If you were trying to move a fridge up a flight of stairs, you would probably struggle to do it by yourself; an extra person would make the job a lot easier.
Maybe a third would be somewhat useful too - to hold doors open or move obstacles out of the way, but they clearly wouldn't be as valuable as the second person holding the other end of the fridge.
A fourth person would probably struggle to find anything meaningful to do beyond offer encouragement.
A fifth would just get in the way.
If you have just wandered in from the desert, lost and dehydrated, the first glass of water may save your life. Glasses two and three would also be welcome, but by glass ten or twelve, you'd probably be feeling ill.
Thus the law of diminishing returns, also referred to in economics as diminishing marginal utility:
As you add inputs to a process, you will reach a point where there is a decline in the utility of each additional input.
One of the keys to efficiency is operating at the sweet spot on the point of diminishing returns.
In business, this means throwing more resources at a problem is not necessarily the most economical way to solve it. Hiring more people than your workload requires, or spending more on advertising when you are already struggling to keep up with demand, is operating past the point of diminishing returns and will result in waste.
Operating below the point of diminishing returns is also not sensible. Sending only one person to try to move the fridge up the stairs is not efficient, because they will probably take more than twice as long as two people, if they can do it at all. Thus, there is usually also a threshold effect at play.
Examples:
Schedules: Working past the point of fatigue will still achieve something, but each hour will not be as productive as when you are rested and fresh.
Staffing: Underinvesting in quality administrative systems and personnel will result in costly mistakes and a lack of coordination. Add administrative staff and systems until you approach the point of diminishing returns, and no more.
Language: Learning the 1000 most common words will deliver great benefit and allow you to reach conversational fluency. Each word learned after that is less and less useful. It will tend to be rarer and will not add as much value as the most common words.
Chess: To be a successful chess player requires a certain minimum IQ (probably around 130). Above that, each IQ point seems to matter less and less. Further gains in performance are more dependent upon training and other skills such as focus, memory, creativity and emotional control.
Stock: Maintaining minimum stock levels of high-turnover items can increase efficiency by ensuring continuous delivery. But holding inventory that you will not run out of before you can easily restock it is wasting money by over-investing in storage. This is the basis of Just-In-Time inventory management.
Learning: Knowledge and skill acquisition usually follow the laws of diminishing returns. Initial progress is often rapid and satisfying, resulting in an intermediate plateau. The effort required to get from "good" to amazing, from decent hobbyist to professional, is large, because each new skill learned forms a decreasing percentage of your current skillset.
Finding The Sweet Spot
The point of diminishing returns lies between the points of maximum efficiency and maximum output. (The orange area on the curve above.) The sweet spot for where to operate on that curve will vary depending on the importance of that particular activity. Many people will advise avoiding investing in anything past the point of diminishing returns. Why bother? It's just a waste of time. And in most areas, that is perfectly sensible.
But in the area of your competitive advantage, it is always worth investing past the point of diminishing returns, up to the point of maximum output. Because even though returns on that particular metric will be diminishing, the value of your differentiation on that metric will flow through to everything else.
Excellence is largely a matter of investing well past the point of diminishing returns. And excellence can be a key part of competitive advantage.
For example, if your business depends upon faster service than all your competitors, focussing resources on shaving minutes off your delivery time will help ensure your competitive advantage, and so is not wasted effort. If your competitive advantage lies in stocking the largest range, then efforts to track down obscure suppliers and closely manage stock levels are worth throwing everything behind.
That is why it makes sense for an elite athlete to cut the distractions from their life and spend so much time in the gym or on the track, even at the expense of other areas of their life. An increase of just a few percent in their performance can be the difference between fortune, fame, and success, or a career that never gets off the ground.
In highly competitive, winner-take-all environments, the rewards are distributed exponentially, not linearly, to the highest achievers. The difference between the top percentiles is larger than any other.
Breaking Through
With continued investment of resources, you will inevitably reach the point of diminishing, or even negative returns. At this point, you may have outgrown your frame of reference, and be ready for the next phase of growth. This is the theory behind overlapping S-curves, the topic of the next article.
Prompting Questions
If I cut back on the amount of time/effort/personnel/money I spent on this area, would I still get the same or better results? (If yes, then do so.)
Are there any areas where I could substantially increase my returns by increasing my inputs? (If so, you're probably underinvesting in this area.)
What would really happen if I invested more / invested less in area X?
In which areas is it vital that I/we excel far past the point where others usually give up?
Which areas of my life or business are important enough for me to keep investing in, despite diminishing returns?
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