Page 209 - DMGT206_PRODUCTION_AND_OPERATIONS_MANAGEMENT

Production and Operations Management

Notes 10.4.3 Single Sourcing Strategy

Single sourcing as a concept evolved from the work carried out by the Boston Consulting Group
(BCG) in the 1960s. The breakthrough came while BCG was working for a major manufacturer
of semiconductors. In a study on the cost of television components BCG found striking differences
in the rate of cost improvement between monochrome parts and color parts. This was difficult
to explain since the same factory, the same labor, the same processes were involved at the same
time. BCG explained the phenomenon through the experience curve.
BCG had earlier observed in many of their studies that producers tend to become increasingly
efficient as they gain experience in making their product, and costs usually declined with
cumulative production. They came up with a hypothesis to explain how an organization with
the greatest accumulated volume of production will have the lowest cost relative to other
producers in the market. This explained why monochrome parts had progressed down a cost
curve to a larger degree than the color parts. The accumulated experience in monochrome parts
was much greater than in color parts.
Figure 10.3: The Experience Curve

COST
1.00

.80

.64

.50

10 20 40 60
TOTAL EXPERIENCE

The experience curve is shown as Figure 10.3. According to the experience curve concept, costs of
value added decline approximately 20 to 30 percent in real terms each time accumulated experience
is doubled. If the growth rate is constant, the cost decline continues indefinitely as long as the
growth rate continues. If the growth stops, costs continue to decline, but the rate of decline is cut
in half each time the accumulated experience doubles.
The cost declines identified by the experience curve do not occur automatically. It is assumed
that there is added investment in an amount commensurate with the marginal cost of capital.
Study of the experience curve shows, if high return on investment thresholds is used to limit
capital investment, then costs do not decline as expected.
BCG was able to collect the evidence on a wide variety of semiconductors that were a part of the
original study. Price data supplied by the Electronic Industries Association was compared with
accumulated industry volume. Two distinct patterns emerged:

 In one pattern, prices, in current dollars, remained constant for long periods and then
began a relatively steep and long continued decline in constant dollars.
 In the other pattern, prices, in constant dollars, declined steadily at a constant rate of about
25 percent each time accumulated experience doubled.
This pattern seemed to have applicability across the board. Systematic cost differences arise
between competitors because some develop more knowledge about production than others.

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