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What is a Diminishing Return?
Malcolm Tatum
Malcolm Tatum
Diminishing returns are the point in which the resources utilized in a particular effort no longer return enough reward in order to justify the use of those resources. In terms of business, this often means the breaking point at which the current cost of production and marketing ceases to be generate a reasonable profit for the company. Just about any good or service has some point where the resources exerted in supplying the product ceases to be in the best interest of the manufacturer.
The economic theory behind the diminishing return is relatively straightforward. Essentially, the idea of a diminishing return states that when an equal amount or quantity of one factor is increased and other factors remain the same, there will come a point where the work involved to perform a task ceases to be as profitable. At that juncture, the producer has a decision to make. Is it worth reevaluating the use of resources in an effort to restore the former profitability for each unit produced, or would it be better to abandon the production altogether?
One key advantage of identifying this point of diminishing return well in advance is that it allows producers of various goods and services to take steps in advance to avoid ever coming close to the point where returns are minimal at best. Reviewing cost of production and comparing it to units sold in the same period provides a rough idea of how much profit is made from the production effort. This makes it possible to spot trends where the profit or return is decreasing and thus moving closer to the point of diminishing returns.
When such a trend is identified, the production process can be reviewed and strategies employed to cut costs and thus restore the profit earned from each unit produced to a higher level. At the same time, resources such as marketing efforts can also be evaluated, with an eye toward expanding the demand for the product. This can also help to increase the profit margin and thus move the product away from this point of diminishing return.
Maintaining a reasonable balance between the input of resources to produce goods and services and the output of enough product to generate a sufficient product is the goal of just about any company that wishes to stay in business. By calculating the point of diminishing return and making sure to keep a credible distance away from that point, the company has a much better chance of remaining successful.
Malcolm Tatum
After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including WiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.
Learn more...
Malcolm Tatum
After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including WiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.
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Discussion Comments
My economy teacher has a really interesting way of explaining diminishing return. He gave the example of eating doughnuts and how the first doughnut we eat gives so much satisfaction and happiness. But with each additional doughnut we eat, we are less and less satisfied and there comes a point where we are so full that eating another doughnut is no longer enjoyable.
He says that this is diminishing return. Just like the doughnuts, there is a point where producing a good is no longer profitable and desirable for a company.
Isn't it a great way to explain this concept? It's so easy to understand it this way.
@Suntan12 - The law of diminishing returns is really not just a term used in economics. It can also be referred to everyday life as well. For example, if you are hungry and eat something, the first few bites are more satisfying than the bites towards the end of your meal because toward the end of your meal, you start to become full.
When you eat past this state you do not appreciate or enjoy the food any longer and have reached the law of diminishing returns because the food no longer has the same effect as it did in the very beginning of the meal. The same could be said of exercise.
Exercise has a lot of great benefits that you immediately feel when you are engaged in the activity, but after a while you do start to get tired and are no longer as invigorated as you were in the beginning of the workout.
If you continue to workout past this point, you will start to see a decline in your ablity to perform the exercise and will not be nearly as effective and will be receiving diminished returns.
I learned way back in my college economics class that the law of diminishing returns describes the circumstances in which a business is no longer as profitable if they continue doing business a certain way.
Many times businesses use advertising to promote their businesses and while the first bits of advertisements do attract attention from potential customers, subsequent ads beyond a certain point will not bring in any more additional customers. This is really the point of diminishing returns which is way a lot of companies track their advertising response carefully and why businesses will often ask a customer how they heard of the organization.
Advertising can be expensive, but if it is done strategically it can be very effective. You just can’t over do it.
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