QUANTITATIVE LEARNING CuRVES LEARNING CURV’ IN SERVICE: MANUFACTURIN' APPIYING THE LEARNING IRV ‘Arithmetic Approach Logarithmic Approach Learring-Curve Co ificie proach STRATEGIC IMPLICA’ ONS F LEARNING CURVES LIMITATIONS OF LEARN’ G CURVES SUMMARY KEY TERM USING EXCELOM FC "RNIN: USING POM FOR WINDOW OR LEARNING CURVES, SOLVED PROBLEMS INTERNET EXERCISES FOR /ARNING ‘CURVES DISCUSSION QUESTIONS PROBLEMS. CASE STUDY: SMT’s NEGOTIATIO WITH tom BIBLIOGRAPHY MODULE E LEARNING OBJECTIVES Identify or Define Exomple of learning ‘The doubling concept Describe or Explain How te comput834 MobULE E Learning Curve Learning curves The premise that people and organizations get better st their tasks a¢ the tasks are repeated sometimes called experience curves Medical procedures such as heart surgery fllow a learning curve Research indicates thatthe death rate fom: heart transplants drops at a 79% learning curve, learning rare not unlike ‘har in many industrial senting! appears that doctors and medical teams improve. ax do your odds as a patient with experience. Ifthe death rae is halved every three anerutions, practice may indeed make perfect. ‘Most organizations learn and improve over time. As firms and employees perform a task over and aver, they leam how to perform more efficiently. This means thet task times and costs decrease Learning curves are based on the premise that people andl organizations become bet. ler at their tasks as the tasks are repeated. A learning curve graph (illustrated in Figure E.1) displays labor-hours per unit versus the number of unis produced. From it we see that the time needed to produce a unit decreases, usually following a negative exponential ‘cure. as the person or company produces: more units In other words i takes Fess rime 10 complete each additional unit a firm produces. However, we also see in Figure E.| that the time savings in completing each subsequent unit decreases, These are the major altri Dutes of the learning curve Leeming curves were first applied to industry in a report by T. P. Wright of Curtie ‘Wright Corp. in 1936.! Wright deseribed how direct labor costs of making a particular t= plane decreased with leaming, a theory since confirmed by other sirraft manufacturers. Regardless of the time needed to produce the first plane. learning curves are found to apply to various categories of airframes (e.g. jet fighters versus passenger panes versus bombers). Learning curves have since been applied not only’ to labor but also to 3 wide ve Fiely of other costs, including material and purchased components. The power of the leaming curve isso significant that it plays 2 major role in many strategic decisions re= lated to employment levels, costs, eapueity, andl pricing. ‘The leaming curve is based on a doubling of productivity: That i, when production doubles. the decrease in time per unit affects the rate of the learning curve, So. the learning curve is an 80% rate. the second unit takes 80% ofthe time the frst unit Ne fe o aes ul Dit By theLEARNING CURVES IN SERVICES AND MANUFACTURING FIGURE E.1 m The Learning-Curve Effect States That Time per Repetition Decreases as the Number of Repetitions Increases fourth unit takes 80% ofthe time of the second unit, the eighth unit takes 80% of the time of the fourth unit, and so forth. This principle is shown as 7X L* = Time required forthe nth unit «1 Where T= unit cost or unit time of the first unit L = leaming curve rate ‘n = number of times T is doubled Ifthe first unit of a particular product took 10 labor-hours, and if 70% learning curve is Dresent, the hours the fourth unit will take require doubling twice—from 1 to 2 to 4, ‘Therefore, the formula is Hours required for unit 4 = 10 (.7)? = 4.9 hours LEARNING CURVES IN SERVICES AND MANUFACTURING Ditleren organizations—indeed, different products—have differen leaming curves. The ‘ate of learning varies depending upon the quay of management and the potential of the process and product. Any change in process, product. or personnel dsraps the learning Curve Therefore, caution shouldbe exercised in assuming that a leaming curve i contin ing and permanent. ‘AS you can seein Table E., industry leaming curves vary widely. The lower the number (say 70% compared 1 90%). the steeper the slope and the faster the drop in costs By tradition, learning curves sre defined in tems ofthe complements of thet imove. ‘ment rats, or example, 70% leaming curve implies a 30% decreas in time each time ‘he numberof repetitions is doubled. A 90% curve means there isa corresponding 10% ‘ate of improvement 835 Ty testing the learning- curve effect on some activity you may be performing. For example, if you need to assemble four bookshalver, time