October 6, 2005

Let the Invisible Hand grab your Long Tail

Posted in business, tech at 12:20 am by Francisco

There has been a lot of buzz recently about leveraging The Long Tail as the new way to do business. The idea in a nutshell is to turn the Pareto rule of 80/20 on its head. Traditional business wisdom states that since 20% of whatever you sell will give you 80% of the revenue, you should focus all your effort on the most profitable 20% and ignore the other 80%. This is a good idea when it costs you money to carry an inventory and you serve a limited geography, but when that does not apply as it is the case with many web-based businesses, it pays to serve the traditionally ignored 80%. This typically ignored 80% is what Chris Anderson called the Long Tail.

Netflix is a good example of a company leveraging the Long Tail. I am a big fan of a show called Babylon 5 which aired in the mid 90s, but was moved from public TV to cable because not enough people were interested on it. I was not in the mainstream who didn’t care for the show, I was in the Long Tail of the relatively small fan base. I figured I would rent it later when it came out on video, but since it was an unpopular show to begin with, movie rental places didn’t carry it. Finally, thanks to Netflix, I watched all the episodes from beginning to end last year on my own schedule and without commercials. By paying attention to the areas where I fall on the Long Tail, Netflix has made me a loyal customer, and it has taken my business away from Blockbuster, not only on the Long Tail products, but on the mainstream products as well.

In contrast to the Long Tail which is a relatively new idea, the concept of The Invisible Hand has been around since 1776, when Adam Smith wrote The Wealth of Nations. In this masterpiece, Adam Smith argued that when individuals are left alone to act in their own self interest, the aggregate effect of all their actions raises the welfare of society as a whole as if it was directed by an Invisible Hand. Ever since then, the concept has been used to refer to the inherent power that free markets have as a way to create spontaneous order and prosperity. In modern Economics, the Invisible Hand is an euphemism for the market equilibrium and efficiency that is achieved globally when rational (i. e. self interested) individuals are free to maximize their utility locally.

So what does the Long Tail have to do with the Invisible Hand? I believe that in the long run, the most prosperous business models will be those that harness the power of markets (the Invisible Hand) in order to serve their Long Tail customers. The quintessential example of that business model is eBay. eBay leveraged the Invisible Hand by creating a market where self-interested individuals can buy and sell things. eBay doesn’t have to spend large sums of money marketing the products it sells, or scouting the market to buy products at a low price. Instead, buyers and sellers do all the work for them, and all eBay has to do is take a cut of every transaction. People go to eBay because they want to buy or sell things that are too odd for normal retailers to carry. Standard retailers serve the 20% of customers that want to buy typical things, eBay serves the 80% of the customers in the Long Tail that want to buy strange, one-of-a-kind things. However, once people start using eBay they get hooked and start buying and selling things that they would have bought or sold in a more traditional store.

Another business that takes the Invisible Hand to the Long Tail is online matchmaking. This is not a monetary market, but it is still a market where self-interested individuals try to “buy” and “sell” their products. Each one of them wants to get matched to the best person they can “afford”, so they do all the work, and the matchmaking site takes a piece of the action. The traditional matchmaking market, the singles bar, caters to the 20%. In contrast, online matchmaking allows “non-standard” people to find each other based on things that are not apparent in a singles bar, such as personality, books read, political ideas, career goals, and even fetish preferences. The first customers of online matchmaking sites were considered “losers” in the traditional market. However, by leveraging the Long Tail of the matchmaking market, online sites were able to attract more “normal” customers, and today their typical customer is very similar to the typical customer of the singles bar.

Why do I think that leveraging the Invisible Hand is important? Because the Long Tail of the market is a lot more difficult to serve than the 20%. Their demands are unique, and even without carrying a physical inventory, trying to satisfy unique demands takes effort, which translates into costs. eBay would have to have a very large warehouse in order to serve their customers without the use of a market, which would be very expensive. Matchmaker sites would have to have their own city in Nevada to serve their customers without the use of market forces, and their service would be a lot more expensive.

If you want to take business away from established competitors who ignore the Long Tail, you need to service the Long Tail, but doing so is going to cost you, and you can mitigate these costs by creating a market. In a market the service provider for one of your customers is another customer, not you. The key to getting customers to serve each other’s needs, is to create an environment where both sides of each transaction are serving their own self-interest. It is in the self interest of buyers in eBay to give their money in exchange for the unique products they seek, and it is in the self-interest of sellers to promote their products in order to get money for them. In the matchmaking market, it is in the self-interest of each side of the match to provide as much information as possible in order to “close the deal” and get matched to another person.

Another reason why it is important to create a market is network economics. Markets are natural monopolies, a market is more valuable as more people use it, so a company that can build a market creates a competitive advantage that gets stronger every day and provides a barrier to entry for competitors. Every new eBay user makes it more valuable for all other eBay users to be there. A matchmaking site is more valuable when it has more customers because it has more potential matches. The beauty of this model is that the larger the market gets, the more you can charge the users of that market, and they will pay because they find value from being in that market.

But the main reason why you need to use the Invisible Hand in order to serve the Long Tail, is that you cannot possibly do it by yourself as well as the free market. Trying to serve the Long Tail without the local knowledge of each individual is like trying to control an economy via central planning. The communist experiment showed that it does not work. Successful governments serve the Long Tail of their populations by creating the conditions for a free market, and they get paid handsomely by taxing the participants on that market. If you use the Invisible Hand to grab your Long Tail, you will be able to do the same.

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6 Comments »

  1. […] F. 2005. Let the Invisible Hand grab your Long Tail (accessed April 29, […]

  2. […] create an environment where both sides of each transaction are serving their own self-interest.” (Francisco Gutierrez, 2005) SOMC is a clever example of the creation of a market served by its users since the products SOMC […]

  3. […] 7: Leveraging the Long Tail Leveraging the Long Tail. Nice title uh? But what does it mean? It means that being online gives you the possibility to sell niche products, without loosing a lot […]

  4. […] the Long Tail. Nice title uh? But what does it mean? It means that being online gives you the possibility to sell niche products, without loosing a lot […]

  5. […] the Long Tail. Nice title uh? But what does it mean? It means that being online gives you the possibility to sell niche products, without loosing a lot […]

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