Great Business Ideas: The experience curve

Great Small Business Ideas to Start: The experience curve

In creases in production allow workers to become more experienced—and firms with experienced workers are able to reduce their costs and increase their revenues.

The idea

In the mid-1960s, Boston Consulting Group (BCG) noticed that a manufacturer of semiconductors was able to cut unit production costs by 25 percent every time it doubled its production level. It was concluded this was because the workers gained valuable experience, which allowed them to be become more efficient.

A slight variation of the traditional “economies of scale” principle, the idea’s emphasis on employee experience has a range of broad, strategic implications that should be taken into consideration when deciding which workers to hire and how much to produce.

However, the effects of the experience curve are not universal to all companies and industries. Although it is generally estimated that a cost reduction of 20–30 percent will occur when experience doubles, there are many firms that deviate from these figures, with some only gaining a cost reduction of 5 percent. This is thought to be because different production processes provide different opportunities for gaining experience. It is also not feasible for many firms to drastically increase their production levels when there is a fixed demand for a product or when the production process is highly time-consuming and complex. It should also be noted that some firms simply do not have the resources to increase their production.

Nevertheless, the experience curve has valuable lessons for every company, even those that cannot actually increase production. Experience can be gained secondhand, through books, videos, and “mentoring” by individuals who are already experienced.

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Alternatively, firms can hire workers that are already experienced veterans of their industry (although it is usually necessary to pay higher salaries to such workers). Also, businesses that are currently inexperienced can use innovation to bring out new products, change market preferences, and render a competitor’s experience obsolete.

In practice

  • Encourage employees to view their job as an active learning experience.
  • Recognize when it is not appropriate to increase your production—if your demand is fixed, then increased output will lead to wastage.
  • Avoid high employee turnover by finding out why people leave.
  • Provide opportunities for workers to gain secondhand experience (for example, through reading and teaching) as well as firsthand experience in the production process.