Today I focus on the experience curve and how it should form the basis of your long term cost reduction strategy.
Background to the Experience Curve
My last business strategy article explained the importance of economies of scale on cost levels but in the early to mid 20th Century people started noticing another cost phenomenon.
Even if the size of the factory plant didn't increase, unit cost levels reduced progressively over time.
In fact research has shown that as cumulative output doubles, unit costs often fall by between 20 to 30%.
See Wikipedia if you would like to read the technical issues of the experience curve and how to calculate it.
Seeing the experience curve in action for yourself
When you do something once you have to take time and reflect how to do it.
It isn't easy, natural or quick.
Perhaps you try one way and quickly realise it's not going to work as well you had hoped. So you try another way.
The next time you repeat the task, you have a little experience and you do it using your second method because you know it works. But as you work, you see little things that are wrong or frustrating and you make a mental note to yourself.
When you do it again you'll remember the problems with the existing method and you'll look for ways to improve.
You don't want to change too much because you need it done quickly but you can see some areas where you can save a little time.
And this gradual improvement through learning is the basis for the experience curve and why it is sometimes known as the learning curve.
Business Implications - Using The Experience Curve To Drive Your Cost Reduction Strategy
The experience curve comes from a few sources:
- People learning how to do the task and putting that learning into practice.
- Standardising the product or service to remove unwanted variations in what is expected from the process.
- New work processes that are standardised and continually improved
- Task specialisation (which is also linked to economies of scale)
The benefits of the experience curve (it's a curve because costs start high and reduce by a proportion each time historic output doubles) are not automatic.
It's true that people will become more experienced but that doesn't automatically lead to improvements.
Does your business have the processes, policies and procedures in place to encourage learning from experience and building that knowledge into your systems?
Clear focus on continuous improvement is necessary to achieve the experience curve cost savings
Taking advantage of the experience curve starts with a desire for continuous improvement.
A desire to do something better than last time.
As the experience curve is concerned with cost reduction, better in this case means the same quality output but for a reduced cost.
Can you see the desire for improvement and challenging existing methods in your team?
I'm sure you've got it but too often employees just go through the motions of turning up, doing what's expected and then going home when the clock strikes 5 o'clock.
Leading your team towards experience efficiencies and lower costs
Reduced cost savings from the experience curve can come from:
- Better purchasing - with experience you may find suppliers who charge lower prices or are more reliable in their quality and service.
- Increased productivity - doing what you do more efficiently.
- Innovation - changing what you do because you've found a better way to achieve the same end result.
- Better quality - learning should lead to lower waste from mistakes, bad production and process scrap.
- Faster throughput - reducing time taken from the start of the process to the finish, both in terms of activity time and waiting time.
- Increased flexibility of your employees and machines in terms of what they can do and how quickly they can change over between activities.
Helping your team to achieve experienced based cost savings
You need to lead your team to achieve these cost savings and that usually requires three issues to be tackled:
- Your team needs to understand why it is important that you progressively improve and reduce your costs.
This is not just about boosting your profits.
It is fundamental to the competitiveness of your business and the security of their employment.
You need to clarify the overall direction and importance of continuous improvement and then set a good example. Employees listen to what you say but take notice of what you do.
- You need the appropriate measures and targets in place.
It may be a cliche that "what gets measured gets done" but it shows your team that you take the matter seriously.
No measurement means that it's the desire for learning is just words and not actions.
It's only through testing and measurement that you can see whether any new improvement idea is working.
- There need to be appropriate incentives.
Just as "what's in it for me" is the main question you have to answer in your marketing, it's the same with your employees.
If you tell them to do one thing but your payment scheme says do another, your staff have a choice.
And they will choose the option that is best for them. It's the only rational thing for them to do.
You also need to counter the fear that product improvements from the experience curve will lead to fewer jobs. Employees will be reluctant to make suggestions if they fear they or their friends will lose their jobs.
Standardising Your Products And Services
Standardisation is the driver of the experience curve and your cost reduction strategy.
The reason is simple.
Every time you produce a special, one-off product you start back near the beginning of the learning curve. You have to work out what to do and how to do it.
But if you provide standard products and services then learning and experience matter and you give your staff something to work with.
Even if you pride yourself on your customised products and you believe that it brings a flood of customers to your door, all willing to pay a massive premium, you should still try to find ways to standardise the early activities in your processes.
