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

ldlllt 2E.0K' ^90, Ml Htym

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.

Was this article helpful?

+1 0
Avoiding Credit Card Disaster

Avoiding Credit Card Disaster

People who struggle with saving money and getting out of debt will find these things in common: They don't know how to stop blaming. They have no idea where their money needs to go! They don't know they need to forget the home equity line. They also don't understand they need to sell some investments. Many more problems untold. Well don't worry, With the strategies that I’m about to let you in on , you will have no problems when it comes to understanding how to get out of credit card debt.

Get My Free Ebook

Post a comment