The 80/20 Rule Revisited

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:

1. You can offer many more products.
2. 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.
3. 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.

Comments

[John "Z-Bo" Zabroski]

Chris, you said "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." I am not going to debate how many there are, but in two of your "three changes" you group causation with effect. Do the causations change as well? If so, that's a dangerous proposition because you are saying the "factors for change" in changes #2 and 3 might be substitutable. In other words, as an example:

2. 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.

Might be read as, "Because [there is a change in ways to find these products]," causation seperate from effect, "sales are spread more evenly between hits and niches." From how I read that, what that would mean is there are actually multiple forks in the way things may change depending on the causation. The premise is if something changed before it can change again, which might imply that every time there is a change in the ways to find (and maybe even use) products there is a change in the way sales are spread. That's very general but it also might just be true.

I also don't think filters necessarily make it easier to find products, it just makes it easier to stare at the shelf. In other words, I may be interested in buying a product (A) unrelated to another product (B) but the filters unintentionally (due to imperfections in filtering) include noise (product B) so I buy product B instead of A. Comparably, if I go into Barnes & Noble store, everything is grouped according to genre. But if I search for something online with Amazon everything is grouped by the search filter. It's a different way of browsing. Also, similarly, a recommendation doesn't necessarily make it easier to buy a book... i.e., the more diametrically opposed and passionate the reviews are for the book I am looking at the more confused I am (just one example). You may want to phrase it "helpful filters and recommendations."

[Shawn]

All in all, it looks like online retailing in entertainment (music, books, dvd's, etc.) is a better retailing model than bricks-and-mortar. The theory behind it is interesting. But what I see, from a marketing perspective, that lurks in the shadows of all this, is the guy that makes the book, cd, dvd... The writers, the actors, the producers, etc. It's not exactly in their best interest for the consumer to be free to wander into niches. Artists want hits, in general... and they'd do almost anything to get it. They don't want to be a loser. That's where I see a major vested interest that would have a problem with all this freedom bestowed on consumers...since TV, music, and movies, rely on a captive audience, or limited shelf space, in order to build a following and give a resonable probability of success. If the products are virtually unlimited, and just a click away, the capitive audience effect is going to erode away... and consumer "tastes" will get much broader than ever before, and the number of products will grow and grow... which will draw revenue from where it used to go before, I think. It's gonna get tougher and tougher to buy an audience, with all of these choices available.

[Jakob Nielsen]

It would be nice if you could also present an analysis of the changes in the "profits" bar. After all, profits are what really matters to companies, not sales.

In your diagram, the 90% of products in the tail account for 25% of sales (credible) and 25% of profits (maybe). I can argue for both why profits should be smaller and why they should be larger.

Why profits may be a smaller percentage:

Shelf space is not free, even in the virtual world. Let's say you have a traditional e-commerce site with one product page per item you sell. This means that you need ten times as many product pages on your site if you go down the tail.

On some sites, product pages are created by humans: a real cost per page. On other sites, product pages are mainly created by importing data provided by the manufacturer (i.e., publisher/or author, in the case of a book). These pages are free if nothing goes wrong and nothing ever changes. In the real world, there needs to be a support team in place to deal with updates and corrections, and the size (and thus cost) of this team scales by the number of products.

Thus, if you have ten times as many products, you may not have ten times the expense of maintaining your product pages, but something close to that.

Why profits may be a bigger percentage:

Most of the revenues from the tail products are direct contribution margin, under the assumption that all the fixed costs of your operation are allocated to the 10% of products that you would be selling in any case. For example, you need to develop an e-commerce site in any case, you need a fulfillment warehouse in any case, you need customer service in any case. These costs are bigger if you sell 1/3 more, but the costs don't increase by 1/3.

We should think on the margin, that's what they always teach you in economics. In other words, going from tail-out to tail-in gives us that last 25% of revenues but only increases costs by maybe 10%. Thus, profits would increase by a larger percentage.

It would be very interesting if you could dig out some real numbers for these marginal costs so that we could get a better estimate for the incremental profits caused by adding long-tail products.

[chris anderson]

Jakob,

Excellent suggestion. I'm not sure how much detail I'll get on those marginal costs, but it's the right question to ask. Perhaps for the post-book research project, which is bound to run for a long time...

[Matt]

Of course artists want hits. But the point of the Long Tail hypothesis is that, in the new market, "not a hit" is not the same thing as "loser".

It goes without saying that everybody wants to be in the top 5%. But, by definition, 95% of those who try to get there will fail.

