The Experience Curve is one of the most famous frameworks in consulting. It was developed in the 1960s by Boston Consulting Group (BCG), one of the biggest consulting companies in the world at the time. It was inspired by manufacturing learning curves, which were first identified in the 1920s and 1930s.

Here is an excerpt from Lords of Strategy about how BCG helped to repackage this thinking:

BCG devised the curve in 1966. A client, General Instruments, was having trouble matching competitors’ prices in its television-components business. Bruce Henderson dispatched John Clarkeson, a recently minted Harvard MBA—and twenty years later the elected head of BCG—to study what might be wrong. He also suggested that the younger man gather as much literature as he could find on the learning curve, a subject that had long intrigued Henderson.

Literature there was, including a 1964 Harvard Business Review article, “Profit from the Learning Curve,” by a professor of chemical engineering, Winfred Hirschmann. As Hirschmann noted, as early as 1925, manufacturers of aircraft had begun to observe that the amount of labor that went into making an aircraft declined predictably as the number of planes manufactured increased. Typically, the fourth plane took only 80 percent of the labor required to make the second, the eighth only 80 percent of what had gone into the fourth.

This early research showed that costs decreased over time but it was hard to prove that learning or experience had a direct effect on this. However, after research at many companies, they concluded that there was a link and that it had a direct impact on the market share of a company.

The Experience Curve relies on the underlying assumption that the more experience a business has in producing a particular product or rendering a service, the lower its cost. In other words, your business will experience a lower unit cost as you develop experience or expertise in your niche. 

The Experience Curve posits that “there’s a consistent relationship between the cumulative production quantity of a company and its production cost.” When you double your company’s production capacity, there will be a steady decline in your value-added cost. Value-added costs account for the cost of manufacturing, marketing, distribution, and administration.

From BCG’s perspective, the most important thing for a company was to increase its speed of moving up the experience curve in order to become the low-cost producer of a product.

Wishful Thinking?

In 1985, two academics published a paper arguing, “Few strategy concepts are more likely to give misleading insights than the experience curve.” Damn. Not great. They argued that the problem with the experience curve was that learning may only play a minor role in some of the improvements and may be hard to measure. They pointed out two things about the problems with experience curves.

  1. Cost reductions due to learning and technology are the result of continuous, planned efforts by management. Cumulative experience does not guarantee that costs will decline but simply presents management with an opportunity to exploit.
  2. Where the cost reductions are being achieved primarily from economies of scale through more efficient, automated facilities and vertical integration (Porter 1979), then cumulative experience may be unimportant to the relative cost position. In these situations, a new entrant may be more efficient than more experienced producers.

Instead of purely “experience,” it was likely learning, technological improvement, and economies of scale that drove efficiencies.

How I’d Use The Experience Curve

This does not mean it’s not a useful framework. In general, consulting frameworks get too much flack for being “not proven” and not enough credit for being useful mental models for decision making. Despite a lack of a direct causal link between learning and cost, it’s still a helpful mental model if I were thinking about a business.

If you have a product, you should try to aim to achieve decreasing costs over time. As a business owner, you likely don’t care how these cost reductions are achieved, but it’s still helpful to think about how “experience” however you define the term, will accelerate or improve over time.

To track this, I’d be keeping track of unit costs and overhead costs and making sure that they do not increase with scale and time, at least from factors in control by the company. If they are, then there is a clear problem.

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