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Predicting future price and cost trends is not rocket science in a volume industry like electronics or technology. Price declines observed in personal computers, consumer electronics, cellular telephone and network bandwidth etc. are mathematically predictable using experience curves. |
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Experience curves project future market behavior and can determine if a product's cost reduction efforts are keeping pace with industry price erosion. It they are not, profit margins will shrink and the viability of the product will be threatened. Business teams must correctly anticipate cost reduction requirements or risk having to withdraw from the market.
Similar to learning curves, experience curves are based on production and distribution improvements attributable to economies of scale. The mathematics is well established and states that for every doubling of industry volume, the average market sales prices declines by a certain ratio. For much of the electronics industry, the average market sales price erodes 30% for each doubling of industry volume. This is referred to as a 70% experience curve. Other industries may experience less dramatic cost erosion i.e. such as 80% or 90% experience curves.
When plotted on a log-log scale, the declines appear as straight lines. |
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The above chart depicts a hypothetical $100 product, launched prior to 2001, and competing in an increasingly expanding marketplace. Three different erosion trajectories are shown for reference (solid lines).
The dotted blue line represents the factory cost of the product, and the future projected factory cost. If the market follows a 70% experience curve, the product will become unprofitable sometime in 2005. The factory cost improvements do not keep pace with price erosion.
Analytical models such as experience curves can lend considerable weight in strategic investment planning. New, rapidly expanding markets are exceptional opportunities, but likely carry the burden of intense price competition and demands for on-going development investment.
Many companies recognize that experience curves provide accurate predictions and use them for cost reduction goal setting. |