your work on each and note the rate of improvement.836 MODULE ELEARNING Curves ‘TABLE E.1 m Examples of Learning-Curve Effects Losing Cumulative Slope Example Improving Parameter Parameter (2) Time Frame 1. Model Ford production Price Unis produces 16 2 Alrraftasembly Direelaborshours per anit Unis produced rs 3. Equipment minienanee Averagetimetoreplacea Number ofeplacenents 76 HOE soup ot parte 4. Ste production Production worker labor ours Unis produced 79 toss peru roduied 5. meqrated circus ‘Average price per unit Unis produces 96972 6. Handed calculator Average factory sling price Uni produced 4 iwrsis7e 11 Disk memory dives Average price per bit amber of bis % wisi 8 Hear ampans 1-year death ates Transplants complet 79185-1988 *constat dlr Sources: James A. Cunningham, “Using the Leeming Curve as a Management Tool” IEEE Spectrum Uune 1980}: 5, © 1980 IEEE {and David 8, Smith and Jan L. Larsson, “The Impact of Leaning on Cost The Case of Hear Tenspanttion,” Hospital and Mesh Senvices Administration pring 1989) 65-77 Stable, standardized products and processes tend to have costs that decline more steeply than others, Between 1920 and 1955, for instance, the tel industry was abe 0 reduce labor-hours per unit o 79% each time cumulative production doubles Leamng curves have application in services as well a industry. As was noted in the caption for the opening photograph, I-year death rates of heat wansplam patients at Temple University Hospital follow a 79% laring curve. Te results of tha hospital's 3-year study of 62 patients receiving transplants found that every three operations resulted ina halving of the 1-year death ate, As more hospitals face presse fom both insurance companies and the govemment to ener fixed-price negotiation for their services, their ability toleam from experince becomes increasingly erica. n adtion to having appi- cations in both services ad industry, laming curves are useful fra variety of purposes “These include: Failure to consider the effects of leaming can 1. Intemal labor forecasting, scheduling, establishing costs and budgets. lead to overestimates of 2, Extemal purchasing and subcontracting (see the SMT case study atthe end of this labor needs and module), underestimates of 3. Strategic evaluation of company and industry performance, including costs and material needs, pricing. APPLYING THE LEARNING CURVE A mathematical relationship enables us to express the time it takes ro produce a certsin Unit. This relationship isa function of how many units have been produced before the unit in question and how long it took to produce them. Although this procedure determines how long it takes to produce a given unit, the consequences of this analysis are more far reaching. Costs drop and efficiency goes up for individual firms and the industy. Thetefore, severe problems in scheduling occur if operations are not adjusted for implica- tions of the learning curve, For instance. if leaning-curve improvement is not consideredAPPLYING THE LEARNING CURVE. 837 when scheduling, the result may be labor and productive facilities boing idle a portion of the time, Furthermore, firms may refuse additional work because they do not consider the improvement in their own efficiency that results from learning. From @ purchasing per- spective, our interes is in negotiating what our supplicrs’ costs should be for further pro. duction of units based on the size of our order. The foregoing are only a few of the ramifi- cations of the effect of lesming curves. ‘With this in mind, let us look at three approaches o learning curves: arithmetic analy- Although in many cases sis, logarithmic analysis, and leaming-curveeoefiiens analysts can examine " 7 their company end ft 2 Arithmetic Approach grate tot journals also publish ‘The arithmetic approach is the simplest approsch to leaming-curve problems. As we industrywide data on noted at the beginning of this module, each time that production doubles, labor per unit specific ypes of declines by a constant factor, known as the learning rat. So, if we know that the learning ©Perations ‘ate is 80% and thatthe first unit produced took 100 hours, the hours required to produce the second, fourth, cighth, and sixteenth unis areas follows: [Nth Unit Produced ___ Hours for Nth Ut 100.0 2 800 = (8 x 100) 4 64.0 = (8 x 80) é 512= (8 x 64) 16 410= (8 x 51.2) As long as we wish to find the hours required to produce N units and Nis one of the dow- bled values, then this approach works. Arithmetic analysis does not tell us how many hours will be needed to produce other units. For this flexibility, we must tam to the loge. rithmic approach. Logarithmic Approach ‘The logarithmic approach allows