Boeing sees a big order from the world’s largest airline as a chance to “walk down its learning curve”
Airplane Learning Curve (cont’d)
American knows its order will allow Boeing to reduce costs for future sales, they want to capture some of Boeing’s profit
If American could know how many planes Boeing would make over the lifetime of the plane, they could offer Boeing’s average cost
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Airplane Learning Curve (cont’d)
What actually happened with American and Boeing:
American offered to purchase planes exclusively from Boeing over the next 30 years
This provided Boeing with a big chunk of demand that would lower costs
In exchange, Boeing offered a discounted price
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Guitar Fingerboards
Firm X produces guitar fingerboards
Rosewood is used for budget guitars
Ebony is used for high-end guitars
However, there is a decreasing supply streak-free
of ebony
Brown streaks in ebony are seen as a blemish for high-end guitars, but a step up from rosewood.
The streaked ebony can be used on budget guitars
Better than rosewoodg cost and quality advantage
Therefore, there are economies of scope between production of high-end and low-end guitars.
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Economies of Scope
If the cost of producing two products jointly is less than the cost of producing those two products separately then there are economies of scope between the two products
Cost(Q1, Q2) < Cost(Q1) + Cost(Q2)
You want to exploit economies of scale by producing both Q1 and Q2
Major cause of mergers
Example: Kraft, Sara Lee and ConAgra sell a variety of meat products, hot dogs, sausage, and lunchmeats because they can derive economies of scope by distributing these products together
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Diseconomies of Scope
Production can also exhibit diseconomies of scope when the cost of producing two products together is higher than the cost of separate production.
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Pet Food Production
AnimalSnax, a pet food company has 2,500 products (SKU’s) with 200 different formulas
They receive a lot of pressure from large customers like
Wal-Mart to reduce prices
These requests worry the firm because of the so-called 80/20 rule (80% of a firm’s profit comes from 20% of its customers)
To respond to Wal-Mart, the company shrinks it product offerings
AnimalSnax reduced its product offerings to 70 SKUs using only 13 different formulas AND it began offering price discounts for larger orders.
The company could consolidate small orders into large ones to
reduce setup costs.
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Pet Food Production Graph
Typical savings for one extruder line are illustrated below
Under the new approach, the same amount of pet food could be produced faster
This led to a 25% savings for the company because of reduced production costs (see graph)
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Sample Question
Learning curves: every time you double production, your costs decrease by 50%. The first unit costs you $64 to produce. On a project for 4 units, what is your break-even price?
You can win another project for 2 more units.
What is your break-even price for those units?
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Answer
The break-even price for 4 units is $33.
The extra costs for the fifth and sixth units is only $24, so break-even is $12/unit for those two.
If the project were for six units total, break-even would be $26/unit for those six.
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Q MC TC AC
1 $64 $64 $64
2 $32 $96 $48
3 $21 $117 $39
4 $16 $133 $33
5 $13 $146 $29
6 $11 $157 $26
QMCTCAC
1$64$64$64
2$32$96$48
3$21$117$39
4$16$133$33
5$13$146$29
6$11$157$26
Sheet1
| Q | MC | TC | AC |
| 1 | $64 | $64 | $64 |
| 2 | $32 | $96 | $48 |
| 3 | $21 | $117 | $39 |
| 4 | $16 | $133 | $33 |
| 5 | $13 | $146 | $29 |
| 6 | $11 | $157 | $26 |
