Without us even realizing it, diminishing marginal returns are deeply present in our daily lives—and digital marketing is no exception. They significantly impact the performance of your campaigns and the budget planning of your media strategy.
In this article, Benoit Bédard, Media Director at Hamak, shares his analysis to explain the concept of diminishing marginal returns in marketing and highlight the importance of integrating it into your strategies.
The law of diminishing returns and its application
At its core, this economic principle can be summed up as follows: the more a production factor is used, the less additional value it generates over time.
To illustrate this in everyday life, let’s look at a few simple examples. Our first coffee in the morning usually brings us the most utility and enjoyment. Depending on our consumption habits, we might have a second or even a third cup, but these won’t have the same impact as the first.
We can observe the same principle with income: each additional increment brings diminishing benefits. Initially, income is used to meet basic needs such as housing and food, essentials that provide high utility. Once these needs are met, the remaining income can go toward leisure activities like concert tickets or travel, which still offer value, but less than basic necessities. As income continues to rise, wealthier individuals often spend on increasingly luxurious goods, which bring significantly lower, or even negligible returns in terms of benefit.
Very concretely, a person who goes from an annual income of $40,000 to $60,000 gains much more utility than someone moving from $80,000 to $100,000. At the extreme, a billionaire would gain virtually nothing from that same $20,000 increase.
Understanding the basics of diminishing returns in digital marketing
As in many areas of life, the law of diminishing marginal returns is a fundamental principle in digital marketing. The more a company invests in its advertising campaigns, the lower the marginal return on that investment tends to be.
The reasoning is simple: if a business invests $100,000 annually in advertising and decides to inject an additional $100,000, it’s likely that the second portion will target a less qualified and therefore less profitable audience. After all, if that audience had been more valuable, it would have already been included in the initial investment. Of course, this assumes the strategy is managed efficiently and optimally.
The basic principle behind diminishing marginal returns is that all resources are limited. In digital marketing, this is illustrated in paid search by the finite number of searches related to a company’s products or services, or in social advertising by the limited size of a qualified audience. That’s why the more a company invests, the more it must gradually move away from its ideal target, because the number of users genuinely interested in its offerings is also limited.
Let’s take the example of a company that wants to generate as many leads as possible through its digital campaigns and, for the sake of simplicity, has only two advertising channels available: paid search and social advertising. In the first year, it will allocate its budget to the placement that delivers the highest possible return on investment.
In the case of our fictional company, it invests $100,000 in paid search, initially focusing on an audience that has shown strong interest in its services, the right person at the right time. Since this investment isn’t enough to cover all search queries related to its services, the company can even concentrate on keywords that reflect the highest purchase intent.
The following year, the company’s leadership is pleased with the results and decides to double its digital campaign investment to generate even more leads. Since the campaign manager is running an efficient strategy, the initial $100,000 budget already covers the highest-intent search queries. As a result, the additional $100,000 must be allocated to keywords that are still relevant to the company’s services but have a slightly lower purchase intent. The incremental cost per action (CPA) for this second investment is naturally higher, which increases the company’s overall average CPA
In the third year, the company’s leadership wants to increase the budget by another $100,000. However, it reaches a point where it’s no longer possible to invest in the same tactic, as all relevant search queries for its services are already being covered. With its paid search budget fully saturated, the company shifts toward placements focused on consideration and brand awareness, targeting users who fit the profile of its typical customers but who haven’t necessarily shown purchase intent (the right person, but not quite at the right time).
The campaign manager therefore suggests investing in social advertising targeting a qualified audience that isn’t actively in the buying process for the company’s services. The incremental CPA for this third round of investment is higher but still remains profitable for the company.
Of course, this scenario is greatly simplified to illustrate the concept, but the idea is straightforward: the more a company invests in digital campaigns, the further it must move from its optimal target. When campaigns are managed optimally, each additional investment must be directed toward placements that are progressively less effective—resulting in an incremental (and average) CPA that increases along with the investment level.
Optimizing budget planning with diminishing returns in mind
Now that we’ve defined diminishing marginal returns and their foundation in digital marketing, it’s important to highlight their impact on a company’s budget planning. In fact, evaluating them is essential to answer two key questions: how much should we invest in our digital marketing campaigns, and how should that investment be allocated across different media placements?
The first question is relatively straightforward to answer. From a purely theoretical standpoint, a company should or at least could invest up to the point where the marginal cost of acquiring a new customer equals that customer’s marginal benefit (i.e., their estimated lifetime value). For example, if a company estimates its customer lifetime value at $1,000, it could theoretically invest until its marginal CPA reaches $1,000.
Of course, in practice, companies typically factor in a minimum profit margin. However, what’s most important is to rely on the incremental CPA from the last round of investment, not the average CPA across the entire budget which is a common mistake. In fact, if a company invests up to the point where its average cost equals its average return, it will generate no profit at all. But if it invests up to the point where its marginal cost equals its marginal return, it will capture all available profitability and maximize the profits generated by its digital marketing efforts.
Analyzing diminishing marginal returns also helps optimize how a company allocates its budget across different advertising channels. Ideally, the incremental CPA of each channel should be equal if the goal is to maximize return on investment.
The reasoning is simple: if the incremental CPA differs across channels, part of the investment should be reallocated from the channels with a higher incremental CPA to those with a lower one. Once again, the most common mistake is to use the average CPA of each channel to guide budget distribution. However, this analysis is flawed because different tactics have different return curves. That’s why it’s always the incremental CPA, not the average, that should be used for optimal allocation.
Limitations
It’s important to note, however, that there are certain situations where the principle of diminishing marginal returns may be less applicable.
First, if a company’s budget is so low that advertising algorithms don’t have enough data to optimize effectively, an additional level of investment may actually generate higher returns in this specific case.
Second, if digital campaigns are not being managed efficiently, improving targeting can lead to better returns even with a higher level of investment.
Finalement, si l’on débloque de nouveaux marchés, et donc qu’on élargit notre cible, que ce soit par la commercialisation de nouveaux produits ou une expansion géographique, il est évidemment possible de contourner temporairement le problème, car on élargit le bassin de ressources limitées.
Finally, if new markets are unlocked whether through the launch of new products or geographic expansion the issue can temporarily be bypassed, as the pool of limited resources is broadened.
Final thoughts
In conclusion, diminishing marginal returns have a significant impact on the results generated by your digital campaigns. It is therefore crucial to calculate them properly and factor them into your budget planning otherwise, your strategy cannot be truly optimized. In an industry that places a great deal of emphasis on technical optimizations, it’s important not to overlook the fact that high-level strategy and media planning are just as capable of being refined and optimized to drive stronger performance.