us to determine labor for any unit, Ty, by the formula. TABLE E.2m Learning Eine Vues of (Ne) (E.2) iN") (E.2) Learning where Ty = time forthe Mth unit feet ib T, = hours to produce the first unit 70 ‘b= (log of the learning rate)/(log 2) ‘slope of the learning curve 5 = Senect the wus fr due pesto REE? rane Iss hw ts fomule Sons ei fra min St en ati 00 EEO tn Te ous eed ode tna Se coe os T= TN T= C00 pour) = 00}, = 100)" = 70.2 labor-hoursPe 838 MopuLe E caRniNG Curves ‘The logarithmic approach allows us to determine the hours required for any unit pro duced but there is & simpler method. Learning-Curve Coefficient Approach The leaming-curve coefficient technique is embodied in Table E.3 and the follwing equation: Ty=T,C 2.3) Where Ty = number of labor-hours required to produce the Nth unit ,, = number of labor-hours required to produce the first unit (C= leaming-curve coefficient found in Table E.3 ‘The learning-curve coefficient, C, depends on both the learning rate (70%, 78%, 80%, and. 0 on) and the unit of interest, ‘Example E2 uses the preceding equation and Table E.3 to calculate leaming-curve effets whore Coofficient = Nice ote tees 2 70% 75% 20% 25% 90%.[ee APPLYING THE LEARNING CURVE 839 1: took 2 Korean shipyard 125,000 labor-hours to produce the frst of several toss that you expect to purchase for your shipping company, Gres Lakes, In. Boats and 3 have been pro ‘uced by the Koreans with a learing facior of 856. At SAO per how, what should! you, as pur chasing agent, expect o pay forthe fourth unit? First, search Table E.3 forthe fourth unit and a learning factor of 85S, The leaming-curve coefficient, C, i723. To produce the fourth uit, then, wakes Te TiC n 125,000 hours).723) = 90.375 hous ‘To find the cost, multiply by $40: 90.375 hours x $40 per hour = $3/615.000, ‘Table E.3 also shows cumulative values. These allow us to compute the total number of hours needed to complete a specified number of units. Again, the computation i straight forward. Just multiply the table value times the time required forthe first unit. Example 3 illustrates this concept. Example E2 computed the time to complete the fourth tugboat that Great Lakes plans to buy Eos How long will ll four boets require? ‘Looking this me a the “total time” column in Table E.3, we find thatthe cumulative coe- lent is 3.345. Tous, the time required is 125,000).345) = 418,125 hours in otal for al 4 oats Foran illustration of how Excel OM can be used to solve Examples E2 end E3, see Program E.] at the end ofthis module. As later times become availabe, it can be useful Using Table E.3 requires that we know how long it takes to complete the firs unit Yet, to rovae the base ene ‘hat happens if our most recent or most reliable information avaiable pertains to some this a especially so when other unit? The answer is that we must use these data to find a revised estimate for the the fst units estimated first unit and then apply the table to that number. Example E4 illustrates this concept. prior to production, Great Lakes, ne, believes that unusual circumstances in producing the fst boat (sce Example EZ) imply that the time estimate of 125,000 hous is nota valid a base asthe time required to Produce the third boa Boat number 3 was completed in 100,000 hours, ‘To salve forthe revised estimate for boat umber 1, we rtum to Table E.3, with unit value (FW = Banda leaming-crve coefficient of C = 773 in the 85% column, To find the revised ex. ‘imate, we divide the actual time fr boat number 3, 100,000 hous, by C = 773840 Movute E ‘Applications of the learning curve 1. Internal ~+ determine labor standards and rates of material supply required, 2. External — determine purchase costs. 3, Strategic + determine volume-cost changes. LEARNING Curves STRATEGIC IMPLICATIONS OF LEARNING CURVES So fer, we have shown how operations managers can forecast labor-hour requirements for 2 product. We have also shown how purchasing agents can determine « suppliers cost %nowiedge that can help in price nepotitions. Another imporant application of leaming ‘curves concems stategic planning. ‘An example of @ company cost line and industry price line are so labeled in Figure E.2. These learning curves are straight because both scales are log scales. When the rate (of change is constant, # log-log graph yields a straight line. If an organization believes its cost line to be the “company cost” line and the industry price is indicated by the dashed horizontal line, then the company must have costs at the points below the dotted line (for ‘example, point a or b) or else operate ata ls (point c) Lower costs are not automatic; they must be managed down, When a firm's strategy is to pursue e curve steeper than the industry average (the company cost line in Figure E.2), it does this by 1. Following an aggressive pricing policy, 2, Focusing on continuing cost reduction and productivity improvement. 