Learning curve effects can be a major barrier to entry for new firms. If existing incumbent firms have developed substantial experience in the industry that you are trying to enter, they may have substantial advantages relative to a new company, making it hard for new firms to enter the industry.
This article explores some of the specific ways that learning curve effects can act as a barrier to entry.
Learning Curve Effects
Learning curve effects are improvements in your operations that arise from having conducted the activity many times before. If you have been undertaking the same activity many times (potentially across many decades), you will have built up experience in how to undertake the operations. This can result in cost savings, including:
- Faster processing: You may have developed routines that allow you to produce the products quicker or more efficiently.
- Fewer mistakes: Errors that you may have made the first time are unlikely to be made later.
- Streamlined supply chain: You already have established contracts with your suppliers.
The basis of learning curve effects is the number of times that you have done the activity before. This makes learning curve effects slightly different from economies of scale (with relates to benefits you gain from producing a high volume in a particular time period) – learning curve effects are cumulative, and you gain benefits from all the historical products, potentially stretching back many decades.
Learning curve effects puts new firms at a disadvantage relative to firms that have been in the industry a long time
New firms do not have the experience relative to existing firms, potentially putting them at a significant competitive disadvantage. The learning effects favor firms that have accumulated the experience – new companies lack this, and in turn face greater challenges and costs associated with their operations.
As with other barriers to entry, this challenge can make success much less likely, or can deter entry – the competitive disadvantage means that new firms do not enter the market because they would not be able to successfully compete against incumbent firms.
Example: Ship building
Shipbuilding is an example of an industry where learning curve effects can be significant. Shipbuilding is a complicated project-based activity. A new firm faces significant disadvantages relative to existing companies that may have decades of experience.
Some examples of specific disadvantages that new firms would face include:
- Greater likelihood of mistakes: Without experience in designing and constructing a ship, large costly mistakes are possible. Bet it design issues or manufacturing troubles, new companies are much more likely to experience challenges relative to firms that have already undertaken the activity many times.
- Time overruns: As with many large projects, unanticipated problems are likely to crop up, delaying the project. Not only are firms with experience better placed to foresee difficulties, but their experience may result in them having fewer delays than a new company would have.
- Supplier arrangements and difficulty coordinating the project: Lare projects such as shipbuilding often require the involvement of many different suppliers. Existing companies already have these relationships established – new firms face the challenge of having to build these relationships.