The Experience Curve

The more experience a firm has in producing a particular product, the lower its costs

The experience curve is an idea developed by the Boston Consulting Group (BCG) in the mid-1960s. Working with a leading manufacturer of semiconductors, the consultants noticed that the company’s unit cost of manufacturing fell by about 25% for each doubling of the volume that it produced. This relationship they called the experience curve: the more experience a firm has in producing a particular product, the lower are its costs. Bruce Henderson, the founder of BCG, put it as follows:

Costs characteristically decline by 20-30% in real terms each time accumulated experience doubles. This means that when inflation is factored out, costs should always decline. The decline is fast if growth is fast and slow if growth is slow.

There is no fundamental economic law that can predict the existence of the experience curve, even though it has been shown to apply to industries across the board. Its truth has been proven inductively, not deductively. And if it is true in service industries such as investment banking or legal advice, the lower costs are clearly not passed on to customers.

By itself, the curve is not particularly earth shattering. Even when BCG first expounded the relationship, it had been known since the second world war that it applied to direct labour costs. Less labour was needed for a given output depending on the experience of that labour. In aircraft production, for instance, labour input decreased by some 10–15% for every doubling of that labour’s experience.

The strategic implications of the experience curve came closer to shattering earth. For if costs fell (fairly predictably) with experience, and if experience was closely related to market share (as it seemed it must be), then the competitor with the biggest market share was going to have a big cost advantage over its rivals. QED: being market leader is a valuable asset that a firm relinquishes at its peril.

This was the logical underpinning of the idea of the growth share matrix (seearticle). The experience curve justified allocating financial resources to those businesses (out of a firm’s portfolio of businesses) that were (or were going to be) market leaders in their particular sectors. This, of course, implied starvation for those businesses that were not and never would be market leaders.

Over time, managers came to find the experience curve too imprecise to help them much with specific business plans. Inconveniently, different products had curves of a different slope and different sources of cost reduction. They did not, for instance, all have the same downward gradient as the semiconductor industry, where BCG had first identified the phenomenon. A study by the Rand Corporation found that “a doubling in the number of [nuclear] reactors [built by an architect–engineer] results in a 5% reduction in both construction time and capital cost”.

Part of the explanation for this discrepancy was that different products provided different opportunities to gain experience. Large products (such as nuclear reactors) are inherently bound to be produced in smaller volumes than small products (such as semiconductors). It is not easy for a firm to double the volume of production of something that it takes over five years to build, and whose total market may never be more than a few hundred units.

In theory, the experience curve should make it difficult for new entrants to challenge firms with a substantial market share. In practice, new firms enter old industries all the time, and before long many of them become major players in their markets. This is often because they have found ways of bypassing what might seem like the remorseless inevitability of the curve and its slope. For example, experience can be gained not only first-hand, by actually doing the production and finding out for yourself, but also second-hand, by reading about it and by being trained by people who have first-hand experience. Furthermore, firms can leapfrog over the experience curve by means of innovation and invention. All the experience in the world in making black and white television sets is worthless if everyone wants to buy colour ones.

Further reading

De Bono, E., “Practical Thinking”, Cape, 1971; Penguin, 1976

Ghemawat, P., “Building Strategy on the Experience Curve”, Harvard Business Review, March–April 1985

Gottfredson, M. and Schaubert, S., “The Breakthrough Imperative”, HarperCollins, 2008

Henderson, B.D., “The Logic of Business Strategy”, Ballinger Publishing, 1984

Sallenare, J.P., “The Uses and Abuses of Experience Curves”, Long Range Planning, Vol. 18, No. 1, 1985

Stern, C.W. and Stalk, G. Jr (eds), “Perspectives on Strategy: From the Boston Consulting Group”, John Wiley & Sons, 1998

Offshoring

Economists argue that offshoring is a win-win phenomenon

Offshoring—the wholesale shifting of corporate functions and jobs (particularly those of back-office workers in it and accounting-type roles) to overseas territories—is what gave outsourcing a bad name. It is important, however, to note a crucial distinction between the two:

• Outsourcing need not necessarily result in job losses in a particular territory or country. A job can simply be handed over to another organisation of the same nationality and geographical location where (the company handing it over hopes) it can be carried out more efficiently. Sometimes that other organisation may be in another country, but more often than not it is not.

• Offshoring, however, does involve shifting jobs to another country, but it may not involve transferring jobs to another organisation. For example, a company may simply decide to move its local customer services operation to one of its own subsidiaries abroad. That is offshoring, but it is not outsourcing.

