Economics has always interested me, but not enough to pursue a career in it. Much like any system of checks and balances, the very nature of economics is fluid and easily manipulated, though often with results not planned for. I’m gonna quote Newton on this one: “To every action force there is an equal, but opposite, reaction force”. More on this in another article.

One facet of this action and reaction that I’ve always found interesting as it applies to business “The Law of Diminished Returns”. The economic Law of Diminished Returns was originally coined by David Ricardo and expressed a relationship between input and output, stating that adding more units of any one input (labor, capital, materials, anything tangible etc) to fixed amounts of the others will yield successively smaller increments of until the curve of improvement becomes flat (or deflates).

What does this actually mean for us, the business people?

This means that sometimes, adding more of anything does not make more. Infact, it can make for less, or opposing results.

Lets run through a couple of examples of this in action.

1. A doctor loves his job and wants to see more patients. He’s already working 60 hours/week and sees about 60 patients per week. If he works 80 hours/week, he could potentially see 80 patients/week, correct? How about 100 patients/week in 100 hours? How far could he go before he begins losing the quality or his work to the quantity of his work? Lets say the doctor adds a series of nurses to his roster to help in other tasks so he can see more people and get more done? There comes a point where only a doctor can do what a patient comes to them for and the doctor will still be required to be there. There also comes a point where the physical limits of the human body will cause the quality of the doctor’s work to suffer. In this case, adding more man-hours (at the doctor’s personal expense to his free time) or adding more personnel (and thus more costs) will simply not create the return on investment that was produced at 60 hours/week. After a while, the law of diminished returns may actually cause the doctor to lose patience as his competency and ability to perform will fail.
2. A production line is capable of producing 10,000 widgets/hour using 50 employees. If you wanted to produce 20,000 widgets/hour, it would make sense to make the line go twice as fast or to hire twice as many people. Again, at the limitation of the human body, the attention to detail and coordination required by the human beings involved will limit this process. Because of your process, adding twice the employees may actually DECREASE your output from overcrowding, social unrest or increased downtime.
3. A product hits the market that revolutionizes an industry. You have orders for 10,000/week. You’re able to produce 5,000. Your production is not able to compensate quickly, and your product buzz begins losing momentum. You ramp up your production so you can meet the demand of 10,000/week. After 6 weeks, the demand falls down to 5,000/week.. and then 2,000/week. If your production is not able to keep up with initial demand, the rectified demand will be surplus and your excess is simply waste from having dimished capacity now turned into excessive production. The cost per unit drops, the margin drops and you quickly fall victim to the law of diminished returns.

I’m going to be following this up with an article about material waste, another about the cost of downtime and another about limitations of supply chains. They all have to do with the Law, so tune back in next time.