Diminishing marginal utility or diminishing returns is a factor in both marketing and investing. We will primarily be addressing its applications in marketing, but the fundamental theories are applicable to many fields of study.
In marketing, as in finance, we are looking to create machines that generate cash flow. Essentially for every one dollar we put in, we want to be making profit after it comes out the other end of our sales, supply chain, distribution, etc processes. If we have a more “complex sale” (expensive product) the sales cycle can take months to years - which leaks into periodized interest considerations as well.
Each of these machines need to generate a positive ROI. But lets forget about that for the time being and instead focus on the investment of capital into a machine.
Return (30 Day)
As you can see on the left from our investments into various marketing campaigns, the expected return has an issue. The more we invest, the less return we receive.
To put it simply, for every unit of money we invest, every subsequent dollar returns less. This is known as diminishing returns or diminishing marginal utility.
Our next step is to look at the net return and ratio of return to investment.
Return (30 Day)
As you can see we generally want to invest $400 to maximize our return.
Causes of Diminishing Returns?
What are the primary causes of diminishing returns? They are typically representative of nearing the maximum capacity of a given environment.
Let’s take for example dusting your room. You can get 80% of the dust out of your room by doing an hour of cleaning. After a certain point you need to pay $1,000 for professionals to come and get your room to 90% dust-free. After that you need to remove all the furniture and have everything treated with expensive chemicals and sanitization processes for $10,000 to get you to 99%.
As you near maximum capacity for anything, the difficulty and expense increase exponentially.
One of the core problems in marketing is the campaign structure. A campaign is a cool branded idea built in many mediums such as tv commercials, web banner ads, and experiential events. The brand will then show it to a limited “target audience” of people they feel will respond to it. However this audience tends to be limited:
1) Not everyone is easily accessible via “media buying”.
2) We switch in and out of feelings and beliefs, it’s hard to track.
3) Only a certain audience will see the campaign as interesting.
So the brand launches the campaign. At first it does well. But each time someone see the ad, the probability they will convert will go down. After all, the most eager consumers would have converted off the first ad seen. After four exposures, the marketing loses effectiveness.
Pair this with the costs (usually $10,000+) for the campaign itself before buying media space, and campaigns can be highly detrimental if the message is not well received.
The marketer could expand the audience to customers less likely to convert (scale). However this also leads to a form of diminishing returns - these new customers are less likely to convert (non-core audience) and thus returns diminish.
The marketer can create different creative executions, and it does help, but after initial exposure to the campaign, the marketer has already captured a lot of the market.
Finance is a game of investing one’s money in the most efficient machine it can to generate a net positive output (factoring risk). The problem is scale. You can find an efficient investment at $1000 - lets say 15%. However once you have $10,000 the number of opportunities decreases and the investor is forced to settle on a 12% return. Once the investor has $10,000,000 they become hard pressed to find sufficient opportunities that beat a typical index fund.
In other words, every dollar you invest will typically return less money than the dollar before.