Several people have mentioned that our latest estimate of between 20% and 36% for Amazon's Long Tail book sales is "not far off from the traditional 80/20 rule," suggesting that this somehow minimizes the significance of Long Tail markets. I think this is a mistaken reading of the 80/20 rule in the Long Tail context (although that's easy enough to do, given that I've been guilty of it myself from time to time). Let me try to help clear it up here.
The 80/20 rule is one of those phrases that means pretty much whatever you want it to mean. But in retail, it typically refers to the rule-of-thumb that 20% of products in a category account for 80% of the sales. It's basically the economics of hits: a small number of bestsellers account for most of the business. Such skewed distributions are common to almost all markets, even Long Tail markets (although they're not as skewed)--it's simply a function of powerlaw distributions, which are ubiquitous.
What's different in Long Tail markets is the consequence of that skewed distribution. After failing a few times to describe clearly in words how the Long Tail changes the 80/20 rule assumptions, I've drawn this graphic in hopes that it will be clearer:
What this graphic shows on the top is a simplified traditional retail scenario in which 20% of the products account for 80% of the revenues and virtually all of the profits (because high-turn products use shelf space more efficiently). But in Long Tail market at the bottom, where shelf space is infinite and the cost of carrying a niche product is roughly the same as carrying a hit product, three things change:
- You can offer many more products.
- Because it is so much easier to find these products (thanks to recommendations and other filters), sales are spread more evenly between hits and niches.
- Because the economics of niches are roughly the same as hits, profit is spread as evenly as sales.
Now let's apply this to the Amazon case. We've revised our estimate of Amazon's Long Tail sales, from 57% to 25%-36%. This refers to the portion represented by yellow bars in the graphic above--sales of books not available in bricks-and-mortar retailers, such as Barnes & Noble. (The graphic is just representative; it's not real data. But for the sake of argument, you can imagine that we're using the low end of our current estimate and the Long Tail book sales are the shown 25% of total sales.)
What are the consequences of this change? For
starters, it simply puts Amazon back in line with the other Long Tail
retailers we've analyzed, Netflix and Rhapsody, both of which have
between 20% and 30% of their sales in products not available in their
main offline competitors. Note that in the year since we began our
research on this, those numbers have all gone up. Rhapsody, for
instance, went from 23% to 28% in that year. So although we corrected an analysis error in Amazon, the numbers are still significant and are getting larger.
Secondly, don't think that sales of books not
available offline is the only Long Tail effect. Amazon also sells more
of the niche books that are available offline (thanks to its
recommendations, search, reviews and other features that have the effect
of flattening the demand curve), and it makes more money on those niche
sales because they don't consume scarce shelf space. Combined, you get
the profit picture in the bar on the bottom right, which is the result
of all these effects.
Now let's go back to the 80/20 rule. One way of looking at it is to observe that the Long Tail effect actually makes the 80/20 phenomenon worse. Now, because you have so many products available, the hits that still represent most of the sales become an even smaller fraction of the total inventory. For instance, in the case of Rhapsody, which has a million tracks, it's closer to an 80/8 rule: just 8% of the songs account for 80% of the sales. That's what happens when you can add products without limit to your inventory; the percentage that sell a lot shrinks.
Which leads to an important Long Tail lesson: it's not about about percentages. It's about absolute sales. Each niche item may not sell a lot, but because there are so many of them and because you can sell them so efficiently, the aggregate sales over all the niches can add up to a big new revenue--and profit--source.
My original thesis regarding the 80/20 rules was the following, which is a bit more subtle than simply the end of 80/20 (despite my occasional bombast along those lines):
"The products that represent 80% of sales at a traditional bricks-and-mortar retailer will account for just 50% of sales at a Long Tail retailer. The rest--including all the products that are not available in traditional retail at all--will account for the other 50%."
You can see this in the above graphic. The 20% of products (red area in the top left) represent the 80% of sales (top middle) in traditional markets, but those same products are just 50% of sales in Long Tail markets. I sometimes sloppily shorthand that by saying "the 80/20 rule is turning into the 50/50 rule". But since that shamelessly changes the definition of the terms from one end of that sentence to the other, I can see why there's been some confusion. My bad.
You might wonder whether this thesis is turning out to
be true as we collect hard data. So far, it's looking pretty close. The
top 1,500 albums represent 80% of CD sales in traditional retail,
such as Wal-Mart,
but only 40% of the sales on Rhapsody. Netflix data is looking closer
to 50%. And, once we get our Amazon methodology more solid, I'll be
able to test the thesis against that, too. I'll let you know.