The Learning Curve

ACC2140

Learning outcomes
Describe the effects of the learning curve and situations in which is applicable: Calculate the incremental times using both the cumulative average and marginal learning curve models; Explain the meaning and applications of Pareto analysis.

What would we include in the variable cost of manufacturing a product? Material / Labour / Variable Overheads All of these are things that we could use less of if we got better at our job. If we can REDUCE labour costs we will get a cheaper product.

The Learning Process

The more we do something, usually the better we get. Practice makes perfect. The Learning Curve is often also called the Experience Curve. Typically, in the context of work, this could be applied to the labour cost.

The more an individual does a task, the quicker and better we would expect them to become, that is the more efficient they are going to be. We could also apply it to a business unit as a whole.
Assembling Flat pack furniture for example The Learning curve was first reported in the 1920s in the US aircraft industries where it was found that the time taken to assemble aircraft reduced significantly as more were made, up to a certain point. Why doesnt the learning curve continue forever?

Comes a point where we cannot physically do things any faster (unlike robots/ machines) This is the point where we have reached the optimum production time and the variable cost is as low as it is going to get. The point where we just cant get any better.

The Learning Curve doesnt just apply to time. It also applies to other measures such as quality, use of raw materials (waste) and others, even though most examples tend to focus on time saving.
We can plot the learning curve on a graph: Average Hours per unit

Total Cost

Steady State 0 Units

The Learning curve may exist in a business, it probably should exist, but it doesnt have to. Usually the effect is greatest where there is good management and good training of staff.

Repetitive nature of work Labour intensive

Only people give us the learning curve, machines dont learn (get quicker). If you introduce new machines and production improves, that is not a learning curve effect, it is a one-off improvement.

There are two common models of the learning curve effect. Marginal Model and Cumulative Average Model Marginal Model We calculate the time taken to make each individual extra unit. The time taken on each will reduce (up to a final point when there is no individual saving on each extra one). The time taken to do all the work is the total of all of the times taken to do each unit. The marginal model states that the marginal time (the time to make the last unit) goes down by a certain percentage every time production doubles.

So if we had an 80% learning curve (an 80% learning rate) then as we doubled production, the time taken would be 80% of the time taken at the previous point.
Say it took 10 hours to make the first. Question. How long to make the 2nd? Question. How long to make 2 units?
Units 1 2 4 8 16 Marginal time 10.00 8.00 6.40 5.12 4.096 Cumulative time 10 18 ?

Cumulative time for 4 units = (10 +8 +? + 6.4) If we want to make 4 units, how long to make the 4th unit? How long to make the 8th unit? = 5.12 hrs How long to make the 16th unit? = 4.096 hrs

= 6.4 hrs

Calculation of the time taken where the rate has doubled is quite straightforward, but how much time does it take to make the 5th unit? Without formulae we are limited to calculating the required time to doubling points. Marginal Learning Curve Model formula y = axb y= the marginal time needed for the xth unit unit a= the hours needed for the first unit x= the number of units b= log learning curve/log 2 (it is always over log2) In this example with an 80% learning curve: b = log 0.80 / log 2 = -0.0969/0.3010 = -0.3219

Question: The 3rd unit? The 9th unit? The 13th unit?

How long to make? Y = axb = 10 x 3-0.3219 = 7.02 hours Y = axb = 10 x 9-0.3219 = 4.93 hours Y = axb = 10 x 13-0.3219 = 4.38 hours

What is the cumulative time to make four units? 1st 10.00 2nd 8.00 3rd 7.02 4th 6.40 31.42 Hours We add up the times of making each additional uni

Cumulative Average Model This model says that the cumulative average time per unit declines by a constant percentage every time production doubles.

Units 1 2 4 8 16

Marginal time 10 8.00 6.40 5.12 4.096

x1 x2 x4 x8 x16

Cumulative time 10.00 16.00 25.60 40.96 65.536

(Marginal Model) 10.00 18.00 31.42

The formula for the calculation is exactly the same for odd numbers of units.
The 3rd unit? = 7.02 hrs x 3 = 21.06 hrs to make 3 units The 9th unit? = 4.93 hrs x 9 = 44.37 hrs to make 9 units The 13th unit? = 4.38 hrs x 13 = 56.94 hrs to make 13 units What is the cumulative time to make four more units if we start production after the 9th unit has been completed? 13th 9th = 56.94 hrs 44.37 hrs = 12.57 hrs

So why are we saying the times are different? 1st unit takes 10 hours, the incremental time is 10 hours. 2nd unit takes eight hours, 2 x 8hrs = 16 hours, so the average time is 8 hours. The incremental time to make the second unit is 16 hours 10 hours = 6 hours. These numbers are very different to those calculated under the marginal model.

