Notes:

The Experience Curve

This is another well-known concept. As plants produce more products, they gain experience in the best production methods, which reduce their costs of production in a predictable manner. Every time a plant's cumulative production doubles, its production costs decline by a specific percentage depending on the nature of the business.

Where Economies of Scale Meet the Experience Curve

The astute reader will realize that larger plants can have a two-way cost advantage over their competitors. Not only does a larger plant gain from economies of scale, but it will also produce more, giving it experience curve advantages as well. Companies often use this dual advantage as a competitive strategy by first building a large plant with substantial economies of scale, and then using its lower costs to price aggressively and increase sales volume. The increased volume moves them down the experience curve more quickly than their competitors, allowing the company to lower prices further, gaining still more volume. There are, however, two criteria that must be met for this strategy to be successful: The product must fit customers' needs and the demand must be sufficiently large to support the volume. Consider the case of Chrysler. By the 1970s, economies of scale and experience had given Chrysler the lowest production costs of all of the U.S. auto manufacturers. Unfortunately, its cars no longer fit customers' needs so Chrysler could not sell enough of them to operate its large plants at their design levels, driving their costs up to the highest level among the other U.S. producers in the United States.