Economists argue that offshoring is a win-win phenomenon: the country that sends the work abroad gains from lower costs, and the country that gains the work gets extra jobs. But countries sometimes panic about the scale of offshoring. When production jobs moved en masse to China and other cheap labour destinations, rich-world governments did not worry unduly because they thought that their workers could glide painlessly from manufacturing jobs to service jobs. Who, they thought, would begrudge giving up a lifetime on the factory floor for a lifetime in a clean, antiseptic office?

The real problem arose when the service jobs also started to go abroad, when every other service company’s call centre suddenly seemed to be based in Bangalore, in the middle of India, not Indiana. What were western workers going to move on to this time, once they had been priced out of the services sector?

At one stage, Americans became almost hysterical about the issue. A 2004 report by Forrester Research, a highly reputable firm, estimated that 3.3m American jobs would have gone offshore by 2015. This was immediately taken as a known fact. But the author of the report subsequently told the Wall Street Journal that his estimates were no more than “educated guesses”. As one commentator said: “The public’s intense desire to understand the scope of the problem has bred a reliance on statistics that even [Forrester] admits are based heavily on guesswork.”

In practice, the hysteria died down, even as the benefits of offshoring were being questioned more and more. Managers found it increasingly difficult to manage far-flung service operations in cultures they did not understand, and firms began to bring some functions back to their home base—especially call centres, where customers often found it difficult to explain localised problems to someone working in a totally different climate in a totally different time zone. Indeed, in 2006 an Indian call-centre operator opened a new centre in Northern Ireland.

Closely allied to offshoring is the concept of nearshoring, a phenomenon whereby companies shift operations, often IT-related ones, to foreign countries that are close to their own, but where they can still gain a labour-cost advantage—from the United States, for example, where Spanish is the second language, to Mexico; or from Japan to the Chinese city of Dalian, which was occupied by the Japanese for many years and where there are Japanese-speakers. Nearby countries are more likely to speak the same language as the country of the corporation doing the offshoring; they are more easily accessible at short notice; and they are unlikely to leave the short-stay visitor with jet lag.

Further reading

Kobayashi-Hillary, M. (ed.), “Building a Future with BRICs: The Next Decade for Offshoring”, Springer, 2008

“Offshoring: Is It a Win-Win Game?”, McKinsey Global Institute, August 2003

OPERATIONS RESEARCH

The use of computer modelling and the simulation of business processes as a means of coming up with improvements in the way that things are done within an organisation

At the heart of operations research (OR) is the use of computer modelling and the simulation of business processes as a means of coming up with improvements in the way that things are done within an organisation. The tasks that OR examines are complex and involve many variables. They include things like designing an optimal telecommunications network in a situation where future demand is uncertain, or automating a paper-based bank clearing system.

According to the Operational Research Society:

Operational Research (OR), also known as Operations Research or Management Science (OR/MS), looks at an organisation’s operations and uses mathematical or computer models, or other analytical approaches, to find better ways of doing them.

The term “operational research” is generally used in the UK; the United States favours “operations research” or “management science”. Information technology is central to the skill of an operational researcher. But OR also draws on mathematics, engineering, physics and economics.

The heyday of OR was the 1950s and 1960s when, as Russell Ackoff, an OR academic, once put it, “use of quantitative methods became an ‘idea in good currency’”. By the 1990s, though, Ackoff found that OR had been pushed into “the bowels of the organisation not the head. When it could no longer be pushed down, it was pushed out”. This, he believed, was because OR had been “equated by managers to mathematical masturbation and to the absence of any substantive knowledge or understanding of organisations, institutions or their management”. Ackoff also claimed that there was a more fundamental flaw to OR. It is, he said, designed to “prepare perfectly for an imperfectly predicted future”, and it “helps us little and may harm us much”.

Igor Ansoff, author of the classic “Corporate Strategy”, was heavily influenced by the time he spent working on sophisticated operational research for the Rand Foundation in the early 1950s. Among other things, he analysed the extent of the exposure of NATO air forces to enemy attack.

OR was given a big boost by the second world war when researchers applied the principles of physics and engineering to military operations. After the war, military personnel took these practices with them to civvy street, and to the companies that they then went to work for. OR was often the entry point for engineers, like Ansoff, to come into general management. Many management gurus, including Frederick Taylor, W. Edwards Deming (the founder of the quality movement), Henry Mintzberg and Bruce Henderson (the man behind the experience curve), were trained first as engineers.

