When Netflix launched in the late 1990s, it disrupted the movie rental industry by offering a DVD-by-mail subscription service without late fees. It was a novel idea that found an eager customer base.
In the early years, Netflix aggressively invested in optimizing its DVD rental operations. They refined the movie recommendation algorithm, expanded their distribution centers, and grew their DVD inventory to offer a wider selection. These efforts drove steady growth.
However, in the mid-2000s, it became clear that the tide was starting to turn away from physical media. As high-speed broadband internet became more widely available, consumers were shifting towards streaming content online. Netflix realized that clinging to its legacy DVD rental model would soon lead to diminishing returns despite further investment.
What is the Law of Diminishing Returns?
The economic principle known as the law of diminishing returns states that continuing to invest more resources into
a given activity will eventually yield smaller and smaller returns. There comes a point where additional input
leads to declining marginal output. This phenomenon applies not just to individual projects but to entire business
ventures as well. Many entrepreneurs have experienced pouring time, money, and energy into getting a business off
the ground, only to realize down the road that continuing to invest in the venture was leading to frustration
rather than progress. Pushing ahead once diminishing returns have set in often means missing out on opportunities
to direct efforts toward more promising prospects.
How Can You Recognize Diminishing Returns?
- Identify Key Metrics: The first step in addressing diminishing returns is to identify key
performance metrics for your business. This could include sales, customer acquisition costs, or production
output. By monitoring these metrics closely, you can recognize when they start to plateau or decline,
indicating diminishing returns. - Regularly Analyze Data: Regular data analysis is vital to spot trends and make informed
decisions. When you notice diminishing returns in a specific area, it’s time to reevaluate your strategy.
This might involve examining market conditions, consumer behavior, or production processes that could be
causing the decline. - Optimize Resource Allocation: As diminishing returns set in, it’s important to reassess
where you allocate your resources. This might mean shifting investments from one aspect of your business to
another. For example, if your advertising spend is yielding diminishing returns, consider reallocating
some of that budget to product development or customer service. - Experiment and Innovate: Innovation can be a powerful tool to combat diminishing returns.
Encourage your team to brainstorm new ideas, products, or services that can revitalize your business.
Experiment with different strategies and approaches to break through plateaus. - Diversify Your Portfolio: Sometimes, diminishing returns occur because a business has become
overly reliant on a single product or market. Diversifying your product offerings or expanding into new
markets can help mitigate the impact of diminishing returns in one area. - Continual Learning and Adaptation: Be prepared to adapt to changing circumstances. Markets,
consumer preferences, and technologies are constantly evolving. A business that can adapt quickly and learn
from past experiences is more likely to thrive in the face of diminishing returns. - Cut Your Losses: While it’s essential to innovate and adapt, there may come a time when
it’s more prudent to cut your losses and exit a declining business venture. This can free up resources to
invest in more promising opportunities. - Seek Expert Advice: Don’t hesitate to seek advice from business consultants or industry
experts when dealing with diminishing returns. They can provide an external perspective and offer insights
that may not be apparent from within the organization. - Maintain a Long-Term Vision: It’s important to remember that not all investments yield
immediate results. Some ventures may experience temporary diminishing returns, but with patience and a
long-term vision, they can bounce back. Carefully weigh short-term setbacks against long-term potential. - Measure and Adjust: The key to effectively managing diminishing returns is to continuously
measure, adjust, and iterate. Your business strategy should be flexible and responsive to changing conditions
and should be based on data and informed decision-making.
Lessons From Netflix
Rather than stubbornly trying to salvage their original business, Netflix pivoted. They began the transition to
become a pioneer in the emerging world of online media streaming. This involved building out a digital
infrastructure and licensing deals to offer on-demand movies and shows. In 2007, Netflix launched its streaming
service, allowing subscribers to watch content online instantly. This move positioned them to ride the wave and
appeal to changing consumer preferences. As DVD rentals declined, Netflix was ready to thrive in the booming
streaming sector. The strategic shift enabled Netflix to avoid the fate of Blockbuster, who clung too long to
physical rentals and went bankrupt. Instead, by adapting to industry trends, Netflix capitalized on the growth
potential of streaming and thereby cemented its role as a leading entertainment powerhouse.
The Netflix story reinforces that companies need to keep assessing whether current models still offer growth, or if it’s time to pivot.
Recognizing diminishing returns early and having the courage to change course can mean the difference between falling behind and staying ahead of the curve.