The Experience Curve

I was rereading George Gilder’s excellent book Knowledge And Power this morning and I ran into something that was something rather profound, if all too often ignored these days. From the book:

The root of a company’s value is experience, which is a product of the knowledge in the company, the learning of the customer, the balance sheet of assets and liabilities, and not least, the policy environment.

The quote came from the chapter where Gilder discusses his history with Bill Bain and Bain Capital’s people including Mitt Romney.  In the chapter Gilder explains a companies experience curve and how that adds to the value of a company.  Here are some links on the experience curve.

The idea of the experience curve was first conceived by the Boston Consulting Group based on the work done by the Navy on learning curves.  This explains what BCG was thinking about.

The experience curve is one of BCG’s signature concepts and arguably one of its best known. The theory, which had its genesis in a cost analysis that BCG performed for a major semiconductor manufacturer in 1966, held that a company’s unit production costs would fall by a predictable amount—typically 20 to 30 percent in real terms—for each doubling of “experience,” or accumulated production volume. The implications of this relationship for business, argued BCG’s founder, Bruce Henderson, were significant.  In particular, he said, it suggested that market share leadership could confer a decisive competitive edge, because a company with dominant share could more rapidly accumulate valuable experience and thus achieve a self-perpetuating cost advantage over its rivals.

The experience curve theory proved a valuable descriptor and predictor of competitive dynamics across much of the business landscape through the 1970s, providing a sound guide for investment and pricing decisions and an invaluable tool for strategists. Is the idea applicable to today’s environment? Yes, but in some industries it is no longer sufficient by itself as a blueprint for competitive advantage. In contrast to the 1960s and 1970s, when the general business environment was relatively stable and new-product introduction relatively infrequent, today’s business climate is characterized by higher volatility, less stable industry structures, and frequent product launches in response to rapidly changing technologies and tastes.

Experience of the type addressed by the experience curve is still necessary—often critically so, depending on the industry. But we argue that most companies today need an additional kind of experience if they hope to create and sustain competitive advantage.

See “The Experience Curve,” BCG Perspectives, 1968, and “The Experience Curve—Reviewed (Part I),” BCG Perspectives, 1974.

Two Types of Experience

The type of experience that the classic experience curve refers to—the ability to produce existing products more cheaply and deliver them to an ever-wider audience—can be considered experience in fulfilling demand. This type of experience remains very important in many industries, especially those that are relatively stable, cost-sensitive, competitive, and production-intensive.

Hard-disk drives, for example, showed a cost decline of about 50 percent for each doubling of accumulated production from 1980 through 2002, bringing the average cost per gigabyte from $80,000 in 1984 to $6 in 2001. Laser diodes showed a similarly steep cost decline of 40–45 percent with each doubling of volume, with prices decreasing from the roughly $30,000 of fiber amplifiers in the early 1980s to $1.30 for 0.8-micrometer CD lasers (unpackaged) in 1999. But to win in today’s environment, many companies also need experience in shaping demand, or creating demand for new products and services.

Exhibit 1 is a visual representation of the two types. Experience in fulfilling demand is represented as the classic experience curve: it shows a reduction in costs as a function of cumulative volume (which is a straight line in a log-log scale). Experience in shaping demand is represented as repeated “jumps” across successive experience curves, representing a company’s ability to move from product generation to product generation repeatedly and successfully. The relationship between the two types of experience might also be visualized as an endless version of the popular board game Snakes and Ladders. To maintain competitive advantage, companies have to both “slide down snakes” (that is, fulfill demand) and “climb ladders” (that is, shape demand). The relative emphasis on each depends on a company’s particular circumstances.


The two types of experience are inherently different, as is the way they are accumulated and the benefits they confer. Experience at fulfilling demand is acquired through a logical deductive process: capture your cost data, analyze them, determine opportunities for improvement, implement changes, iterate. The main features of the learning process are repetition and incremental improvement, both explicit and implicit. Experience at shaping demand, in contrast, is acquired through an inductive process: sample consumer behaviors, formulate a hypothesis on unmet needs or imagine the possibilities permitted by new technologies, test the hypothesis with a new offering, shut down the test or expand it based on empirical results, formulate new hypotheses based on the latest empirical results, repeat.

It should be noted that neither experience type, by itself, has ever been sufficient for long-term competitive advantage. Both have always been necessary. What has changed recently is that the required speed of cycling between the two has increased dramatically. We refer to this ability to develop and leverage both existing and new product knowledge concurrently, or to switch between them effectively over time, as ambidexterity.

What papers like this from the Boston consulting Group don’t mention, but should, is that the experience a company has is by and large inside the heads of the people who work there.  While the IP and balance sheets can hold some of the company’s experience, without the intelligence that created the information that information can be essentially useless.  All too often, the devil is in the details that don’t get written down as a project goes forward no matter how much documentation you try to get. Mostly because there are little things that “everybody knows.”

The most experienced employees keep a good deal of a company’s value as a trust.  In previous times a part of that trust was passing that value forward  to the next generation.  Reading the histories of companies the passage of the crucial knowledge to the apprentices coming in can be seen quite clearly as the young and the old worked side by side and careers were developed.

Unfortunately, the modern management systems only see the tangible.  All too frequently, in the name of cost saving and efficiency the companies are laying off the employees with the longest tenures or those over fifty.  These are the very employees that are most likely to be holding the company’s experience in their heads.

This trend has been exacerbated by the rise of the professional manager who never gets the mentoring and apprenticeship that young management trainees had previously received.  Managers   start their careers in management by and large without the seasoning that their predecessors had or the in depth knowledge of the business.  It’s no wonder that all too often they seem out of their depth when dealing with those who actually have the experience.  It’s also all too easy for these managers to see the experienced and knowledgeable as threats that need to be disposed of. Especially since their education doesn’t tell them the value of experience, something that’s missing from MBA programs.

As for younger companies and far too often established companies, they adopted a youth culture. As far as the balance sheet that might work, but from a standpoint of gaining experience it doesn’t quite work out. There are two ways of gaining experience. One is talking to somebody who’s already been through the hard knocks or taking the hard knock yourself.  Sometimes you are forced to do the latter by circumstances. That tends to get expensive rather quickly.  The other way is to find somebody who’s been there, done that.  They may cost more in salary, but even the most expensive salary is far cheaper than even the smallest business issue.

By laying off or refusing the experienced a company is doing one of the things that will, in the end, destroy their own asset value more than even the worst possible natural disaster or fire.  By disposing of the people that make a company work, a company will stop working.  The business news is filled with companies having large layoffs and shortly thereafter being mired in one business crisis or another.    Which the pretty young things in charge have no clue how to solve. Which makes the papers.

In the chase for efficiency at all cost the big companies have been not so slowly destroying the one thing that made their asset value more than the sum of the various parts that make them up.  By random and frequent layoffs, especially of senior employees, chasing H1B employees and moving production offshore these companies are destroying the very experience that makes them valuable.  At some point these companies will reach the end of all the token pushing, stock buybacks and increasing their debt and what will they have left?  Since all too frequently these same companies are owned by mutual funds that are the holders of the trusts that many people have their retirement funds what happens when these company’s houses of cards get blown in the wind?

By chasing immediate cost cutting all too many companies are losing that asset that doesn’t appear on their balance sheets, yet is there nonetheless.  If the companies don’t begin to realize what’s happening, there will be more AOL’s, IBM’s, Wells Fargo’s and even worse failures as more companies lose the experience that gave them the stability to weather storms and the smarts to avoid the kinds of stupid stuff that American business seems to all to often, engage in. The companies have been killing their futures for the ake of the present and that is not going to end well.



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