Law of Diminishing Returns in IT

The law of diminishing returns may be one of the most important ‘laws’ for CIO’s to understand and apply in nearly every decision making situation. CIO’s often use a number of shorthand adaptations of the law of diminishing returns such as “cost vs quality” or “the 80-20 rule”.

The more I think about it though, the more I believe the shorthand is not helping CIO’s overcome the challenges of achieving an appropriate balance between the cost of IT versus the value of IT. For that reason I have decided the law of diminishing returns deserves to be directly applied in nearly all IT decision making.

Law of Diminishing Returns

Law of Diminishing ReturnsThe law of diminishing returns is mostly used in economics, managing productive systems, and other applications where there are inputs to a system or process that are expected to produce a yield or output.

The simplified definition of the law of diminishing returns is that as you add more of one factor (input) in the process there will come a point where the yield (results) will begin to decrease. That means the ratio of the inputs to the yield begins to decline. That point is referred to as the point of diminishing returns.

The law of diminishing returns goes on to say that if you continue adding more of that factor you will come to another point where the total yield actually decreases. That point is the point of negative returns.

The 80/20 Rule

The 80/20 rule relates to the law of diminishing returns as a way of describing that in many productive systems the first 80% of the yield curve requires only 20% of the inputs and the last 20% of the yield requires 80% of the inputs. This can be very simplistic for some systems but the concept is still very powerful.

Law of Diminishing Returns Examples

Agriculture gives us one of the more common law of diminishing returns examples of using fertilizer to increase crop yields. The example is that by using some fertilizer you can dramatically increase crop production over not using any fertilizer. But there comes a point where using additional amounts of fertilizer begins to have less effect on yields and at some point can actually begin to cause crop yields to decline.

Other examples often used which apply to IT relate to the case of adding more labor to a project or process to increase the result. But you can actually have too many people involved to a degree that it affects overall productivity.

Ever heard the old saying “too many cooks spoils the broth”?

IT Examples of the Law of Diminishing Returns

I am not going to rehash my earlier post on Capacity Planning Maturity Pipe Dream which offers several law of diminishing returns examples to consider. I will summarize it here by pointing out that you can only throw so much hardware at a problem before you hit the point of diminishing returns.

That is true with adding more chassis, more blades, more CPU, and more memory whether for performance or availability reasons. It is also true that if you throw too much hardware at a problem you can actually exceed your ability to effectively support it resulting in crossing the point of negative returns.

You can also experience the diminishing returns and negative returns by leap frogging into new or advanced technology which your staff has no skills to implement or operate. Many shops have experienced this first hand in their VDI implementations or in implementing more advanced storage systems or applications that rely on new technologies.

Believe it or not, you can also experience diminishing returns and negative returns from having excessive processes and standards. That may not seem believable to some of you.

So just imagine if the requirements of your IT processes and standards grew to the point were one more requirement no longer produced the improvement you expected. Imagine you add even more requirements in the form of IT controls or processes that they actually interfere with normal execution.

That’s why I usually advocate taking the “just enough to be good enough” approach.

Applying the Law

CIO’s must apply the law of diminishing returns in the decision making surrounding the right-sizing IT process and IT controls. CIO’s must apply the law to IT investment decisions so they can weigh options for the required input versus the yield.
To do that requires you to use a business case template that forces options to be presented that commit to the yields they can deliver. That means you need proposals that compare the projected yield of a $1M solution versus the yield of a $4M option so you can decide if 4 times the cost (inputs) gives you 4 times the value (yield).

Law of Diminishing Returns Example

It also requires that CIO’s build the accountability systems to hold their department to delivering the expected value. This means accountability systems for the value realization of technology investments. It also means the value realization of additional FTE’s or new processes.

For every one of these scenarios, CIO’s should construct the yield curve for the decision to be made and force the discussion of where on the curve they are at, where is the current business requirement, and where do the options being considered put you.

PS – Because this site is also intended to help the non-IT professional get more value from their IT dollars regardless of where they spend them, I should also point out that you deserve the same kind of illustration from your IT service provider.

This entry was posted in IT Financial Management, IT Performance Management. Bookmark the permalink.

3 Responses to Law of Diminishing Returns in IT

  1. Pingback: Law of Diminishing Returns in IT | digitalNow |

  2. Dan Allen says:

    I agree with the article so I’m sorry to be a pedant.
    The law of diminishing returns doesn’t guarantee a point of negative return.
    However in practice there almost always is a point of negative return.
    In the classical example, at some point more fertilizer poisons the soil and there is a negative return.
    However (say) stockpiles of vaccine never become less effective.
    Obviously there comes a point when you bankrupt yourself buying ridiculous amounts of vaccine but that isn’t the point the law is making.

    In fact I would say that ‘opportunity cost’ tells us that there is in fact a point at which more of X having zero yeild is a negative return as an opportunity cost. But that isn’t what the Law of Diminishing Returns is telling us.

    I told you it was pedantic. Good article.

  3. The Higher Ed CIO says:

    Dan – yours is one of my favorite comments in some time because it inspires me to be pedant +1.

    The stockpile of vaccine should be compared to the stockpile of fertilizer not its application. So for consistency the over vaccination of a person or population can have diminishing returns as many in the US argue under the theory that childhood vaccinations are the cause of the rise in autism rates. But to just stick with the stockpile scenario the reason to stockpile this to be prepared for a possible use and so there is a size of a stockpile that would exceed the likely need and begin to produce no advantage to add more to the stockpile irrespective of the cost and spoilage.

Comments are closed.