Experience Curve (Economics) - Explained
What is the Henderson's Law?
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Table of ContentsWhat is the Experience Curve (Henderson's Law)?Experience Curve FormulaReasons for the EffectAcademic Research on Experience Curve
What is the Experience Curve (Henderson's Law)?
The experience curve is also known as Henderson's law. An experience curve is an economic term which means that the more a firm produces of a particular good or service, the more it gains in efficiency. Thus, the cost of production decreases in proportion to the volume of products produced. Bruce D. Henderson and Boston Consulting Group (BCG) introduced experience curve in 1960s when they were analyzing the cost behavior of products.
Experience Curve Formula
The formula for the experience curve is: Cn= C1 n- Where: C1shows cost of first produced unit Cnshows the cost of n the produced units nshows the volume of production ashows elasticity of cost in relation with output
Reasons for the Effect
There are many reasons of experience curve. Following are the reasons:
- Labor efficiency- As the labor force works on particular goods and services, they become more skillful and efficiency. Also, they become less hesitant, make little mistakes, and experiment confidently. With the passage of time they learn new skills and have strong command of producing particular products. Labor efficiency covers administrative staff as well.
- Standardization, specialization, and methods improvements- When employees are assumed to work on specific task in which he/she specializes, they become more productive. Also, standardization of tools, techniques, processes, material, etc., increase the organizational efficiency. This allows the firm to achieve cost reductions and earn more profit.
- Technology-Driven Learning Information technology and new machines enable workers to use new methods of production.
- Product redesign - As the company specializes in a particular industry, it becomes easy for them to produce goods and services in bulk at a lower price. This enables them to achieve cost efficiency.
- Shared experience effects - When similar goods and services share common operation and functions, the efficiency achieved from one product may be applied to other product as well. And, hence, experience curve effects are reinforced.
Academic Research on Experience Curve
- Theexperience curvereviewed, Henderson, B. (2012). Own the Future: 50 Ways to Win from the Boston Consulting Group, 211-214. This chapter explores various aspects of experience curve in the field of strategy evolution. Experience curve is the name applied in 1966 to overall cost behavior by Boston Consulting Group (BCG).
- Diagnosing theexperience curve, Day, G. S., & Montgomery, D. B. (1983). The Journal of Marketing, 44-58. This paper analyses the possibility for some select few strategy concepts to provide misleading insights than the experience curve. It further reviews the measurement and interpretation problems that have to be overcome before the experience curve can be productively applied.
- Anexperience curveexplanation of export expansion, Ursic, M. L., & Czinkota, M. R. (1984). Journal of Business Research,12(2), 159-168. This article proposes that while many factors contribute to export behavior, experience curve effects are a major variable explaining the international activities of firms. Results from research conducted in this text shows that younger firms are much more faborably disposed toward and active in international marketing than older firms.
- The economics of the combined cycle gas turbineanexperience curveanalysis, Colpier, U. C., & Cornland, D. (2002). Energy Policy,30(4), 309-316. In this article, the experience curve is used to analyze the economics of the natural-gas-fired combined cycle gas turbine (CCGT). This article discusses whether or not the rapid decline in price is a trend that can be expected to continue in the future. The analysis indicates that the CCGT technology has been in a steady state of decline during the last decade. The decline of the specific investment price is likely to level off in the future. The implications of this expected development on the future price of CCGT plants and the electricity they generate are discussed.
- Second sourcing and theexperience curve: price competition in defense procurement, Anton, J. J., & Yao, D. A. (1987). The RAND Journal of Economics, 57-76. This paper examines a dynamic model of price competition in defense procurement that incorporates the experience curve, asymmetric cost information, and the availability of a higher cost alternative system.
- Theexperience curvefrom the economist's perspective, Hall, G., & Howell, S. (1985). Strategic Management Journal,6(3), 197-212. This paper undertakes a critique of experience curves from several angles. It considers the extent to which they can be regarded as an extension of learning curves, and gives a prediction on the length of its benefits. It goes on to consider the evidence that there is a common slope to experience curves, their usefulness for forecasting prices, and possible reasons for a spurious correlation between accumulated output and average cost. It concludes by demonstrating the differences in strategic implications between the various possible economic factors which may underlie the experience curve.
- A review ofexperience curveanalyses for energy demand technologies, Weiss, M., Junginger, M., Patel, M. K., & Blok, K. (2010). Technological forecasting and social change,77(3), 411-428. This paper explores the application of the experience curve to renewable and non-renewable energy supply technologies. The main aim of this paper is to show that technological learning is as important for energy demand technologies as it is for energy supply technologies.
- The application and misapplication of theexperience curve, Henderson, B. D. (1984). Journal of Business Strategy,4(3), 3-9. The author wishes to analyse the misunderstanding and misapplication of the curve by some managers. The basic validity and usefulness of the curve remain unchallenged. This article provides a guide to using the curve properly.
- Competitive cost dynamics: theexperience curve, Hax, A. C., & Majluf, N. S. (1982). Interfaces,12(5), 50-61. This article deals with the experience curve and how it supports strategic decision-making. The objective this article is to describe an important technique or an application area forreaders who are non-experts in the field of experience curves.
- A resourcebased view of the firm, Wernerfelt, B. (1984). Strategic management journal,5(2), 171-180. The paper explores the usefulness of analysing firms from the resource side rather than from the product side. In analogy to entry barriers and growth-share matrices, the concepts of resource position barrier and resource-product matrices are suggested. These tools are then used to highlight the new strategic options which naturally emerge from the resource perspective.
- Theexperience curvedoctrine reconsidered, Alberts, W. W. (1989). The Journal of Marketing, 36-49. The author studies the relationship for a typical business unit between an advantaged cost position and the decision to build market share. He first offers a rebuttal of experience curve doctrine, the widely taught argument that causation runs from share building to cost advantage. The rebuttal counter-argues that the key to generating a cost advantage is innovation. The author then makes a case that in most market circumstances rate of return building, not share building, is the most profitable way for a unit to exploit an innovation-caused cost advantage.
- Theexperience curve, option value, and the energy paradox, Ansar, J., & Sparks, R. (2009). Energy Policy,37(3), 1012-1020. This paper develops a model to explain the energy paradox, the inclination of households and firms to require very high internal rates of return in order to make energy-saving investments. The model abstracts from many features of such investments to focus on their irreversibility, the uncertainty of their future payoff streams, and the investor's anticipation of future technological advance.