The magical diminishing returns link, and why it can fix government budgeting (and yours, too)

A couple of years ago, I was honored to be invited to help with a US government budget. My team and I would fly to Washington, take the metro into Union Station, and meet with our clients, who were struggling with an important question: “how to do more with less?” as they distributed funds to hundreds of departments.

In the midst of the project, sequestration loomed, and then materialized, so this question became critical.

We were happy to be able to do some good work for this client, using a bit of statistics, some regression, R (which I love), some World Modeler, and finally a good dose of roll-up-your-sleeves data gathering and management.

Along the way, we discovered something a bit magical: the “diminishing returns” S-shaped curve. I know, it sounds technical, but bear with me, because it’s the key to doing more with less, which is exciting for both the right and the left.

The curve looks something like this:

On the X-axis, there is some investment. At the personal level, this might be how much you budget for a new computer, how much you spend on expensive organic food, the price of your child’s education, the amount you spend on a house.

On the Y-axis, we see a shape that’s similar in many situations: as we spend more money, we get some benefit, but there’s a point where it levels off.   A $10,000 computer is probably only a bit more valuable for you than one that costs $1,000…A million-dollar-house might not really making you happier than the one that costs a tenth of that amount.

In a business setting, this kind of curve often holds, too. After spending a certain amount on employee training, an additional investment in training levels out in terms of the benefit to the business. After you’ve spent a certain amount on a lavish Christmas party, doubling that amount doesn’t give you double the fun. And so forth.

So, if you could connect the dots between your investments and their eventual impacts, you could know the point at which the next dollar provides less value for Investment A, and more for Investment B. Save that next dollar for the Christmas party and spend it on laptop upgrades. It’ll have a much greater benefit. Save that next dollar from one health care program and spend it on an education program. More bang for the buck.

Of course, we can’t always trace spending all the way down the path from investment to goals. For most, the process is as much an art as a science.   But it turns out that humans do imagine these future paths, as best we can, when making decisions.

And we can do better than invisible paths. Draw the chain of links, talk with your colleagues, and see if you can find any diminishing returns links (they’re everywhere) . When you do, re-allocate budget to where it can do more good. Then re-allocate again when you reach the flat part of the new curves.

As talk of sequestration in the next year grows, I hope they’ll invite us back.

(PS here’s a related webinar)

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