Further reading

Ackoff, R.L., “Redesigning the Future: A Systems Approach to Societal Problems”, John Wiley & Sons, 1974

Kirby, M., “Operational Research in War and Peace: The British Experience from the 1930s to 1970”, Imperial College Press, 2003

Taha, H.A., “Operations Research: an Introduction”, 8th edn, Prentice Hall, 2007

Journal of the Operational Research Society

Kenya switching to Digital T.V

Kenya will officially switch on its digital TV signal in 2015; let’s focus on what this is all about. Firstly, digital TV is not HDTV(High Definition T.V) although it can be used to broadcast HDTV. It’s more like DStv, except that instead of broadcasting a programme via satellite, the programme is broadcast using the terrestrial transmitters that are used for analogue broadcasts such as the KTN and KBC. Most HDTV sets and all HD-ready sets sold do not have a tuner that is capable of receiving the digital TV broadcast (in much the same way as they don’t have a built-in satellite receiver capable of receiving DStv), which is why you would need to buy a digital TV set-top box. One of the fundamental benefits of digital TV over analogue is that:

1. They can fit several channels in the same spectrum that a normal analogue station occupies. It is also possible to broadcast interactive content similar to DStv, such as the EPG (electronic programme guide) on Dstv Channel 1. Kenya has standardised on the DVB-T standard, which is used in most places around the world, with the notable exception of the United States of America. Kenya has chosen to use H.264/MPEG4 AVC codec to encode the video.

MPEG-4 offers much higher compression, meaning that we can potentially get several more channels than with MPEG-2. However, one must be careful when purchasing a set-top box or digital TV tuner and ensure that it supports H.264 decoding.

So, should you rush out and buy a digital TV tuner? Absolutely not! For one, you will be hard pressed to find one available for purchase, let alone one that plays the H.264 video. As it stands, there is no significant advantage to getting a digital TV set-top box right now. Quality-wise, it is on a par with analogue, provided you have good analogue reception (if you don’t, you probably won’t pick up the digital TV broadcast). Content-wise, you get two additional TV channels. Future content providers may encrypt their channels using one of several encryption schemes, so a wait-and-see approach might be better in the long run, before plonking down for a box that might not be able to access those channels.

Bearing in mind that this is still a trial phase of digital TV broadcasting, I am sure there will be more content, EPG, interactive services (such as the intention of the government to provide public services), and better quality broadcasts to come in future when digital set-top boxes are launched. In addition, the DVB-T standard allows the broadcast of DVB-H content simultaneously, which will allow people to watch digital content on their cellphones or portable media players. This is certainly a technology to get excited about and I look forward to the day when the infrastructure is in place and the content providers come to the party.

Fibre Optic Cable & its benefits to Kenyans

Kenya Data Networks, Africa’s second largest private data carrier and infrastructure provider last week slashed its Internet prices by 90% from the current industry average of $5000 per megabytes to $400 per megabytes after successful trials of Seacom Submarine fiber optic cable capacity.

Thomas L. Friedman in his international best selling book ‘the world is flat’ views the world as a level playing field in terms of commerce, where all competitors have an equal opportunity and also alludes to the perceptual shift required for countries, companies and individuals to remain competitive in a global market where historical and geographical divisions are becoming increasingly irrelevant. I can as well argue that Seacom will level the playing ground for Kenyans to be able to finally compete with their counterparts in the west.


Thus the most important question that Kenyans have to answer tonight is what they are willing to do to take advantage of the greatest revolution in information technology that is now at our doorstep to make this country truly great.

No sane person would doubt that the arrival of the undersea cable on our shores is going to transform the way Kenya interacts and does business with the rest of the world.

With just 50 million Web users across the continent, as few as 5% of Africans access the Internet, a percentage far lower than in Asia, Europe or the Americas. In only a handful of African countries do more than 1% of the population use broadband services. (Among OECD countries, broadband penetration averages 18 %.) And the services that exist don't come cheap. Broadband costs more in sub-Saharan Africa than anywhere else in the world.

But now, with the continent linked to the information superhighway with connections of mind-boggling speed, Africa has no reason, or excuse, to remain poor and dark. The new technology means that with an internet connection in the countryside for example, I can transform my bedroom into a call centre through which companies like Safaricom and Kenya Airways can outsource their customer care services. And you can do this for practically any company in the world.

Considering that the World Cup will be held on African soil next year, the business opportunities offered by the billions of phone calls and questions to be asked are enormous; but the people to benefit will be those who are prepared to embrace the opportunities of the new era.

