While it may seem entirely intuitive today, the concept of the “experience curve” was first offered in a Harvard Business Review article in 1964. The thesis was that as the number of units produced goes up, the cost per unit should come down. Within the service economy, there are similar expectations. The bigger you are, the easier it should be to apply overheads and bring costs down.
Almost every industry is more competitive than it was 10 years ago. Customers are more demanding than ever, expecting Nordstrom’s service at WalMart pricing. We have one client whose customers actually have efficiency gains written into their contracts (i.e. their customer EXPECT prices to go down, and not up). In things such as budgets and sales productivity, the entrepreneur must demand incremental improvements every year because that is what customers expect.
In order to survive the experience curve, the entrepreneur must seek out business model innovation. In a world of reverse engineering, where your product can be mimicked around the world in a matter of days, sustainable advantage is more readily maintained through creating entirely new business platforms.
Amazon earns about a 5% markup and turns its inventory 25 times per year, compared to a discounter that might earn a 20% mark up and turn its inventory 5 times. Unlike a typical retailer that is dependent on vendors and cash flow to fund inventory, Amazon’s model is “buyer financed”, creating a float of 41 days between the time a customer buys a book and the time the publisher is paid[i]. Thus Amazon has a distinctive cost and cash flow advantage, even over other internet retailers. In today’s environment, a two percent cost advantage can be material, and allow a competitor to undercut a market.
The quickest way to garner the experience curve is through technology. Organizations can easily benchmark technology spending within their industry through the statements of public companies and the like. If you are spending 2% of revenue on technology, and others are spending 4%, it is likely that some will outpace you in terms of efficiency, speed and cost.
Another experience curve gambit can be found in quality initiatives such as Total Quality Management, Lean Manufacturing and Six Sigma, all derived from a thirst for quality improvement, efficiency and cost cutting. Becoming leaner is not a choice as much as a necessity, and the race is underway in manufacturing environments to be the leanest. The race never ends.
[i] Seizing The White Space Mark Johnson