The Economics of the "Long Tail" Is Transforming Business Models

Most people have heard of the 80-20 Rule. It was formulated in 1906 by an Italian economist named Vilfredo Pareto. In its original form, it states that 20 percent of the people will hold 80 percent of the wealth in any free economy. Further research has shown that it applies to many other aspects of the economy.

For instance, it predicts that 20 percent of a movie studio’s films will produce 80 percent of its income. The same rule applies to books, TV shows, clothing, and other businesses where the free choice of a lot of individuals determines a product’s success or failure.

The flip side of this rule is the Power Law Effect. Power laws have been observed in nature for a long time. One of the first careful observations was by scientists who study earthquakes. They noticed that lots of small earthquakes happened all the time, but big ones occurred a lot less frequently.

They came up with a mathematical formula that described the relationships between frequency and magnitude, which they called a power law. It turns out that the frequency of a given type of earthquake varies as the three-fourths power of its magnitude ? which is just a fancy and quantitative way of saying that the big ones happen a lot less frequently.

If we look at a graph of those earthquakes, we’ll see a few really big ones bunched up on the left side, and then a gradually diminishing tail stretching down to almost nothing toward the right. This graph shape has recently come to be called “the long tail.”

More recently, researchers have discovered power laws in almost everything from the weather to social and economic systems. One of those socio-economic systems is the Internet. It turns out that the popularity of blogs is ruled by a power law. So is the popularity of any given movie that Netflix rents, or any book that Amazon sells. In fact, anything you can rank in a system where people choose freely turns out to follow a power law and to have a graph that looks like a big head with a long tail.

The mathematics of this isn’t complicated. The value for the Nth position will be one-over-N. In other words, the value of the second place item is half that of the first place. The 100th item on the list will be one-one-hundredth the value of the first place, and so on.

Another effect of power laws in this type of system is that most of the items or events are going to rank below average. In other words, if you look at a system of hit movies and rank them all to get an average number for earnings, the largest number of movies will rank below the average earnings, and there will be a lot of them.

In addition, the larger the number of individual choices in the system, the larger the gap between the top-ranking item and the median.

This has profound implications for people doing business on the Internet. For one thing, it completely turns the notion of a hit ? whether it’s a record, a movie, or a book ? on its head.

Take the example of Amazon. Barnes & Noble carries about 130,000 titles on average. But more than 50 percent of book sales at Amazon are not from its top 130,000 titles.

The editor-in-chief of Wired magazine, Chris Anderson, coined the term “long tail” and described its effects in a magazine article that pointed out an intriguing phenomenon: The market size for books that traditional bookstores do not stock is greater in total than all the best-sellers combined.

This is a direct result of the fact mentioned earlier, that most of the rankings are below average. The number of sales for any individual item on Amazon is small. But the cumulative value of all those below-average sales is greater than all of the above-average sales. As Kevin Laws, a venture capitalist, succinctly put it: “The biggest money is in the smallest sales.”

Now that economists are looking more deeply into the subject of long tails, they’re finding them everywhere. And their value is enormous.

Blockbuster carries about 3,000 movie titles in its average store. But 20 percent of rentals from Netflix don’t include any of those A-list titles. Rhapsody is a site for downloading music. Each month, it sells more songs that are not in the top 10,000 than it sells of the hits. Likewise, Google makes most of its revenue from its smaller advertisers, and eBay makes its money from the millions of small sellers.

This phenomenon has another effect that will shape future markets, and this illustration will help illuminate how it works:

Joe Simpson was a mountaineer who wrote a small memoir in 1988 about a near-death experience he had while climbing in the Peruvian Andes. The book came and went without much fanfare, except among fellow mountaineers.

About 10 years later, Jon Krakauer’s book Into Thin Air about a deadly expedition to Mount Everest became a best-seller. For reasons no one could explain at the time, sales of Simpson’s book began surging. Random House, Simpson’s publisher, issued a new edition, which was displayed in bookstores alongside Into Thin Air.