That is why I hypothesize that Business Process Outsourcing is set to become Kenya's biggest driver of the economy, not tourism. There are those who will say that this revolutionary technology will benefit only those who live in towns; nothing could be further from the truth, consider, for instance, that Kenya Data Networks is offering to upgrade any building or school into a digital village under the “upgrade your shags” programme. This offer is available in every constituency and all would-be beneficiaries have to pay a one off fee of Sh58,000 then access the internet for free (www.kdn.co.ke), I cannot imagine of a better deal anywhere in the world.


Through such a system, a village in Kogelo, Siaya for example, where farmers grow maize, could link up with a supermarket chain in China and negotiate prices through email. Business opportunities are only an email away, whether you sell fish or computer parts.

Eleanor Roosevelt once said that the future belongs to those who believe in the beauty of their dreams.

So there you go.

Meet Safaricom, 'the Cosa Nostra' of Kenya's telecommunications industry

Safaricom recently made a profit of Sh15 billion in the year ending March 2009 down from about Sh20 billion recorded in 2008. The profit decline was however not too heavy to dislodge Safaricom’s regional ranking as the most profitable company in East and Central Africa. While millions of Kenyans suffer the very worst of the global economic crisis, it seems counter-intuitive that a telecommunications company can bask in that kind of profitability.

This should spark great admiration. Until you come face to face with Safaricom.

Since its inception, the cellular communications giant has become, not only the dominant force in its market and in the country, but is also aiming to be a global player in telecommunications.

Its corporate logo dominates Kenyan life, leisure and landscape. The company’s sponsorships dominate sports and entertainment. It boasts over 15 million customers, just short of 2500 employees and is one of the biggest and most powerful corporate forces in Kenya.

In fact, “dominance” is so embedded in everything about Safaricom, the megalith ranks cheek by jowl with every other corporate goodfella in history. Hardly surprising that Safaricom now earns the moniker, “Cosa Nostra”.

Communications Commission of Kenya (CCK) is slow to get its teeth into what most Kenyans believe is an extortionist and virtually monopolistic telecommunications giant in the shape of Safaricom.

After decades of suffering Telkom Kenya's take-it-or-leave-it bullying, Kenyan's — and especially the disadvantaged majority deprived of anything but the most rudimentary telephone access — welcomed the arrival of cellphones in the early 2000s. Since then the devices and their multiplicity of noxiously intrusive and expensive add-ons have become ubiquitous features, spanning the spectrum from indispensable lifeline to faddish status symbol. And the docile masses love them.

What lurks beneath the surface of Cosa Nostra though is as dark, rank and untouchable as any secret society. It is also symptomatic of the worst in Kenya’s backwoods version of a telecommunications industry.Safaricom's product across the range is massively overpriced compared to those of its competitors, ensuring Kenyans remain in the telecommunications Dark Ages. While this has always been true of cellular voice communication, it is most keenly felt in data comms where fees would elicit a standing ovation at any convocation of la cosa nostra.

Transparency and truth are shrouded in its cacophony of multi-layered marketing. It treats its clients as would the best drug dealer in any ‘hood, ensuring their “addiction” is fed and they’re kept blissfully comatose. Safaricom's dysfunctional notion of client service is the epitome of the oxymoronic concept of “nurturing disdain”. Michael Joseph should try to call customer helpline to see whether he will get through. He should also place a call to Zain's customer services number and see for himself what good service should be.

Despite the internet’s unparalleled potential for social upliftment, education, progress and bridging the chasm between the unsophisticated, know-no-better, have-not majority and the wealthy minority, it remains shackled behind prohibitive costs, patchy and unreliable networks, intransigent “systems”, myopic business models and the damned stampede to maximise profits at any price. Safaricom's stunning success since its inception bears testament.

It costs the equivalent of Ksh 2500 a month to have unlimited, instantaneous, go-anywhere internet access in the US. The closest Kenya comes is a pitiful 1GB ceiling that costs upward of Ksh 3000 at snail’s pace speeds, excluding the extortionist Ksh 4000 price of a modem. Vast swathes of the country also have no effective 3G network coverage meaning you will most probably be on the painfully slow GPRS.

For one of the most powerful economies in Africa, the internet and free communications remain luxuries, privileges reserved for the megarich. The country’s suspect telecommunications giant will do everything in its power to ensure it stays that way. You don’t make Cosa Nostra -type revenues from ubiquitous free “products”.

