Accumulated Production

Suppose TI runs a plant that produces 3,000 calculators per day. As TI gains experience producing calculators, its methods improve. Workers learn shortcuts, materials flow more smoothly, and procurement costs fall. The result, as Figure 4-10 shows, is that average cost falls with accumulated production experience. Thus, the average cost of producing the first 100,000 hand calculators is $10 per calculator. When the company has produced the first 200,000 calculators, the average cost has fallen to $9. After its accumulated production experience doubles again to 400,000, the average cost is $8. This decline in the average cost with accumulated production experience is called the experience curve or learning curve.

Now suppose TI competes against two other firms (A and B) in this industry. TI is the lowest-cost producer at $8, having produced 400,000 units in the past. If all three firms sell the calculator for $10, TI makes $2 profit per unit, A makes $1 per unit, and B breaks even. The smart move for TI would be to lower its price to $9 to drive B out of

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Figure 4-10 The Experience Curve the market; even A will consider leaving. Then TI will pick up the business that would have gone to B (and possibly A). Furthermore, price-sensitive customers will enter the market at the lower price. As production increases beyond 400,000 units, Tl's costs will drop even more, restoring its profits even at a price of $9. TI has used this aggressive pricing strategy repeatedly to gain market share and drive others out of the industry.

Experience-curve pricing is risky because aggressive pricing may give the product a cheap image. This strategy also assumes that the competitors are weak and not willing to fight. Finally, the strategy may lead the firm into building more plants to meet demand while a competitor innovates a lower-cost technology and enjoys lower costs, leaving the leader stuck with old technology.

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