Strategy Dynamics Briefing 46: The dynamics of technological progress

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Briefing 45 introduced the four main categories of external factors (political, economic, social and technological) that can constrain or enable business development by affecting access to necessary resources. The first three items especially impact on customers and staff, but technological progress has more direct effects on the functionality and cost of products.

A key mechanism in how technological progress works arose from noticing that the unit cost of many manufactured products falls by characteristic amounts as cumulative output (i.e. “experience”) increases. Specifically, each time cumulative output doubles, unit costs fall by 10 – 20%. This process is now so well-known that it is implicit in strategy for all industries with rapidly developing technology. We can add this mechanism to the economic and social issues we looked at in Briefing 45. The following connections can be traced round the structure shown in Figure 1.

  • Initially high unit costs (lower right) result in a price that is affordable only to a very small proportion of the population (lower middle).
  • As incomes rise, the number of potentially reachable consumers rises (left), and advertizing starts to stimulate sales, albeit at a very slow rate (upper left and top).
  • Even this slow sales rate, however, leads to a big fractional growth in cumulative production output (middle right). New sales of just 5000 units, for example, allow unit costs to fall by 15% if cumulative sales to date have been only 5000 units.
  • Consequently, unit cost and price fall significantly (lower right again), accelerating the rate at which ever-likely consumers find the product to be affordable.
  • Escalating numbers of potential customers interact with the small number of already active customers (center), driving rapid increases in sales, and hence further falls in unit cost.

Note that the market’s take-off is also held back by the product’s functionality (top right), which only reaches acceptable levels during the middle of the five-year period.

Figure 1: Adding technological factors to an emerging consumer electronic product. (click to enlarge)

This process continues until limited by four distinct mechanisms:

  1. Progress on functionality slows down, as most possible improvements are found and implemented.
  2. Growth in active customer numbers slows, as the ever-likely population is developed and the resulting potential customers are won to the product.
  3. The scope for reduction in unit costs runs out as actual costs fall — 15% saving on the year-five cost of $63 is less than it was on the original cost of $180.
  4. It takes progressively longer for each doubling of cumulative output to occur — cumulative sales doubled from 5000 to 10000 in less than two months, but doubling from 250000 to 500000 takes nine months.

Until next time…

 

 

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Carbon-efficient technologies
As at 2009, it is a popular myth that we cannot reduce carbon emissions significantly until new technologies are developed. Perfectly viable technologies have existed for many years – a McKinsey report even estimated that over 25% of carbon emissions could be profitably eliminated by doing simple things that save more money than they cost. Other technologies, not yet economic, could become so by being driven down the experience curve through policy to encourage adoption – small, temporary tax-breaks or regulation. Some are simple, small-scale concepts, such as intelligent refrigerators that shut off briefly when the power network is under stress – effectively turning the nation’s fridges into giant energy stores – see www.rltec.com. Others are larger-scale, such as pumping the CO2 from power-stations and industrial fuel users back underground into the rock formations from which the hydrocarbons originally came. All, though, will become cheaper and more effective as cumulative output drives experience.

This briefing summarises material from chapter 6 of Strategic Management Dynamics, pages 379-390.

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Comments

  1. Amin Terouhid  September 2, 2012

    How do you demonstrate the following relationship in terms of formula? What formula can I use to do this?
    – “each time cumulative output doubles, unit costs fall by 15%”

    reply

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