13 Building on shared experience. 4. Keeping capacity growing ahead of demand, Costs may drop as a firm pursues the learning curve, bat volume must increase for the leaming curve to exist. In recent years, much of the computer industry, for instance, has ‘operated at a 25% cost reduction per year, with steep learning curves, Texas Instruments (TD, however, discovered that developing a competitive strategy via the leaming curve is FIGURE E.2 tt Industry Learning Curve for Price Compared with ‘Company Learning Curve for Cost Note: Both the vertical and horizontal axes ofthis figure are log scales This is known asa log-log graphKey Terms 841 rot for everyone:? T allowed other PC producers to lead in cost reductions and price- a Cuting. It paid the price frit mistake when sles ofits PC line dropped. i ‘Managers must understand competitors before embarking on earing-curve stat 2 gy: Weak competitors are undereaptalized stuck with high costs, or do not undewtand ' the logic of learning curves. However. strong. and dangerous competitors contol their costs, have solid financial positions for the large investments needed, and have a track g record of using an aggressive leaming-curve strategy. Taking on such a competitor in'a price war may help only the consumer g LIMITATIONS OF LEARNING CURVES Before using learning curves, some cautions are in order + Because learning curves differ from company to company, as well as industry to in dusty, estimates for each organization should be developed rather than applying, someone else's, + Leaming curves are often based on the time necessary to complete the early unit ‘therefore, those times must be accurate, As current information becomes available, reevaluation is appropriate, 1 + Any changes in personnel, design, or procedure can be expected to alter the learning ‘curve. And the curve may spike up for a short time even if it is going to drop in the Jong run, + While workers and process may improve, the same learning curves do not always apply to indirect labor and material, +The culture of the workplace, as well as resource availability and changes in the ‘process, may alter the leaming curve, For instance, asa project nears its end, worker interest and effort may drop, curtailing progress down the curve. The learing curve is «power too forthe operations manage, This tol can asst pe erations managers in determining fre cost standard for items produced ss wells pr EOE chased. In addition, the leaming curve can provide understanding about company andi dusty performance. We saw thee approaches to leang cuves,aitmaic alysis logarithmic analysis, and laming-curve coefficients found in tables, Safe ea ag belp analyze leaming curves, eee sl Leaming curves (p. 834) KEY ea Pk) Ghomawa, “Building St 1945) 18, LO. tay onthe Experience Cue." Harverd Buns Review 63 (Mateh-Api Ht NeeS ee ee % LEARNING Curves aE USING EXCEL OM FOR LEARNING CURVES Program E.1 shows how Excel OM develops a spreadsheet for learing-curve calculations. ‘The input data come from Examples E2 and E3. In cell B7, we enter the unit number toy the base unit (which does not have to be 1), and in BS we enter the time fortis unit 14|Groat Lakes Ser PROGRAM E.1 m Excel OM's Learning-Curve Module, Using Data from Examples E2 amd £3 {2 USING POM FOR WINDOWS FOR LEARNING CURVES POM for Windows’ Leaming Curve module computes the length of time that future units will take, given the time required for the base unit and the learning rate (expressed as a ‘number between 0 and 1). As an option, if the times required forthe frst and Nth units are already known, the learning raze can be computed. See Appendix V for further details SOLVED PROBLEMS Solved Problem E.1 1b) How long will the firs 11 systems take in total? Digicomp produces a new telephone system with built- _¢) As a purchasing agent, you expect to buy units 12 in TV screens. Its leaming rate is 0%. through 15 of the new phone system. What would 1) Ifthe first one took 56 hours, how long will it take be your expected cost for the units if Digicomp Digicomp to make the eleventh system? charges $30 for each labor-hour?Discussion Questions 843 Solution [— ftom Table 380% unit time 2, 1 nC Ty, = (56 hours) (462) = 25.9 hours b) Total time forthe first 11 units = (56 hours)(6,777) = 379.5 hours from Table E.3—80% unit time ©) To find the time for units 12 through 15, we take the total cumu- Jative time for units 1 t0 15 and subtract the total time for units 1 to 11, which was:compated in part (b). Total time