Experience, Production and Profit

The following appeared as part of an annual report sent to stockholders by a processor of frozen foods:

"Over time, the costs of processing go down because as organizations learn how to do things better, they become more efficient. In color film processing, for example, the cost of a 3-by-5-inch print fell from 50 cents for five-day service in 1970 to 20 cents for one-day service in 1984. The same principle applies to the processing of food. And since our company will soon celebrate its 25th birthday, we can expect that our long experience will enable us to minimize costs and thus maximize profits."

On the face of it the argument looks a bit convincing. However a closer look exposes some flaws in it.

The writer claims, "Over time, the costs of processing go down because as organizations learn how to do things better, they become more efficient". This is partially true. Over a long period of time growing and progressive organizations do tend to learn from their mistakes and do things better. This can make them more efficient. However production cost is assumed to be a simplistic function of learning from experience over time.

This argument does not take into account other factors that come into play over time. Production cost may also come down due to advancement in technology, economy of scale, cheaper and readily available credit, cheap and abundant labour or securing favourable contracts by virtue of networking over time. On the other hand production cost may actually go up over time due to changes in regulations, increase in cost of raw materials, shortage of labour, shortage of resources or simply inflation. Over time a lot of things can happen but the writer singles out experience and takes it as the basis of the whole argument. This in itself is not a good start.

The writer further says, "In colour film processing, for example, the cost of a 3-by-5-inch print fell from 50 cents for five-day service in 1970 to 20 cents for one-day service in 1984. The same principle applies to the processing of food". First of all, printing is not the same as food processing. Food processing can be machinery and labour intensive. It is highly exposed to raw material cost fluctuations, labour market whims and technological changes when compared with the print industry.

Secondly the argument itself is being applied in an inconsistent way by correlating technology with experience. The fall in price of print fell due to technological innovations. The industry did not learn to do print in a better way using experience and old technology but found new and cheaper ways of doing the same thing. Crediting the price fall to experience alone is incorrect. Experience may lead to investments in technology and innovative, patented ways of production. However this is not always true.

Lastly, the writer concludes, "And since Olympic Foods will soon celebrate its 25th birthday, we can expect that our long experience will enable us to minimize costs and thus maximize profits". At the end of the day I believe it is not how many years you live but what you do when you are alive that defines you. Wisdom cannot be linked to how many years we have been on earth but to how much are eyes were really open in this duration. Similarly a company cannot claim to be making profits just because it has "been there" for 25 years. There simply have to be more reasons. Even if we assume that production prices indeed went down, it is very much possible that selling prices went down as well in face of a cut-throat competition. That would mean lesser profits and refute the whole argument.

All in all, the writer tries to correlate experience with falling costs and falling costs with increased profits. The first correlation focuses on only one aspect of experience and tries to show it as the only factor affecting production cost. The example used tries to attribute a technological development to experience. Even though it may be true, the same is not guaranteed. Finally correlating falling production costs with profits may be ok if the selling prices have remained stable or increased over time as well.