In fact, it has taken me two weeks of navigating Safaricom’s labyrinth of duplicity, half-truths, Obfuscation through Multiplicity (a clever type of sales warfare in which companies carpet bomb the consumer into numb, blind submission by overloading them with choices) outright contradictions, falsehoods, misinformation and impenetrable but utterly unhelpful call centres— only to be met with frustration at every turn. In fact, the most helpful people turned out to be Safaricom’s competitor, Zain!

While it is unconscionable that an outfit with 15 million customers does not even think a complaints centre might be a good idea, why would you be surprised that promises to return 15 phone calls, only two were kept? Can't they call me???

The result is I have absolutely no trust in anything Safaricom promises, publicly or privately. And probably never will.


And don’t expect any joy, let alone progress from CCK; ostensibly the industry regulator, it is utterly ineffectual, toothless and lost in senile dementia and unless its Director General has had a road-to-Damascus experience in the past few months, having him in control of communications is like leaving the kids with Michael Jackson for the holidays.


Willis Arodi is the author of: Some of my best friends are drunkards

Weaknesses of Zain's business model

1.ABSTRACT

In this essay, I discuss the current mobile telephony environment in Kenya with special emphasis on Zain's performance in relation to Safaricom's and drawing parallels between the two mobile phone companies. The performance will cover a brief history of Zain, it's business model , weaknesses, and it's financial performance since inception.

This essay will also attempt to offer solutions on how Zain can increase its Average Revenue Per User (ARPU) thereby improving its bottomline.

Kenya's future telecommunications scenario

About a week ago President Kibaki and the PM went to launch the cable station that recently finished construction. TEAMS is an underwater fibre-optic cable being installed along the coast of East Africa — a tremendous boost for all the countries affected. When it comes to internet bandwidth, Africa has always been left behind, thanks to monopolies and poor legislation with devastating effects on its economies and quality of life. I might sound dramatic, but if one takes into account that the digital divide is currently increasing at an exponential rate, it is not far-fetched to once again call us the “dark continent”.

Our primary source of international bandwidth is supplied by the very limited and slow satellite connection, which is also divided up by major operators such as Telkom Kenya. This leads to very low bandwidth actually reaching end users.This is not, however, what the rest of the world calls “broadband”.


True broadband is at least 4 megabits per second (Mbps) and is theoretically uncapped. True broadband is the ability to use the internet without taking the amount of consumption into account. US citizens use internet TV services like hulu instead of having to subscribe to hundreds of channels. Once we have this attitude we can call what we have in Kenya“broadband”. TEAMS might not be that enabler, but it sure does get us one step closer.

TEAMS will boost our bandwidth to 1.28 terabits per second (Tbps). This increase in bandwidth will theoretically make it much cheaper for service providers to buy wholesale bandwidth. These cost savings can then be passed on to the consumer and make it much cheaper to transfer large amounts of data.

Now it is important to remember that “cheaper” internet in Kenya does not mean that the base cost of having “fast” internet will suddenly drop to Ksh100. No, there are still businesses that are built up around a revenue model that relies on customers spending more than Ksh300 for example. If the price is suddenly Ksh50 for instance, those businesses will fold, regardless of how cheap bandwidth might be.

Instead, what we might see in Kenya over the next year (TEAMS goes live in about 3months) is a dramatic increase in the amount of “capped” data we can get for the same amount of money. A big problem currently is that networks in Kenya are currently unable to use all the extra bandwidth properly. Telkom Kenya for instance cannot easily jump above what it currently offers due poor quality cables and infrastructure. But Kplc, KDN and a few cellular operators have started investing in land-based fibre cable, right to the curb in some areas. This means that these players might be the first to actually be able to use the wave of extra bandwidth.Safaricom has also started to enable 7.2 Mbps HSDPA on its network, which theoretically means that if you wanted the fastest broadband line in Kenya, you have to go 3G.

So what does TEAMS mean for Kenyan end users in the near future? In my opinion, a few things will happen. First (the next 6 months) I believe networks will try to get maximum profits because bandwidth is suddenly cheap. This will lead to increasing pressure from end users, and then we can wait for an ISP to offer a “disruptive product” which will cause all subsequent offers from ISPs to drop tremendously in price. The fact of the matter is that ISPs in Kenya have always been used to low-profit margins and can easily adapt their businesses to once again operate on those margins once bandwidth is cheap. It will only take time.

This is an exciting time for communications in Kenya — we are in a perfect storm of situations which can contribute to a sudden reconnection to the world.