Learning Economies Flashcards
What is the Learning Curve?
(Experience Curve)
Depends on CUMULATIVE OUTPUT
- the advantages that flow from accumulating experience and know-how.
Benefits: ○ lower costs ○ higher quality ○ more effective pricing ○ more effective marketing ○ creativity and innovation...and more?
Define Slope
the magnitude of learning benefits
is the relative size of AC when cumulative output doubles
N.B. estimated slopes do not indicate whether learning economies are fully exploited.
Learning flattens out over time and the slope eventually becomes 1.0 (i.e. no reduction in costs per doubling of cumulative output
Calculating Learning Economies
- T x Ln = Time required for the nth unit
- Where:
○ T= unit cost or unit time of the first unit
○ L = learning curve rate
○ n = number of times T is doubled
Strategising Learning Economies
Learning reduces unit cost through experience
! Capital intensive technologies can offer scale
economies even if there is no learning
! Complex labor intensive processes may offer learning economies without scale economies
! What of service businesses?
! Health and surgery (reduction in death
rates)
! Managed Services?
! Professional Services?
Diversification
- Diversification across products and across markets can exploit existing cost reducing economies
- Diversification that occurs for other reasons can be less successful
Motive for Diversification
Managers may prefer diversification even when it does not benefit the shareholders
Why Diversify
§ Economies of scale, scope and learning § Reducing transactions costs § Internal capital markets § Risk and diversification § Identifying undervalued firms
Economies of scale, scope and learning
- Managers develop specific skills (e.g. Information systems, finance)
- Seemingly unrelated business may need these skills
- Spreads ‘under-utilised’ resources
- Logic can be misapplied when skills are not useful in the business into which the firm diversifies
Internal Capital Markets
• In a diversified firm, some units generate surplus funds that can be channelled to units that need the funds (internal capital market)
• The key question:
○ Is it reasonable to expect that profitable projects will not be financed by external sources?
- Product life cycle model and learning cycles combined with an internal capital market, with the firm serving as a banker
- BCG Growth/Share Matrix: Use the cash generated by “cash cows”, for example, to exploit learning economies of “rising stars” and “problem children”
Risk and Diversification
Diversification reduces the firm’s risk and smoothes the earnings stream
Whose risk?
- Shareholders may not benefit - they can diversify their portfolio at near zero cost.
- When shareholders are unable to diversify their portfolios, they may benefit from such risk reduction
Problematic Justifications for Diversification
Diversifying shareholders’ portfolios
identifying undervalued firms
Identifying Undervalued Firms
• Valuation:
○ When the target firm is in an unrelated business, acquiring firm less likely to value the target correctly
• ‘Lemon’?
○ The key question is: Why did other potential acquirers not bid as high as the ‘successful’ acquirer?
• Danger:
○ ‘Winner’s curse’ could wipe out any gains from perceived financial synergies
Costs of Diversification
• Upfront
• Ongoing - Diversified firm:
○ Internal capital markets may not function well in practice
○ May incur substantial influence costs (Milgrom and Roberts 1990)
○ May need elaborate control systems to reward and punish managers
Managerial Reasons for Diversification
• Managers prefer growth by diversification:
○ Adds to social prominence, prestige and political power.
○ Enhances compensation by increasing size of firm
○ Feel secure if performance of firm mirrors performance of the economy (which will more likely happen with diversification)
• Manager-controlled firms tend to engage in more conglomerate diversification than owner controlled firms.
Corporate Governance
- Shareholders may not be knowledgeable about value of an acquisition to the firm
- Shareholders have weak incentive to monitor the management
- Acquiring firms tend to experience loss of value - indicating that acquisitions are driven by managerial motives.
Diversifying Acquisitions
• Shareholders of the acquiring firms do not benefit from the acquisitions
○ Negative effects on the acquiring firms are more severe when:
§ Managers of acquiring firms performing poorly before the acquisition
§ CEOs of acquiring firms hold smaller share of the firms’ equity
Diversification and Long Term Performance
• Long term performance of diversified firms appears poor:
○ A third to half of all acquisitions and over half of all new business acquisitions are eventually divested.
