Wright`s Law Cost Curve

Interestingly, the learning curve has evolved to predict the prices of many products of a completely different nature, including photovoltaic cells (in $/watt – the graph in this post) and DRAMs, although the cost-cutting processes for these two technologies are radically different, as are the slopes of their two learning curves. By the second quarter of 2019, Tesla had produced just over 275,000 Model 3s since its launch. According to Wright`s Law, the cost of making a Model 3 is expected to drop by about 23% as it grows to an additional 600,000 cars, which our analysis says is expected to happen by the end of 2020. Mathematically, Wrights` law takes the form of a power function. Empirical research has validated the following mathematical form for the unit cost Cx of manufacturing the umpteenth unit, starting with unit C1, for a variety of products and services: If we apply Wrights` Law to over 100 years of automotive production costs, we show how well it has served companies like Ford. Assuming the Model 3`s average selling price (ASP) remains at $49,000, we expect its gross margins to be above 30% by the end of 2020. But if the only part of an electric vehicle subject to Wright`s Law`s steep learning curve is the powertrain, and if the powertrain accounts for only 20% of the total cost, why aren`t the total savings 12% by 20% or 2.4% overall? The learning curve model assumes that for every doubling of the total quantity of items produced, costs decrease in a fixed proportion. In general, the production of a good or service shows the learning curve or experience curve effect. Each time the cumulative volume doubles, the costs of value creation (including administration, marketing, sales, and manufacturing) decrease by a constant percentage. Experience curve effects – Wikipedia The unit curve was expressed by Henderson in a slightly different nomenclature:[8] ⦠Wright`s law was developed by Theodore Wright, an aeronautical engineer who wanted to understand how much it cost to make an airplane and why. He looked at the cost of producing aircraft in the 1920s and 1930s and found that construction costs seemed to decrease depending on one model. The more aircraft built, the more engineers, mechanics and designers had to assemble more airframes, and the cheaper each example became. 56 His theory was that for every doubling of units produced, the cost would decrease by a constant percentage.

The exact nature of the decline would depend on the particular technique. In the case of the aircraft studied by Wright, this was a 15% improvement for each doubling of production. This 15% improvement is called the “learning rate.” In Wright`s rendering, the reason was simple. When engineers develop a product, they understand what it takes to build it better. For this reason, the key to continuing Wright`s Law is to increase the volume. Higher demand leads to improvements in the process, which reduces costs, which in turn further stimulates demand, and so on. This is a different concept from the notion of economies of scale – the idea that efficiencies come from larger operations or better prices from suppliers. Instead, Wright focuses on the relationship between demand and skills. As the demand for a product increases, the people who make it need to make the most of it. And that means more opportunities to learn by doing.

If they put into practice what they have learned, the costs are even lower. The experience curve effect can sometimes stop abruptly. [ref. needed] Graphically, the curve is truncated. Existing processes are becoming obsolete and the company must modernize to remain competitive. The upgrade means that the old experience curve will be replaced with a new one. This happens when: Tesla doesn`t explicitly state the cost of the Model 3. ARK calculated these figures based on declared bids, and since Tesla only produced several hundred Model 3s in the second quarter of 2017, these early units are an aberration. A third formulation of Wright`s law is used by a group of innovation investment analysts who work with the cumulative average cost per unit and the cumulative number of units produced. [9] It has been suggested that the inability of production to show the effect of the learning curve is an indicator of risk.

BCG strategists examined the implications of the experience effect for businesses. They concluded that companies should invest in maximizing these learning and experiential effects and that market share is underestimated as a catalyst for this investment, as relatively low operating costs are a very important strategic advantage. [12] The reason for this is that increased activity leads to more learning, which leads to lower costs, which can lead to lower prices, higher market share, higher profitability and market dominance. This was especially true if a company had early leadership in terms of market share. It has been suggested that if an enterprise cannot gain sufficient market share to be competitive, it should exit that activity and concentrate its resources where it is possible to exploit the effects of experience and gain (preferably dominant) market share.