Diminishing Returns is one of those economics terms. Basically, it means that the more you put in, the less you get for each unit.
Consider something like point-buy attributes for D&D, or raising one’s stats with experience points in typical games that allow such things (such as most White Wolf systems.) If you want that 18 Strength or 5 Presence, it’s going to cost you.
Systems that have diminishing returns have a pressure built in to make people well-rounded: if you have a well rounded character, you have more total effectiveness to go around. What stops people from having all their stats at 13? ALL systems, by nature of play, will not rely on each attribute equally. If you know what type of rolls you’ll have to make more often than others (either because of genre, system, or character niche), it’s in your interest to specialize.
Consider HERO for a moment; buying five more points of strength costs only 5 points, whether your Strength is currently 10 or 100. While the nature of HERO combat is such that there’s often a rock-paper-scissors element to defenses, it’s almost always in one’s best interest to raise their offensive (or otherwise definitive) powers as high as they can get away with, thus the prevailing HERO doctrine of ‘active point limits’ and the like.
With diminishing returns however, there’s two opposing forces, and the question becomes: is this increased effectiveness in my area of specialization worth the price I will have to pay for it? Answering that question becomes a (strategic) task in and of itself, and becomes one more area of challenge for the player.
So next time you see escalating costs for a skill or power or what have you, remember that you aren’t being punished- you’re being challenged. What’s it going to be?