In one of his E Myth books, Michael Gerber talks about having his hair cut. Even if he saw the same hairdresser they would do it differently each time he went but this was customisation that he didn't want.
A different process made him feel uneasy about the outcome.
Systematising Your Activities
Once you have a standardised product or service you can then start designing your business to deliver it consistently, effectively (it produces what the customer wants) and efficiently (it is produced at a low cost).
But the first task is to eliminate or reduce the amount of variation going into the system and coming out of it.
The principle is simple.
If something works, keep doing it while experimenting at the edges to find a better way to do the same thing with a better result or a lower cost.
Dangers Of Relying On The Experience Curve
History shows that there are various dangers or mistakes that you can make if you rely on the experience curve in particular and cost reduction generally as your focus for your business strategy.
- Pricing based on the experience curve
Big mistakes have been made in the past by companies believing that if they price aggressively they will win market share, gain experience and costs will reduce to give a comfortable margin.
The big problem with this type of thinking is that it often assumes that your competitors won't react to your special deals and lower prices. But can you really afford to price at levels that they are not prepared to match?
- Loss of proprietary knowledge
You can lose any advantage you have from the experienced based knowledge in two ways. Either your competitor gets to know it or you lose it because it's in the minds of your team and not recorded in your systems.
Both can happen in one move if your star employees leave you and join your biggest rivals.
- Technical innovation
Your knowledge may become obsolete as technology overtakes you and everyone has to start learning the new rules at the same time.
- Globalisation
A focused cost reduction strategy is an important element in fending off competition from the low wage economies but it may only take you part of the way.
You may be 5 times as productive in terms of output per hour but if their wages rates are only 10% of yours, you still have a major cost disadvantage.
Summary of the Experience Curve
The experience curve is part of the answer for your business strategy and you need to be encouraging your team to deliver the cost savings that should arise.
Any cost savings may be temporary if technology shifts but it is still money in the bank and the state of mind that comes from continuous improvement is permanent.
New technology starts a new experience curve and if your staff are experienced and dedicated learners, you can expect to move down the experience curve faster than your competitors.
As you will see in later blogs, I believe that the biggest benefits of business strategy come from focusing on your customers and creative a distinctive position in your market by being different.
Have you seen the benefits of the experience curve or do you know anywhere that it has been a major source of cost savings? If so then please share your story as a comment.
The next article in the series looks at What is Industry Analysis
Systems And Processes Articles
To learn more about the experience curve, take a look at my list of best business strategy books
http://businesscoaching.typepad.com/business_books/2009/08/best-business-strategy-books-but-do-you-agree.html
Posted by: Paul Simister | 01 August 2009 at 11:26 AM
To help you to find more about the experience curve and its role in cost reduction and strategy I have added a few links.
First is Wikipedia but you've probably seen that already since it seems to dominate Google
Experience curve effects
http://en.wikipedia.org/wiki/Experience_curve_effects
A comprehensive review which goes into some of the mathematics of the experience curve.
Over on Google books there is Restoring our competitive edge By Robert H. Hayes, Steven C. Wheelwright
Good stuff and again comprehensive on the experience curve from a manufacturing background
http://books.google.com/books?id=pa2MllRmUsQC&pg=PA251&lpg=PA251&dq=experience+curve+cost+reduction&source=bl&ots=IvTblLLtwZ&sig=pDHiNGFqKHovDbgny9-C1NG9UuE&hl=en&ei=U-GCSuHqDpKZjAfI_ZDzCQ&sa=X&oi=book_result&ct=result&resnum=2#v=onepage&q=experience%20curve%20cost%20reduction&f=false
The Harvard Business Blog asks "Does the Experience Curve Matter Today?"
http://blogs.harvardbusiness.org/bigshift/2009/04/does-the-experience-curve-matt.html
and then follows up with a new concept the Collaboration Curve
http://blogs.harvardbusiness.org/bigshift/2009/04/introducing-the-collaboration.html
I had a little search and couldn't find anything about the experience curve and how it applied in the service sector. Just a few references to restricted academic texts.
If you know different, then please post any experience curve links as comments.
Posted by: Paul Simister | 12 August 2009 at 04:48 PM
Have you used the experience curve thinking to drive a cost reduction strategy?
If so, I'd love to hear your story.
Posted by: Paul Simister | 14 June 2010 at 07:32 PM