Moreover, fashions being the fickle creatures they are, today's hit is unlikely to remain a hit tomorrow. Even to those drawing "hit" revenue today, they're better off long-term in a market where ceasing to be a hit doesn't mean the money supply completely dries up.

[Shawn]

To me, what stands out is not the stats, but the idea that limited shelf space, in effect, allows for companies to buy themselves a monopoly, and, to a great extent, control the direction of consumer trends and fads. It's a great tool for a huge company to take advantage of. If this is taken away, these companies stand to lose a lot of power in the market. They will, and have, tried to fight it... so it may not quite get off the ground in a major way, in the fashion it seems to be getting discussed here...

As an aside, I wonder if this will unleash a bit of chaos in the market, where the fads and trends come completely unglued, because everyone is splitting off in different directions? All I gotta say is, there are a lot of companies, indeed whole industries, that should be feeling really uneasy right now....

[Greg]

This is somewhat off topic, but here it is anyway.

I've been following this blog since day one, and the oft used phrase "infinite shelf space" has been rubbing me the wrong way. So far it has only been spoken about in a positive light (from what I've seen, but I haven't reall ALL the comments). But doesn't infinite shelf space lead to infinite risk? And how are companies like Amazon.com positioning themselves to handle this risk? Amazon.com has done a tremendous job of branding their longtail, but what happens when a customer has a bad experience buying a book and says to themselves "I'm never buying from Amazon.com again!"? Amazon.com's huge longtail is then bypassed by that customer.

Or, on the other hand, is the risk so spread out that the business model remains stable? I suppose if Amazon.com makes a foray into a new business that fails, they would survive because of Harry Potter sales (or any other blockbuster release). But ultimately can a company sustain itself like that? To become a Wall Street darling (not every companies goal, I realize) it has to prove it is good at risk aversion, not the other way around. It seems to me a company that defines its own longtail, rather then just being a small segment of a greater longtail, will always be risking business.

[chris anderson]

Greg,

That's an excellent point: how do you maintain quality control down the tail? It's obviously a concern with eBay, who had to deal with a percentage of scammers in its long tail of sellers. They try to solve it with bottoms-up solutions, like ratings, and Amazon does so with customer reviews, but community policing is not 100% effective, as we've seen. We've also seen the occasional legal mess with controversial stuff in Google's cache and Yahoo's feeds. I suppose it's just the cost of doing long tail business, and the companies that thrive will be those that find scalable solutions.

[kenjimori (from Japan)]

To me, the implication of the Long Tail is already huge.

I would not worry about the detailed number (percentage), in fact 80/20 is never be 80/20 in real life as discussed more than 10 years ago in:

Truth in Concentration in the Land of 80/20 Laws

Shows how common concentration statistics (e.g., 20 percent of customers account for 80 percent of purchases) vary greatly depending on how they are calculated.

[Jessica]

Yea shows us alot but I think its more like 70/30

[Nick Fessel]

Web technology is a major factor in the Long Tail. I'd like to know your opinion about how the Long Tail helps and/or hinders the Web Renaissance, otherwise known as the Web 2.0.

[chris anderson]

Nick,

Web 2.0 technologies, from APIs to RSS, are basically tools of openness and democratization. As such, they help individuals to become producers, influencers, filters and so on. These empowered indivuduals help populate the Long Tail, shop in the Long Tail, and drive demand from others down the Long Tail via amplified word of mouth. So, in short, I see Web 2.0 and the Long Tail as very complimentary.

[teeh]

I think that is simple a recursive case of "80/20", at "20" we will get "16/4", and so on, "3.2/0.8" ...

or maybe use the self apply error rule (reverse ratios) margins: 64-96/36-4;

sure Is a joke?

[]

[John Thacker]

Artists want hits, in general... and they'd do almost anything to get it. They don't want to be a loser.

As other commenters have sort of said, isn't that strongly influenced by how the current system means that either you're a massive selling hitmaker, or you hardly make any money at all? If it becomes more profitable to be a niche seller, then more artists should be comfortable being in a niche, since they'll be better off than currently. In any case, there are still artists who make their art how they want to rather than modifying it in order to make it a hit-- this change would only increase their numbers.

[chris anderson]

John,

I agree entirely. Shawn's suggestion that "not hit" == "loser" doesn't reflect the realities of today, when 99.999% of artists, from book writers to musiscians, aren't mass market hits. Most never expected to be--they were aiming their work at narrower audiences. What they wanted was *an audience*, and many are more than happy with a small-to-medium sized one that shares their interests. And going forward, where the number of creative producers expands by orders of magnitute (with bloggers just one early example), this will be even more true.

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