A dramatic film of Simpson’s book, Touching the Void, was released, and the book hit the New York Times bestseller list and stayed there for 14 weeks. Before it was over, Simpson was outselling Krakauer by more than double.

When the dust settled, industry analysts were able to sort out what had happened. It turned out that when customers looked up Into Thin Air on Amazon, a banner appeared underneath, saying, “Customers who bought this book also bought Touching the Void.” Amazon’s collaborative filtering software had alerted readers to the existence of this obscure book, and they loved it. They in turn, posted glowing reviews at the site, which pushed more sales, and a self-reinforcing cycle ensued for a book that was on the verge of being out of print.

This could not have happened just a decade or so ago. The reason is simple: Physical space constrained sales. The reason that Blockbuster has only 3,000 titles is that everything has to fit inside a bricks-and-mortar building. This limitation had dramatic effects on what could be made available.

For example, a movie theater needs to sell at least 1,500 tickets during the first two weeks that it shows a movie just in order to pay its rent. An average small record store has to sell two copies of any CD it carries to pay the rent. In fact, Wal-Mart has to sell 100,000 copies to make it worthwhile to put a CD on its shelves. Some version of that formula applies to all retail businesses.

Moreover, the geographical area a store can serve is limited by people’s willingness to travel to it. This led to a system of hits and bestsellers. If you could sell thousands of a single item, you could afford to carry a few less popular items. This has resulted in the wide release of books and movies that appeal to the least common denominator of taste, and it explains why we have big bland movies and books. They’re the result of a very cumbersome supply chain, in which even a product with the potential to sell millions couldn’t do so unless the millions were all concentrated in a small geographical area. Under this system, the film “Triplets of Belleville,” which was nominated for an Oscar, was shown on only half a dozen screens in the entire country.

But suddenly, with the advent of the Internet, the dual problems of physical space and geography went away. Songs could be downloaded. Books and films could be mailed to consumers at lower than in-store prices. Moreover, the selection was virtually unlimited.

Because the selection was searchable, the consumer began moving deeper and deeper into the catalog, pushed there in some cases by filtering software, reviews, or other means set up by the seller. And there, deep in the catalog of possibilities, people began finding things that they not only wouldn’t have thought of on their own, but things that they liked. And as with Touching the Void, they recommended them to their friends.

As that trend took off, the sellers, such as Amazon and Netflix, began to recognize that more of their revenue was coming from the bottom half of the list than from the top.

So this phenomenon of the long tail is not only presenting us with a new business model, it’s changing the culture by broadening people’s taste. This has led to phenomena like Ecast digital jukeboxes in bars, which offer more than 150,000 tracks. While most people would assume that a small number of those tracks would generate most of the revenue, in fact, 99 percent of the top 10,000 titles get played each month.

When you remove the physical constraints and the rule of scarcity that it creates, something very interesting happens. Rhapsody, for example, has 735,000 songs that customers can download. The songs sell according to a power law, with big sales for the top few items, which then fall off steeply on the curve to form the long tail.

The average record store has about 40,000 tracks. If you look at what happens below that in a real-world store, say Wal-Mart, you find that there is no long tail. The sales drop precipitously to zero, because they simply don’t carry the rest of the list. But at Rhapsody and all the other long-tail businesses, the sales keep driving right down to the end of the tail. It doesn’t matter how long the tail gets. At Rhapsody, there are sales each month for the top 400,000 songs. That’s an astounding order-of-magnitude difference when compared with a bricks-and-mortar store.

Some businesses cannot, by definition, have a long tail. A grocery store, for example, must sell physical groceries on the spot. The cost of storage and distribution of inventory is the determining factor. But when inventory costs fall to near zero, suddenly even the most unpopular items can be sold. And those unpopular items, in aggregate, outsell the popular ones.

Having said that, it’s important to emphasize that hits are still an essential ingredient ? the long tail must have a head to provide an entry point for consumers. That’s why the formula at Amazon worked: People went looking for Jon Krakauer’s bestseller, an obvious hit, and that drew them into the tail, where Joe Simpson’s nearly-out-of-print book was languishing.

