The Experience Curve
Posted By Rob Millard - 0 Comments -
This posting presents another of the more conventional tools in the professional service firm strategist's arsenal. It is often used in conjunction with the Service Life Cycle, to determine which of the services that the firm offers are trending upwards, which are "question marks" and which are declining. All of which, of course, is critical in deciding where the strategic focus needs to be.
WHAT IS THE EXPERIENCE CURVE?
The experience curve matrix is based on the fact that in many industries (certainly not just professional services,) costs decline by a constant factor as experience (or production volume) increases. In other words, as a firm gains more experience in producing a particular service, the cost of producing that service reduces by a constant factor. This observed statistical law drives many aspects of strategy, including:
-Competitive analysis
-Budgeting and cost forecasting
-Decisions of where to focus business development
-Recruiting
-Service Pricing
It is beyond the scope of this work to delve into the complex algebra underlying the experience curve, however the principle is illustrated in the figure below.
WHAT DRIVES THE EXPERIENCE CURVE?
LEARNING
Intuitively, people become better at the service being delivered as experience increases. The work can be done more quickly, with less mistakes, to a higher standard of quality.
SPECIALIZATION
Specialization allows the fee-earners to focus their learning on narrow areas of the service, intensifying the learning and standardizing processes and workflow to produce improved productivity.
ECONOMIES OF SCALE
The increased volume allows investment in technology and additional staffing, with these fixed costs being spread over greater workflow, reducing the "cost per unit" delivered to the client.
SERVICE DELIVERY PROCESS IMPROVEMENTS
As experience increases, so opportunities for reduction of cost through improved service delivery and other operational improvements become more apparent.
ORGANIZATIONAL STRUCTURAL IMPROVEMENTS
As a particular service becomes more entrenched, firms tend (unsurprisingly) to focus more structurally on delivering that service. Increased revenues and experience also lead to structural improvements in the organization, which in turn also increases efficiency and productivity, reducing the cost of service delivery.
INNOVATION
Innovation is expensive to foster in a firm, and the investment in time and money on any scale is usually only possible in organizations that have reached the required critical mass.
USING THE EXPERIENCE CURVE
The experience curve brings another perspective to bear on the competitiveness and profitability of the different service offerings. Superimposing the experience curve on top of the Service Life Cycle yields the same strategic options, but from a richer perspective:
EMERGENCE
Either set high prices to ensure that costs are at least covered and profits may even be achieved; or deliberately lower prices in order to raise the barriers to entry for other firms while your firm goes through the learning curve more rapidly. This accelerates the experience curve and consequently the reduction of costs, and also increases market share so the firm is better placed when the market enters the growth phase.
GROWTH
Increased competition will cause price wars and even at this stage some firms will drop out of the market. The strategy here will depend on whether the firm wants to continue to provide the service into the maturity phase or not. If so, it should aggressively grow market share as much as possible. If not, it should charge premium rates while it can and accept a smaller market share as a result.
MATURITY AND DECLINE
Low cost, high volume [process] firms only will dominate these stages, some very profitably, as competition moves aggressively to price. Firms that have already achieved significant market share will be well placed to adopt a low margin, high volume strategy if they wish to. Firms that don't want to go this route need to milk the services for as long as they are profitable, and then exit. Profitability needs to be carefully monitored so that when the point is reached to exit, it does not end up continuing through simple inertia.
The challenge in this phase is not to invest in growing practices in this segment. Rather invest the funds in areas of the practice that have high growth potential. This may not go down well with the professionals that practice in these areas, though, which is why so many firms tend to avoid this potentially prickly area until a practice area has become so unprofitable that the discussion can no longer be avoided.
Which of the Service Life Cycle or the Experience Curve is the primary focus will vary from situation to situation. What both do in slightly different ways is place the spotlight firmly on the nature of the services that the firm is offering clients, and what the strategic drivers are of each.
This posting drafted from a Starbucks on West 58th Street in New York.
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