Chris Anderson's Long Tail Theory: Economics and Communication

Introduction

In the past, economics was dominated by vendors that sold large quantities of only one or two items. The Internet has changed the shape of product offerings. The new economic model, first made popular by Chris Anderson in an article published in Wired magazine, examines a fundamentally different approach to selling. This model is based on each vendor selling a large number of unique items in only small quantities each, with the result that the vendor sells fewer units of any single popular item. Amazon and Netflix are two of the best examples of companies applying this new business model. Chris Anderson explains his concept fully in the book The Long Tail: Why the Future of Business is Selling Less of More. Anderson is the Editor-in-Chief of Wired magazine, and the long tail economy is his most famous work to date. This paper examines this new theoretical model and compares it to traditional economic models.

Why the Need for a New Model?

The first question one might ask is why there was a need to develop a new theoretical model at all. The answer is straightforward: the effects of the Internet created changes to the economy that did not exist when traditional models were developed. The Internet changed the marketplace in ways that were largely unpredictable. When the idea of the Internet was first conceived, only a select few believed it would become what it is today. The Long Tail represents a new business strategy that has been applied successfully across a number of business situations, and its success has led to the development of new ways to apply it in other sectors of the market.

The long tail allows businesses to reduce distribution and inventory costs, enabling them to realize significant profit by selling small volumes of high-demand, low-supply items to a large customer base. Chris Anderson introduces the concept of "non-hit" items — a term that simply refers to items that are not the most popular. For instance, Amazon.com is known primarily as a bookseller, and bestsellers represent its most popular items. However, Amazon sells thousands of items that may not be the most popular or that target a primary market, yet sells so many of them in aggregate that the result is significant profit. The total volume of non-hit items is larger than the volume of popular bestselling novels.

The concept of the long tail derives much of its power from its ability to be applied to differing sectors of the market in a wide variety of situations. The long tail has been applied to research, experimentation, online business, mass media, and finance. It has also found its way into social networking and marketing, and it has been known in the insurance industry for many years, finding new applications every day.

The long tail is based on a concept that springs from traditional economic models: the frequency distribution with a long tail. The long tail is the name for a feature seen in some types of frequency distributions, also referred to as heavy tails, fat tails, Pareto tails, or power tails. They first began to be studied in the late 1940s and 1950s. The long tail distribution requires either a high-frequency or high-amplitude population followed by a low-frequency or low-amplitude population that trails off asymmetrically. From a statistical standpoint, events located at the end of the tail have little probability of occurring.

In the traditional market, the seller concentrates on selling a high number of units of only a few products. If one divides a standard distribution chart into four equal sections, it becomes apparent that mass marketing techniques focus on roughly 20% of the products a company offers — that is, only the most popular items, while practically ignoring the rest. These are generally considered high-revenue events in terms of both volume and revenues generated. Marketing efforts and sales techniques treat those products in the long tail portion of the distribution as insignificant add-ons rather than a primary source of revenue. The high-volume products represent less than 50% of total product offerings.

What Is the Long Tail?

Chris Anderson's long tail approach to business operations, by contrast, concentrates on the remainder of the items in the long tail. Those located in the long tail of the frequency distribution represent low-frequency, low-amplitude (revenue) events. The volume, in terms of chart area, of the long tail events can be equal to or greater than the 20% of events that traditional marketing chooses to concentrate on as a revenue source. Growing the tail longer can represent a larger overall volume than the traditional marketing model. This is essentially the core concept of the long tail model.

From an operations standpoint, all of the products a vendor offers require resources. They must be stored in a warehouse, shipped to that location from elsewhere, and then shipped to the final point of purchase when sold. This amounts to overhead whether the item sells or not. The traditional supply and distribution approach results in many items sitting in the warehouse consuming resources. The costs of those items must be supported by the 20% of items that actually sell well. Essentially, the bestselling items must make up for the overhead generated by items that do little more than take up space. This creates operational inefficiency and, in the long term, adds up to losses in retained income. Any drop in revenue results in a double loss under this model: revenue falls due to reduced sales, yet the costs of maintaining the entire inventory remain steady.

Using the long tail approach outlined in Anderson's book, the entire stock of inventory helps to pay for the operational costs of the whole. The long tail approach allows the retailer to generate sales from obscure items not found anywhere else. Inventory that is not on the bestseller list may not generate as much revenue as a more popular item, but it generates some revenue. In the bigger picture, the bestselling items no longer have to support their own weight and the weight of lower-volume items in terms of operational costs. The smaller items now support their own operational costs and do not reduce the profits of higher-volume items. This approach results in a more efficient system with little or no waste.

Anderson's long tail concept can best be illustrated by example. Random House Publishing was the example used by Anderson in the original Wired article. Random House offers many obscure books that are either unavailable in brick-and-mortar stores or out of print. The long tail represents a potential market that is untapped by traditional models, and the Internet offers many distribution and sales channels that allow businesses to adopt the long tail model efficiently.

