There has been a lot of press in recent years about the importance of the “learning organization.” While the idea of a learning organization from the perspective of how learning can be enabled and shared is well-explored, the economic impact of learning, and its resulting effect on competitive advantage, have been less fully examined. This blog post looks at the notion of organizational learning from this perspective.
Hardly anyone today disputes the importance of learning in firms. Learning is essentially the acquisition of knowledge, understanding and skill through experience, instruction or study. For most firms, experience will be the main pathway to learning where people gain knowledge and skill from actually performing a job. By acquiring and leveraging the learning acquired through accumulated experience, a firm can drive significant improvements in quality, work processes and routines, and products and services.
Economists and business strategists have long appreciated the impact of learning on organizational performance. The so-called experience or learning curve shows how costs fall as a function of cumulative output – as a firm acquires learning about how to better make and provide a product or service over a greater quantity of output, it can leverage that accumulated experience and learning to gain greater efficiencies and thereby reduce unit costs.
To see how this works, consider the learning curve for a firm shown in the diagram below.
In this figure, as the firm accumulates output from quantity 1 (Q1) to quantity 2 (Q2), it also moves down the learning curve by accumulating experience and learning. At quantity Q1, the firm’s acquired learning results in an average unit cost of AC1. At quantity Q2, by moving down the learning curve and applying its accumulated experience, the firm is able to lower the average unit cost to AC2.
Proponents of the learning curve have generally held that, as accumulated experience doubles, unit costs can fall 15 to 20 percent. In some industries, the rate is higher. For example, in aircraft manufacture it is not uncommon for unit costs to fall by 25 percent or more by the fourth or fifth year following a new model introduction. However, it should be kept in mind that the learning curve is not uniform across all industries: the accumulated experience that a firm would acquire from making a simple stamped metal part would not be as deep, and therefore not as impactful on unit costs, as the learning that a complex microchip manufacturer, for example, might acquire.
Why do unit costs decrease with accumulated experience? Cost decreases generally result from employees gaining greater proficiency and experience in performing work, higher quality, and also from efficiencies gained by finding better ways to do things. Firms that are able to use learning to drive improved performance use less input factors of production – less labour, less materials, less machines, less facilities, etc. – resulting in lower costs.
An important feature of learning curves is their predictive ability. If a firm can calculate its learning curve, it can predict what its unit costs should be at a given cumulative volume. With this knowledge, and provided other market conditions are appropriate, a firm can set its pricing based on the future unit costs which will be attained once the firm drives down the learning curve and achieves the predicted cumulative volume. Driving down the curve before competitors can result in a gain of market share at competitors’ expense, while at the same time erecting a barrier to imitation which can only be removed through a competitor’s commitment to learning.