Musings on Entrepreneurship and Innovation
Thursday, July 06, 2006Long Tail Economics
Chris Anderson wasn't the first to notice that market outcomes often express themselves in the form of a scale-free distribution. Duncan Watts, Philip Ball, Mark Buchanan, and Albert-Laszlo Barabasi have all written popular science books in the last few years that addressed how interactions among economic agents might be described in terms of self-organized criticality, phase transitions, and information cascades that give rise to power law distributions. So, too, have more business-oriented writers such as Nassim Nicholas Taleb and Paul Ormerod. Anderson, however, has provided a catchy name: The Long Tail. He also has some interesting insights into the interplay of supply and the shape of the demand curve that emerges as a consequence of socially contingent consumer decision making.
By now, lots of people are familiar with the graphical presentation of relationships where there are a very few instances of extreme values and whole bunches of also rans. Here is a fairly typical example of the plot of market shares against market rank in a consumer product category:
Through an examination of the online market for books and music, in particular, Anderson explains how the extent of the tail is revealed as the cost of production, marketing, and distribution decline. For example, when the cost of distribution is high, only the hits make it to market. When costs fall, greater variety is economically viable. There is nothing particularly new or controversial about that. What Anderson brings to life is how the sheer number of products in the tail can be enough to ensure a significant market opportunity for aggregators such as Google, Amazon.com, and eBay. While companies such as Sears have been aggregating the long tail for a long time, Internet technologies seem to be opening up an increasing number of such opportunities.
In addition, Anderson argues that increasing variety will also tend to flatten the market share distribution curve. As he puts it, greater availability "drives business from hits to niches." Howver, the evidence is inconclusive. Rajeev Kohli and Raaj Sah, in a study of the market share of 1171 brands in 91 product categories, found only a loose relationship between the number of brands in a category and the shape of the power law curve.
One critic has suggested, "The successful long-tail aggregators can pretty much be counted on the fingers of one hand." I'm not sure that's true. I'm familiar with at least one local company that is successfully leveraging the trends and techniques advocated by Anderson: PrintingForLess.com ("PFL"). (Disclosure: I've been an advisor to PFL's founder, and I'm a minor shareholder.)
PFL is a commercial printing company. Historically, the commercial printing business has been a local affair that has been driven by the quest for large print run opportunities that take advantage of relatively fixed costs. PFL, however, has turned the traditional model on its head. It has served some 60,000 small businesses throughout the U.S. with print orders averaging in the hundreds of dollars. It's been a successive member of the Inc. 500 by taking advantage of the following:
- PFL uses long tail advertising services such as Google and Overture to help draw prospective customers to its e-commerce website.
- Orders are paid for using credit cards, which helps to minimize the carrying cost of accounts receivable.
- Customers use readily available publishing software and Adobe Acrobat to co-produce their custom designs for business cards and brochures.
- PFL prints about half of all orders in its facility in Livingston, Montana, ensuring a very high rate of capacity utilization, which enables profitability while offering competitive pricing to consumers.
- Additional capacity is tapped by collaborating with a network of print partners throughout the U.S. This has the virtues of faster turnaround, lower inventory costs, and the increased flexibility of on-demand surge capacity. In turn, PFL provides its print partners with sales, customer relations, payment, and guaranteed digital pre-press services.
- The internet-powered logistics of UPS and FedEx are used to deliver finished products according to timetables and pricing chosen by the customer.
Until PFL achieves its ambition of becoming "America's Print Shop," it remains a nice example of a relatively small business that has a successful long tail strategy.
I enjoyed Anderson's book, notwithstanding his occasional tendency to veer into hyperbole:
Soon everything will make it to market and the real opportunity will be in sorting it out.
Fortunately, he usually reels the rhetoric back in:
I've described the Long Tail as the death of the 80/20 Rule, even though it's actually nothing of the sort. The real 80/20 Rule is just the acknowledgement that a Pareto distribution is at work, and some things will sell a lot better than others, which is true in Long Tail markets as it is in traditional markets.
What the Long Tail offers, however, is the encouragement not to be dominated by the Rule. Even if 20 percent of the products account for 80 percent of the revenue, that's no reason not to carry the other 80 percent of the products. In Long Tail markets, where the carrying costs of inventory are low, the incentive is there to carry everything, regardless of the volume of its sales. Who knows - with good search and recommendations, a bottom 80 percent product could turn into a top 20 percent product.
As the information content of products and services increases, I believe it likely that Anderson's right, and the long tail of demand will become more apparent across a widening range of consumer categories. His advice to "1. Make everything available" and "2. Help me find it" can be construed as meaning keep your options open in an environment of increasing uncertainty. After all, while the range of quality may increase as one moves from the "head" of the distribution toward the tail, tomorrow's hits are to be found in the tail.