In 1988, British mountain climber Joe Simpson wrote a book called Touching the Void, which chronicled a near-death experience in the Peruvian Andes. At its first release it experienced only moderate sales, and, as with many books that do not make the bestseller list, sales soon faded to nearly nothing. In 1998, nearly a decade later, another author, Jon Krakauer, wrote a similar book called Into Thin Air, also about a mountain climbing tragedy. This book became an almost overnight sensation — perhaps not because it was better written, but because the author did a better job of marketing and promotion.

This is where the long tail model comes into play. After the success of Into Thin Air, sales of Simpson's 1988 book began to pick up as well. Suddenly, Random House faced increasing sales of a book that had been sitting in their warehouse taking up space and consuming operational costs. Now this previously stagnant book was generating revenues and paying for its own operational costs. Random House rushed out a new edition to keep up with demand and devised a promotional strategy where both books would be placed next to each other on shelves. Sales for both books continued to rise simultaneously. Their next move, according to Anderson's article, was to issue a paperback edition. This once-overlooked book then spent 40 weeks on the bestseller list. The story was picked up by a film company and released as a film, after which sales of Touching the Void nearly doubled those of Into Thin Air by approximately 2 to 1.

In Anderson's example, both books were promoted through traditional bookstores, but Amazon.com was the main sales channel. One of the key factors in this phenomenon was that the online bookseller used software that tracked buying habits and suggested that people who liked Into Thin Air would also like Touching the Void. Readers followed the recommendation and left excellent reviews, generating more sales through algorithm-based recommendations and creating a positive feedback loop for the first book. This is an excellent example where the Internet and algorithm-based marketing techniques are the key to success using Anderson's long tail economic approach.

The general idea is that small-volume product sales of multiple products lead to the generation of more small-volume product sales. These have a summative effect, resulting in a greater overall volume than a single high-volume product. In this case, the sales of a bestselling, high-volume product initiated the long tail effect of a smaller-volume product. Random House saw the opportunity and acted on it. Had Random House not released the second edition and the movie tie-in, it is likely that demand for Touching the Void would have fallen again once shoppers found it was unavailable.

Now consider a model involving numerous bestselling products and numerous low-volume products. In such a model, the initially higher-volume products fell sharply over time, but in the long run they generated interest in the previously lower-volume products. This works particularly well when the products are related, such as books. However, it also works for products such as electronics, where add-ons can be marketed alongside the primary product. One example is the iPhone. When people purchase an iPhone they have the option to purchase carrying cases, skins, and thousands of apps. These add-ons are priced much lower than the initial iPhone purchase, but they increase sales revenues significantly. The sale of apps serves to extend the long tail of iPhone purchases through small-revenue item purchases over a long period of time. Upselling extended service contracts is another way of extending the long tail of an initial purchase, as is offering software with an optional monthly subscription service.

Without these add-on services to extend the long tail, sales of the initial product would follow the standard bell curve. By introducing a next-generation product into the long tail of the initial product and its add-ons, developers can take advantage of the cycle repeatedly. It should be noted, however, that in the case of technology products, the release of a second-generation version can cut off the long tail of the first release — a decision often forced by competitive pressures. This argument takes Anderson's principle further than he did in his book, but it demonstrates how it can be applied to market developments that are a result of technology and the Internet.

The older economic model that relies on high-volume sales of bestselling items to carry the entire operational costs of a company now appears to be a shortsighted approach. The long tail approach, by contrast, appears sustainable and focused on long-term growth. It is also the most cost-effective approach from an operational cost perspective. Under this model, every product must carry its own weight in terms of covering its own expenses.

The long tail approach also makes more sense from a risk management perspective. The traditional economic model that depends on a small basket of high-selling items to carry operational costs for the entire company is inherently risky. A failure to generate revenues from any one of these products significantly impacts the ability to cover operational costs for the rest of the company. Under the long tail approach, risk is spread over the entire basket of products. If demand drops for one item, the effect will be insignificant, and other items will not suffer. The long tail approach can thus be viewed as a form of diversification and a risk management technique.

If one considers Amazon's operations, they are a perfect example of the long tail approach. The key to their success is the algorithm that matches customer interests and achieves the upsell using statistical profiling. Many online merchandisers use similar tactics to increase their total sales volume. eBay uses it as well by collecting information and building a customer profile that it uses to present items of potential interest when a customer first visits its page, and by sending emails suggesting items of interest to individual customers. These techniques represent individualized, personal marketing that would not be possible without the Internet.

Conclusion

The list of supporters and critics could go on for a very long time at this point. In general, the critics could find very little to criticize in the theory itself, and many of their arguments were related to the consequences of long tail theory and its overall effect. At this point, based on numbers, there appear to be more supporters of Anderson's theory than critics. Anderson's theory has gone from a simple economic principle to become a standard part of today's business jargon (Pearlstein). It now represents a concept that includes leveraging all of a company's resources rather than concentrating on only the biggest sellers.