Experience curve is the systematic reductions in the production costs that occur over life of a product.
There is a relationship between the scale of production and the size of the unit cost of the product, known as the effect of experience. Graphical representation of experience effect (created on the basis of cumulative production and average cost) is called experience curve.
A number of studies show that a product’s production costs decline by some characteristics about each time accumulated output doubles. E.g. in aircraft industry, where each time accumulated output f airframes was doubled, unit costs typically declined to 80 percent of their previous level. That is the production costs of the fourth airframe would be 80 percent less of the production costs for the second airframe, the eighth airframe’s production costs is 80 percent less of he fourth’s, the sixteenth’s airframe costs is 80 percent less of the eighth’s and so on.
The graph shows the experience curve that normally allows costs to be reduced with additional output. This is due to two reasons: learning effects and economies of scale.
- Learning effects: refers to the cost savings that come from learning by doing. Labor productivity increases as individuals learn the most efficient ways to perform particular tasks. Management also typically learns how to mange the new operation costs efficiently over time. But it has been suggested that learning effects are important only during the start up period of a new process and that they cease after two or three years. After that, any decline in the experience curve is due to economies of scale.
- Economies of scale: refers to the reduction in unit cost achieved by producing a large volume of a product. This is mainly due to the ability to spreads fixed costs over large volume. By building sales volume more rapidly, international expansion can assist a firm in the process of moving down the experience curve. By lowering the costs of value creation, experience economies can help a firm to build barriers to new competition.