Estimating the costs learning curve

Successful high-tech firms are constantly monitoring costs in order to keep these costs down. To show a profit that encourages future investments, a company must at least cover its variable costs that are linked to production volume and its fixed costs (salaries, rent, administration, R&D) that are necessary to manufacture its product. Identifying and controlling these costs can lead a company to measure its learning curve.

This learning curve effect corresponds to the company's improved know-how as its production increases during the growth stage of the life cycle: purchasing optimization, design simplification for manufacturing purposes, output increase for production facilities, improvement of sales force, selection of distributors, and increased performance of sales promotion campaigns. All these gains in productivity lead to a decrease in the average unit cost. This decrease in cost could be passed on to the price in order to react to a competitor's actions or to increase price-sensitive demand.

This strategy is characteristic of the electronics industry. Intel, Samsung, Infineon, and the other players use this strategy for pricing their memories and semiconductors. Sometimes they engage in price wars, like in 2001 when the market price of PC memory (DRAM) fell below the cost of production, forcing weaker players, such as Hynix, out of the industry (see also Section 9.1.3).

Microcomputer manufacturers have also chosen this strategy. In the cell phone business, Nokia has aggressively pursued a manufacturing cost control strategy to drive the price of mobile phones down in order to enlarge the market and reach "mainstream" and late majority customers, as well as to chase competitors with smaller volumes out of the game.

On the other side, the company can decide to pocket the productivity gains and increase its margin and profitability. This is the successful approach followed by Logitech, the PC accessories leading vendor. Logitech produces about 100 million units per year and because its products have a longer shelf life than with PCs, Logitech can drive manufacturing costs down. In the meantime, the retail price for its products tends to stay constant, allowing the company to keep the same price for a product such as a cordless optical mouse at the same level 18 months after its introduction. The difference between a fixed retail price and a diminishing cost of manufacturing goes directly to the bottom line.

The learning curve is valid for high-tech products because of the high level of R&D costs required by these products. Because the product life cycles are fairly short, these expenses must be written off very quickly (for example, in 1 year for computers, and in 2 years for robotics) and these R&D costs inflate the average unit cost at the beginning of the product's life, before decreasing very quickly. This unit cost variation is reflected in the changing unit price.

Figure 9.3 illustrates the cost experience curve for magnetic disk storage over 10 years. In recent years, the cost of a gigabyte of storage has fallen dramatically, from $165 in 1995 to $1.4 in 2003 and a projection of $0.2 in 2006. Today storage has become a mass product and the quantity of storage capacity is enormous. For instance, in 2003, Aetna, the U.S. leader of health and related benefits, had more than 174 terabytes (1,000 gigabytes) of data based on more than 4,100 direct-access storage devices and representing about 250,000 tape volumes;Boeing had about 150 terabytes of data over 150,000 desktops;in Europe, ATOS-Origin a high-tech service firm managed about 300,000 terabytes attached to 60 mainframes and more than 5,000 mid-range servers.

Every marketing manager must continuously follow the changes in the average unit cost and its position on the price experience curve according to the trend of the market price. A company that notices its costs decreasing much faster than market prices knows that it is benefiting from its experience and is gaining by profit margin and market share.

On the contrary, a company with costs that are increasing faster than the industry average will see its margins fade away. This company is losing its maneuvering autonomy as well as its market share. Usually, at this point,

Storage price ($/gigabyte)

Storage price ($/gigabyte)

^ Projected

Figure 9.3 Cost experience curve for magnetic disk storage. (Source: IBM Research, IDC, analysis by Eric Viardot.)

^ Projected

Figure 9.3 Cost experience curve for magnetic disk storage. (Source: IBM Research, IDC, analysis by Eric Viardot.)

the company will complain of "dumping," "unfair competition," or "companies that are undercutting prices," without realizing that its inability to be more successful (attaining a higher performance level) is leading to its own failure.

Marketers must also avoid another hazard, which is to overstate the manufacturing potential when establishing the price. Indeed, if an aggressive pricing stirs market demand above production capacity, it directly impacts customer satisfaction (and brand image) because of excessive delays. Furthermore, it affects profitability, because firstly the company is not getting the full infusion of revenues at launch time, and secondly, available products could have been sold at higher prices. Apple went through this tough experience in 2003 when it started to ship its 17-inch PowerBook several weeks after the official availability date of February 2003. The previous year, it had had similar problems with the 15-inch flat panel iMac, which was introduced at Macworld Expo in January 2002, but was really available 3 months later in April 2002, leaving the company with a significant backlog of orders for the iMac at the end of its first financial quarter.

Such trouble does not occur for companies that have implemented a "built-to-order" manufacturing model, or a variable pricing scheme, which allows for quick rebalancing between demand and supply through price adjustment. Actually we should note that the learning curve analysis is adapted to products that can be mass produced, rather than to very customized manufacturing systems, even if R&D costs need to be written off in both situations.

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