on November 24th, 2010

Dear Colleagues

In essence, the more experience a firm has in producing a particular product or service, the lower its costs are. Fairly obvious one would think, but something we often don’t consider when planning a large project or job (especially one which has a degree of repetition in it). The Boston Consulting Group noticed that a semi-conductor company’s unit cost of manufacturing fell by about 25% for each doubling of the volume produced. Hence the conclusion that costs can decline by 20% to 30% in real terms, each time the accumulated experience doubles. This law has been known since the WW II when building aircraft. Effectively less labour is required for a given output, depending on the level of experience. Properly managed, experience can facilitate improvement. So this shows the folly of a company replacing experienced engineering professionals with young hacks at a far cheaper rates. Experience and a company’s value reside in its human capital. People. And if talent is not recognised, it leaves the firm and takes away a lot of value and indeed, cost effectiveness of that firm.

Obviously there are ways of bypassing this law in reading up about new techniques, training staff intensively to pass on the knowledge and hiring highly experienced people. And, innovation and change can make this whole approach of the experience curve dead in the water. Innovation can thus leapfrog the experience curve. For example, experience in manufacturing black and white TVs is not of much particular advantage.

What can you do about it ?
The important issue is to realise that you can make greater profits at a lower risk by trying to focus on building up your store of experience in your business.

And naturally, you can budget on the hours spent in reviewing/turning around certain repetitive tasks will decline as the project matures.

As the old saying goes: Good judgement comes from experience. Experience comes from bad judgement.

Thanks to the Economist, Joseph Sherman and Rahul Sha for some interesting discussions in producing this note.

Yours in engineering learning

Steve


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