for the first 15 ‘units = (56 hours) (8.511) = 476.6 hours, So, the time for units 12 through 15 is 476.6 — 379.5 = 97.1 hours, (This figure could also bbe confirmed by computing the times for units 12, 13, 14, and 15 separately using the unit-time column and then adding them.) Expected cost for units 12 through 15 = (97.1 hours) ($30 per hour) = $2,913, a Solved Problem E.2 If the first time you perform a job takes 60 minutes, how Jong will the eighth job take if you are on an 80% Jeaming curve? Solution ‘Three doublings from 1 to 2 to-4 to 8 implies .8. Therefore, we have 60 X (8) = 60 x $12 = 30.72 minutes ing Table E.3, we have C = 512. Therefore 60 x $12 = 30.72 minutes ro INTERNET EXERCISES FOR LEARNING CURVES Visit our homepage at www.prenhall.com/helzer for these additional features + Self-est for this module + Practice problems + Internet exercises + Current articles and research, [D] DISCUSSION QUESTIONS 1, What are some of the limitations to the use of lear: ing curves? problems? 2. What techniques can a firm use to move toa steeper 4. Refer to Example E2: What are the implications for learning curve? Great Lakes, Inc.. if the engineering department 3. What are the approaches to solving learming-curveMopute ELEARNING Curves ‘ants to change the engine in the third and subse- 6. What ean cause « leaming curve to vary from quent tugboats that the fim purchases? smooth downward siope? Nhy isn't the earning-curve concept as applicable 7. Explain the concept of the “doubling” effect in in a high-volume assembly line as itis in most other Jeaming curves human activities? PROBLEMS* & El fe EB ES Acs Bs Aes BS Re: Bs An IRS auditor took 45 minutes to process her frst tax retum. The IRS uses an 85% Teaming curve. How long will the a) second return take? bb) fourth return take? ©) eighth rerum take? Seton Hall Trucking Co. just hired a new person to verify daily invoices and accounts Payable. She took 9 hours and 23 minutes to complete her task on the fist day. Prior em. ployces in this job have tended to follow a 90% leaming curve. How long will the task take atthe end of a) the second day? )_ the fourth day? ©) the eighth day? d) the sixteenth day? If ittook 563 minutes to complete « hospital's first cormea transplant, and the hospital uses ‘90% teaming rate, how long should a) the third transplant take? ). the sixth transplant take? ©) the eighth transplant take? d) the sixteenth transplant take? Refer to Problem E.3: Compute the cumulative time to complete fa) the first 3 transplants the first 6 transplants, ©) the first 8 transplants, @) the frst 16 transplants, ‘Beth Zion Hospital has received initial centficetion from the state of Califomis to become ‘ center for liver transplants. The hospital, however, must complete its first 18 transplants lunder great scrutiny and at no cost to the patients, The very first transplant, just com= pleted, required 30 hours. On the basis of research at the hospital, Beth Zion estimates ‘hat it will have an 80% learning curve. Estimate the time it will take to complete ) the fifth iver transplant. bb) all of the first 5 transplants, ©) the eighteenth transplant, 4) all 18 transplants. Refer to Problem E.5. Beth Zion Hospital has just been informed that only the first 10 transplants must be performed at the hospital's expense. The cost per hour of surgery is estimated to be $5,000. Again, the learning rate is 80% and the first surgery took 30 hours. a) How long will the tenth surgery take? b) How much will the tenth surgery cost? ©) How much will all 10 cost the hospital? Note P ent poben maybe saves with POM for Windows: 3G mets he poblen may be se with Eee OM: and mash problem my be sled wih FO fr Windows an Excel OMPRosLems 845 E.7 Ifthe founh oil change and lube jo at Trendo-Lube ook 18 minutes and he second took 20 minutes, estimate how long 2) the Git jb took 3) the hid job ook ©) the eighth job wil tke @) the actual leaming rat is ; EB A sudent at San Diego State Universi bought six bookcases for her dorm room. Each required unpecking of pats and assembly. wich inched some mailing and olin. She Completed the ist bookcase inS hours an the second in hous. 2) What is her leming rte? 1) Assuming the same at continues, how Tong wil he third bookcase take? ©) The fourth fifth and sixth cases? @) Allsixcass? 