An organization involved in automobile manufacturing wishes to exercise strategic choice at business level. How can the concept of experience curve help in it? Give suitable example.

Understanding the Experience Curve

The experience curve, originally observed by the Boston Consulting Group (BCG) in the 1960s, suggests a predictable relationship between cumulative production and average cost. Typically, each doubling of cumulative production leads to a reduction in unit cost of approximately 20-30%. This cost reduction isn’t solely due to economies of scale, but also to the ‘learning by doing’ effect. The curve is mathematically represented as: C = aW^b, where C is the average cost, W is cumulative production, and ‘a’ and ‘b’ are constants. The exponent ‘b’ is negative, indicating an inverse relationship.

Strategic Choices Enabled by the Experience Curve

An automobile manufacturer can leverage the experience curve to inform several business-level strategic choices:

• Cost Leadership: The most direct application. By aggressively pursuing higher production volumes, the manufacturer can drive down costs and offer competitive pricing. This strategy is particularly effective in price-sensitive markets.
• Market Share Expansion: Lower costs allow for price reductions, stimulating demand and increasing market share. Increased market share further fuels the experience curve, creating a virtuous cycle.
• Product Differentiation (with Cost Advantage): Even with a differentiation strategy, a cost advantage derived from the experience curve can improve profitability. The manufacturer can invest savings in R&D, marketing, or enhanced features.
• Entry Deterrence: A firm with a significant cost advantage due to the experience curve can deter new entrants, as they would struggle to match the incumbent’s pricing.

Application in the Automobile Industry: Toyota’s Production System

Toyota’s success is a prime example of leveraging the experience curve through its Toyota Production System (TPS). Introduced in the 1970s, TPS focused on continuous improvement (Kaizen), just-in-time inventory, and elimination of waste (Muda). These principles, combined with a commitment to high-volume production, allowed Toyota to rapidly descend down the experience curve.

Key aspects of Toyota’s strategy:

• Standardization: Toyota standardized components and processes wherever possible, reducing complexity and facilitating learning.
• Continuous Improvement (Kaizen): A culture of continuous improvement ensured that processes were constantly refined, leading to incremental cost reductions.
• Just-in-Time Inventory: Minimizing inventory reduced storage costs and waste, further contributing to cost efficiency.
• High Volume Production: Toyota consistently pursued high production volumes, accelerating its movement down the experience curve.

As a result, Toyota was able to produce high-quality vehicles at lower costs than its competitors, gaining a significant competitive advantage and becoming a global leader in the automobile industry. According to data from 2022, Toyota held approximately 14.5% of the global automobile market share (Statista, 2023 - knowledge cutoff). This was partially attributable to its cost efficiencies.

Limitations of the Experience Curve

While powerful, the experience curve isn’t without limitations. Technological disruptions can render existing experience obsolete. Rapid changes in consumer preferences can also diminish the benefits of cost leadership based on accumulated experience. Furthermore, the curve assumes a stable operating environment, which isn’t always the case.