Building Strategy on the Experience Curve

by Pankaj Ghemawat In 1972 Du Pont decided to exploit the experience curve to preempt competitors in the titanium dioxide industry by investing $410 million over the following seven years. By 1979 capacity use in the industry had plummeted from 88% to 64% and Du Ponts return on sales dropped to half its initial level of 7.5%. Du Ponts misadventure is not unique. The most notorious example is Fords blind progress down the Model T experience curve. Between 1910 and 1921, Ford cut Model T costs by three-quarters by modernizing plants, integrating vertically to reduce the cost of purchased inputs, increasing the division of labor, and eliminating model changes. (The Model T came only in black because black paint dried the quickest, which helped speed up the cars assembly.) Market share soared from 10% to 55%, and Ford was enormously profitable. The Model T and the Experience Curve But by its single-minded focus on cost reduction, Ford had sown the seeds of its own downfall. As consumer demand shifted to a heavier, closed body and to a greater emphasis on comfort and styling, Ford responded by tacking on features to the Model T rather than changing models, as General Motors did. Worried about having to replace its massive investment in facilities dedicated to the Model T, Ford continued to build the car until 1927, when customer preferences forced it to close down its plants for nearly a year while it retooled the Model A. In the process Ford lost $200 million and suffered an irreversible decline in market share.1 Despite these gloomy stories, some companies have built strategies successfully on the experience curve. Since 1980, for example, Bausch & Lomb has consolidated its position in soft contact lenses by automating, using computerized lens design, and continuing to expand its one Soflens plant. As a result, its market share climbed from 55% in 1980 to 65% in 1983 and it now earns gross margins 20 to 30 percentage points higher than its competitors. Lincoln Electrics continued cost leadership in electric arc welding supplies derives in large part from personnel policies designed to encourage experience-based cost reductions. What distinguishes the winners from the losers in the experience curve game is their grasp of both the logic of the experience curve and the characteristics of the competitive arena that determine its suitability as a strategic weapon.

How It Works
Use of the experience curve concept began over three decades ago to describe the mathematical relation between the cumulated output of a product and its costs. Literally thousands of studies have shown that production costs usually decline by 10% to 30% with each doubling of cumulated output. For example, if the thousandth unit of a product costs $100, the two thousandth unit will normally cost $70 to $90. (Experience curve slopes generally fall in the 70% to 90% range.) Exhibit I illustrates the 70% experience curve encountered in chip production.

To a strategist, the experience curve suggests that the company with the highest share of an industrys cumulated output will also be the low-cost producer. Some consulting firms have argued that a business units route to a cost advantage lies through cutting price in order to buy share. The increased share of current output is supposed to propel the aggressive business units costs down the experience curve more rapidly than its rivals, thus improving its relative position. But the Du Pont and Ford examples show that such a strategy can be a recipe for failure. The experience curve is too complex to be encapsulated in simple prescriptions. Successful strategy formulation requires a closer analysis of why and how the curve works. Reprint: 85206

The Model T and the Experience Curve

by Alfred D. Chandler, Jr. From Giant Enterprise: Ford, General Motors, and the Automobile Industry by Alfred D. Chandler, Jr. (New York: Harcourt, Brace & World, Inc.) 1964 by Harcourt, Brace & World, Inc. Reprinted with the permission of the publisher. The price of the touring car on October 1, 1908, was $850, and it was increased to $950 on October 1, 1909. From that date there was a progressive reduction of the price of this car until it reached a low of $360 on August 1, 1916. During the period of rising wage rates and prices of materials in the latter part of the war period and the immediate post-war period, the prices were increased from time to time to a maximum of $575 on March 4, 1920. After that date, prices were again reduced progressively and reached a new low of $290 on December 2, 1924. There was an increase of $20 on February 11, 1926. Commencing with a price of $590 on October 1, 1911, the prices of the runabout followed a course paralleling that of the prices of the

touring car. A minimum of $345 was reached on August 1, 1916, after which the prices were increased progressively to $550 on March 4, 1920, and again were progressively decreased thereafter to a new low of $260 on December 2, 1924. The price of the runabout was increased $30 on February 11, 1926. With these progressively diminishing prices, the sales of Model T cars increased by leaps and bounds. The aggregate sales during the calendar year 1908 amounted to 5,986 cars. The sales during the succeeding calendar years up to 1919 were as follows: 1909, 12,292 cars; 1910, 19,293 cars; 1911, 40,402 cars; 1912, 78,611 cars; 1913, 182,809 cars; 1914, 260,720 cars; 1915, 355,276 cars; 1916, 577,036 cars; 1917, 802,771 cars; 1918, 402,908 cars; and 1919, 777,694 cars.