Which is right? The one that fits closest to the actual experience with the product/process in question. The choice can only be determined on a case-by-case basis. You have to look at the learning curve in practice in your business and see which model is the most appropriate and apply that model. If you wanted to be safe, you should use the marginal model because savings could be bigger if the cumulative average model actually applied.

Practical application of the Learning Curve

Determining the Learning Rate We can only really calculate after the work has been done, but this wont help us in predicting resource requirements. The accurate way of doing this is by regression analysis, but that will not be covered in this unit. Can use a similar job to predict learning curve for a new venture At best it will be a good guestimate, at worst it could mean that you completely underestimate your resource requirements. Output continuous If you dont make the same thing all the time, you have a break in production, staff will end up unlearning very quickly Task repetitive

To get the most from the Learning Curve effect, tasks must be labour repetitive. The more variation there is going to be in the job then the smaller the effect is going to be.

Tasks labour intensive If there is not much labour in the job, there isnt much scope for learning Stable conditions required If you change staff, or methods of manufacturing, then you wont get the full benefits of the learning effect. Motivation You may not see the effect if staff are not motivated to work quicker. Usually financial bonuses or to clock off once completed Preplanning/Training Where you train staff before they start doing the job there will be less learning effect. Will start further along the learning curve therefore less scope for improvement

Practical uses of the Learning Curve

Pricing Costs associated with time will be lower for later units than for the earlier ones. Prices set on the basis of experience with the first few units will be higher than necessary and may be uncompetitive. Using the learning curve can substantially reduce estimating errors. Budgeting

Resources (particularly time related ones) will be budgeted for on the basis of the unit data. If the unit data changes with levels of production then the company may think it needs more resources than it actually does.
Standards and Variance Analysis If standards are set ignoring the learning effect then there will be a variance between resources consumed and those budgeted for. Although this will be positive (favourable) it will produce a variance that needs examination. It could also lead to variances between periods where a later period has all the benefits of the learning effect that will need explanation if they have not been taken into account in setting the budget (standard).

Pareto Analysis
It is often found that a large proportion of the value of something is accounted for by a small percentage of the units. Called Pareto analysis after the first person to describe the effect. Wealth in the UK is mostly held by a small number of people. Most of your sales will be to a small number of your total customers. Most of the profits from sales will be from a small number of your products. It has also been observed many times that 80% of something is attributable to 20% of something else. Apart from just being an interesting observation, it does give you the opportunity to understand your business better. If you know that 2 out of every 10 customers are more important to you than the other 8, then you might focus your work more if you know which two they are. Often we tend to look at the business as a whole. Using Pareto analysis allows us to identify the most profitable customers, products, services, locations etc. This will enable us to focus our efforts and resources on these. It is harder to get a new customer than to keep an existing one.

Example. From CIMA Paper 9 Management Accounting- Decision Making Foulkslynch (2000) p 16.
We have the following items in store:
Value 1 101 1,001 10,001 Items

100 1,000 10,000 100,000

12,929 6,848 216 7 20,000 Cumulative value 385,000 1,573,000 5,339,400 5,985,850 Total % 6.43 26.28 89.20 100.0

Midpoints of values 55,000 5,500 550 50

Frequency Cumulative Actual 7 216 6,848 12,929 20,000 7 223 7,071 20,000

Total value % 0.035 385,000 1.12 1,188,000 35.36 3,766,400 100.00 646,450 5,985,850

We put the values in descending order.

We work on the midpoint for the frequency, to give us an average. Pareto analysis often shows an 80:20 ratio, but it doesnt have to. This example shows approximately a 90:35 relationship. We can see that 89.2% of the value is represented by just 35.36% of the products. These are clearly the most important ones to us and are the ones we need to take the most care of (inventory, stock taking etc) rather than the 12,929 items worth less than 100. Often when Activity Based Costing is applied to a business, we find that products that we thought were profitable actually arent. Combining this with Pareto Analysis, you might find for example that a number of your customers are actually losing you money. If 80% of your profits are coming from just 20% of your customers, amongst the other 80% of customers, there could be those with there frequent orders of small quantities of low value items who may actually be losing your money in servicing.