9 Cleanings toxi landfill tok one EPA contactor 300 labor days the eonactor folows an 85% learing rae, how long wilt take, in toa to clean the next five (hati, andl ‘two through six)? E10 The rst vending machine that Smith, In, assemble tok 80 labor hours. Estimate how Jong the fourth machine wil require foreach ofthe following leaming rae 2) 95% ») 1% ©) 72% E11 Referto Problem .10,in which the time fr the fourth unit was estimated, How long wil the sstenth vending machine tke to assemble under the same thre leaming rl samy a) 95% ») 8% oT Ae! BAZ Babimore Assessment Center srens and tsns employes fora computer assembly fm in Towson, Marland. The progress of al trainees fs tacked and those not showing the proper progress are moved to less demanding programs. By the tenth repetition winees ruse able to complet the assembly task in 1 our or less. Tom Chou has jst spent hours on the fourth unit and 4 hours completing his seventh uit while another trainee, Betty Stevenson, tok 4 hous on the sx and 3 hours onthe ninh unit. Should you en: courage ether or bah of tetanes to connie? Why? EAS The beter sudems at Baltimore Assessment Center (ee Problem E.12) have an 80% learning curve snd can do a ask in 20 minutes after ust six ines, You woud like w weed out the weak students sooner and decide to evaluate them aftr the third unit. How long Should the third unit take? Ed As the purchasing agent for Nonhcas Aisines, you are interested in determining what 4you can expect to pay for airplane number 4 ifthe third plan took 20,000 hours to pro duce. What would you expect to pay for plane number 5? Number 6? Use an 85% lear: ing curve and a $40-per-hourlaor charge E18. Using the data from Problem E14, how long wilt take to complete the ive plane? ‘The fifteenth plane? How long wilt take 1 complet planes 12 through 15 inclusive? At 40 per hour, what ean you, as purchasing agent, expec to pay for al 4 planes? E.A6 Dynamic RAM Corp. produces semiconductors and has a learning curve of 7. The price Per bit is 100 millicents when the volume is .7 x 10! bits. What is the expected price at 1.4 & 10"? bits? What is the expected price at 89.6 x 10!? bits? 1 takes 80,000 hours to produce the frst et engine at .R's aerospace division and the learning faciors 9%, How lng does it take to proce the eigth engine? EAB It takes 28.718 hous to produce the eighth locomotive ata large French manufacturing fom. Ite learning factor is 80, how long does take to produce the tenth ocomaive? we e gi MODULE E LEARNinG Curves x E19 E20 Ea Ifthe firs unit of a production run takes 1 hour and the firm is on an 80% learning curve. hhow long will unit 100 take? (Hint: Apply the coefficient in Table E.3 on p. 838, twice.) As the estimator for Umble Enterprises, your job isto prepare an estimate for a potential customer service contract. The contract is for the service of diesel locomotive cylinder heads. The shop has done some of these in the past on a sporadit, basis. The time re. ‘quired to service each cylinder head has been exactly 4 hours, and similar work has been accomplished at an 85% learning curve. The customer wants you to quote in batches of 12 and 20, a). Prepare the quote, b) After preparing the quote, you find a labor ticket for this customer for five locomotive cylinder heads. From the sundry notations on the labor ticket. you conclude that the fifth unit took 2.5 hours. What do you conclude about the leaming curve and your quote? Using the log-log graph below, answer the following questions. a) What are the implications for management if it has forecast its cost on the optimum, Tine? 1b) What could be causing the fluctuations above the optimum line? ©) Wf management forecast the tenth unit on the optimum line, what was that forecast in hours? 4) If management built the tenth unit as indicated by the actual line, how many hours did ittake? ‘oarage lor Sour part 8 | = Case Study ‘SMT"s Negotiation with IBM puter product. The RFQ (request for quote) asked that the overall bid be broken down to show the hourly rate, it 1 price, and any ‘SMT and one other, much larger company were asked the parts and materials component inthe pr bby IBM to bid on 80 more units of a particular com- charges for subcontracted services. SMT quoted $1.62Case Stupy 847 | operation, million and supplied the cost breakdown as requested, The second company submitted only one total figure, 85 million. with no cost breakdown. The decision was ‘made to negotiate with SMT. ‘The IBM negotiating team included two purchas- ing managers and two cost engineers. One cost engi- reer had developed manufacturing cost estimates for every component, working from engineering drawings ‘and cost-data books that he had built up from previous, ‘experience and that contained time factors, both set and run times, fora large variety of operations. He es- timated materials costs by working both from data supplied by the IBM corporate purchasing staff and from purchasing journals. He visited SMT facilities to see the tooling available so that he would know what processes were being used. He assumed that