by the commander of Wright-Patterson Air Force Base in 1925, helps us to determine enterprise’s control decisions for assembly operations and price making policies.
It explains the relationships between including the labour time, required to perform a task and the times of experience. To put it simply, as the times of experience increases, the less cost w be required to perform the task.
Bear in mind that, these relationship does not continue forever, and 20% decreases in hours spent in performances with each doubling of performances are said to be a typical pattern.
Experience effect is a wider notion than learning-curve effect. Experience effect is identical to learning-curve effect in terms of explaining the cost and experience relationships, but the former covers all costs including labour hour. It can be applied to almost all activities within an enterprise.
Since continuing trial or experience helps to boost an operation efficiency, it should reduce the total cost of the operation if the other conditions are the same.
This means that the observation over a long-term should eliminate the influence of the prices, both deflation and inflation. In addition, changing accounting methods and indirect cost allocation should be adjusted to the extent that it does not have a severe effect on the observation.
If the concept holds true that cost declines in line with the multiplying number of production, the company who has produced the most should have the lowest cost with the most efficiency. As all players are doomed to follow the each market price with the rest of a substantial profit, the price should be similar to each player based on the cost approach. Then the enterprise who can produce most efficient can set a lowest price and usually dominant the market.
This relationship between market share and market growth potential will be focused on other blog next time.
Thank you for reading.
Strage, H.M. (1992). Milestones in management: an essential reader. Oxford: Blackwell.