An example of what happens to a tail with no head came from a 1997 experiment called MP3.com. The idea was to transform the way music was distributed by allowing any musician to upload his songs. People could then pay a fee to download the music. The trouble was that most of the start-up bands weren’t any good; and even when they were, there was no mechanism to let people sort them out. There were no big hits to lead the way. MP3.com never got off the ground.

In Wired,2 Anderson outlined three rules of long-tail marketing that seem to make sense in this atmosphere:

First, make everything available. You never know where you’ll find revenue. Every niche has potential. India produces hundreds of so-called Bollywood films each year, and although there are almost 2 million Indians in the U.S., few rental stores carry them. Netflix does, and they rack up 100,000 rentals a month.

Second, cut the price in half, then lower it. Rhapsody experimented with a 49-cent price on downloads and tripled its sales.

Third, help the customer find it. The successful long-tail strategy pushes consumers deep into the catalog by learning what they like and guiding their explorations.

In light of this compelling trend, we offer six forecasts for your consideration:

First, in the next five years, expect to see long-tail strategies spread rapidly in the media and cultural industries. This approach will have the greatest impact on industries whose production, marketing, sales, and distribution are dramatically improved by migrating to the Internet. New technologies, including software aimed at improving the economic upside, will flourish.

Second, as pointed out by David Hornik, the aggregators and filterers are going to be the big short-term winners. Hornik is a long-time strategic communications and public relations advisor to VC-funded start-up companies and also writes VentureBlog.3 He foresees that the aggregators will enrich the long tail with as much content as possible, no matter how unpopular it seems. These will become the one-stop shopping sites. The filterers will guide consumers to the content, and many aggregator sites, such as Amazon, will do their own filtering.

Third, as more and more businesses scale up toward becoming true aggregators, expect a proliferation of affiliate programs and content syndication, as the customers become the filterers for their site content. We’ve already seen this in Amazon, but it will spread even more rapidly. Specialized solutions that do nothing but help consumers navigate the amazing richness of offerings in these long tails will win big.

Fourth, as the established entertainment companies recognize the long-tail phenomenon, they will begin to reissue long-dead titles for music, movies, and books, just to name a few. For example, when a film has been amortized to zero, any revenue is profitable. Although each title will appeal to a relatively small niche, the aggregate revenue will be large. In addition, new technologies, such as publishing-on-demand, will make it more and more possible to make everything available all the time.

Fifth, no one piece of content will increase in value because of a long-tail strategy. The system as a whole will grow. In other words, the long-tail strategy will occasionally push an obscure title up toward the head and improve its popularity, but that won’t be the general rule. The greatest benefit ? and money ? will accrue to the long-tail business itself, rather than to any particular artist represented within it. But as the functioning of long-tail systems becomes better understood, people will develop and automate strategies for taking advantage of them to push titles up the list. One of the first places this will happen is in the area of blogs. Some will become popular enough to qualify as mainstream media and be leaders in selectively directing consumers to content in the long tail.

Sixth, the aggregation of small audiences will gradually drive the price of entertainment down, as competition intensifies for the same share of a consumer’s attention. Movie theaters as we know them will become far more rare and exclusive, while home entertainment becomes more sophisticated and cheaper. When a given channel can aggregate audiences over the entire U.S. or even the globe, even a small niche can become part of a competitive strategy. Big hits and blockbuster bestsellers will still sell at a premium, but the vast majority of entertainment and cultural output will be cheap and readily available.

References List :
1. WIRED MAGAZINE, October 2004, “The Long Tail,” by Chris Anderson. ⓒ Copyright 2004 by The Conde Nast Publications, Inc. All rights reserved.Link: www.wired.com/wired/archive/12.10/tail.html 2. ibid.3. To access David Hornicks commentary “Wheres the Money in the Long Tail?” visit the VentureBlog website at: p6.hostingprod.com/@ventureblog.com/articles/indiv/2005/001227.html