there would be perfect conditions and trained operators, and he developed cost estimates for the 158th unit (previous orders were for 25, 15, and 38 units). He added 5% for scrap-and-flow loss: 2% for the use of, temporary tools, jigs, and fixtures; 5% for quality control; and 9% for purchasing burden. Then, using an 85% learning curve, he backed up his costs co get fan estimate forthe first unit, He next checked the data, ‘on hours and materials for the 25, 15, and 38 units al- ready made and found that his estimate for the first unit was within 4% of actual cost. His check, how. fever, had indicated a 90% learning-curve effect on hours per unit In the negotiations, SMT was represented by one of the two owners of the business, two engineers, and ‘one cost estimator. The sessions opened with a discus- sion of leaming curves. The IBM cost estimator ‘demonstrated that SMT had in fact been operating on @ 90% leaming curve. But, he argued, it should be possi- ble to move to an 85% curve, given the longer runs, re- duced setup time, and increased continuity of workers fon the job that would be possible with an order for 80 units. The owner agreed with this analysis and was willing to reduce his price by 4%. However. as each operation in the manufacturing process was discussed, it became clear that some IBM cost estimates were too low because certain crating and shipping expenses had been overlooked. These oversights were minor, however. and in the following discussions. the two parties arrived at a common understanding of specifications and reached agreements on the costs of each manufacturing ‘At this point, SMT representatives expressed great concer about the possibility of inflation in materials costs. The IBM negotiators voluntecré! to include a form of price escalation in the contract, as previously agreed among themselves. IBM representatives. sug- gested that if overall materials costs changed by more, than 10%%, the price could be adjusted accordingly However, if one party took the initiative to have the price revised, the other could require an analysis of all parts and materials invoices in arriving at the new price. ‘Another concem of the SMT representatives was that a large amount of overtime and subcontracting ‘would be required to meet IBM's specified delivery schedule. IBM negotiators thought that a relaxation in the delivery schedule might be possible if a price con- cession could be obtained. In response, the SMT tear offered a 5% discount, and this was accepted. As a re- sult of these negotiations, the SMT price was reduced | almost 20% below its original bid price. In a subsequent meeting called to negotiate the prices of certain pipes to be used in the system, it be- ame apparent 10 an IBM cost estimator that SMT. representatives had seriously underestimated their costs. He pointed out this apparent error because he could not understand why SMT had quoted such a low figure. He wanted to be sure that SMT was using, the correct manufacturing process. In any case, if SMT estimators had made a mistake, it should be noted. It was IBM's policy to seck fair price both for itself and for its suppliers. IBM procurement man- agers believed that ifa vendor was losing money on a job, there would be a tendency to cut comers. In addi- tion, the IBM negotiator felt that by pointing out the error, he generated some goodwill that would help in | future sessions. Discussion Questions 11, What are the advantages and disadvantages to IBM | and SMT from this approach? 2. How does SMT's proposed leaming rate compare ‘with that of other companies? 3. What are the limitations of the leaming curve in this case? Source Adaped fom E, Raymond Corey. Procrene ‘Monasenen Sates, Orsaation ond Decision Masog Nes York: Van Nostrand Reinold. ET ay Se aMopute E Learnine Curves BIBLIOGRAPHY ‘Avemathy, W. J, and K. Wayne. “Limits of the Learning Curve" Harvard Business Review 52 (Seprember-October 19749: 108-119. 1J.°A Note on Leaming Curve Parameters Decision Sciences (summer 1985): 325-327 Hall, G,, and S. Howell. “The Experience Curve from the ‘Economist's Perspective.” Srategic Management Journal, (Guly-September 1985): 197-210 Hart, CW, G. Spirizen, and D. D. Wyckotl. “Scale ‘Economies and the Experience Curve” The Cornell HRA. Quarterly 25 (May 1984): 91-103 cx Smith, J, Learning Curve for Cott, Control. Industrial Engineering and Management Press, lstnte of Indus teal Engineers, Norcross, Georgia (1998). ‘Taylor, M. L. "The Learning Curve—A Basic Cost Projection “Took” N.A.A. Bulletin (February 1961): 21-26 Zangwil, W. 1, and P. B. Kantor “Toward 2 Theory of Continuous Improvement and the Leaming Curve ‘Managemen Seience 44, n0. 7 Gly 1998): 910-920.