Competition and The Long Tail

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Includes: AABA, CNET, GOOG
by: David Jackson

Wired editor Chris Anderson's discussion of The Long Tail is important, but investors in Internet stocks need to analyze the impact carefully.

Chris focused on the positive impact of The Long Tail - the realization of demand for products whose limited appeal meant that they were previously unprofitable to sell, due to shipping, marketing and inventory storage costs.  Changes in technology that slash these costs can suddenly make these products profitable to sell. Amazon's centralized warehouses and web marketing, for example, have made viable the sale of thousands of books that no bookstore would otherwise stock.

But there's also a negative effect of The Long Tail. Look at the standard distribution chart used to discuss The Long Tail:

Long_tail_chart

The chart shows the demand curve for a set of products - say books. The most popular books, in the red area of the distribution curve, enjoy strong demand and are stocked by physical book stores. The yellow area of the curve represents less popular titles that are unprofitable for a physical book store to stock, but become profitable to sell when technology slashes the costs of marketing, distribution, and inventory stocking. The chart suggests that the introduction of new technology will increase demand by unlocking the viability of the products in the yellow area, The Long Tail.

But is that really correct? It's not necessarily true that unlocking the products in The Long Tail will lead to an increase in overall demand. The chart, after all, represents consumers' desires, not what is actually sold. When the products in The Long Tail are unavailable due to excessive costs, it's likely that there's a substitution effect to more popular products. In other words, if you can't get the book you really want because your local book store doesn't stock it, you may well buy another (more popular) book which is in stock. Conversely, when you discover that you can get exactly the books you want from Amazon and the movies you want from Netflix, your purchase of mass market books and movies may actually drop.

This is borne out by the data. Book sales in the US have been largely stagnant, despite the rise of Amazon and the availability of millions of titles. If unlocking The Long Tail led to a rise in demand for books, overall book sales would have increased noticably. But they didn't. So it's likely that unlocking The Long Tail of books resulted in strong substitution effects as well as a small absolute increase in overall demand.

The chart, then, is not really accurate as a depiction of actual sales, because unlocking demand for the yellow area would lower the height of the red area.

This effect, which I'll call The Competitive Impact of The Long Tail, will likely have tangible effects on publicly-traded companies. But some smart people have misunderstood these effects. In a recent report, for example, Morgan Stanley Internet analyst Mary Meeker argued that Yahoo! is a beneficiary of The Long Tail in web publishing since it promotes the use of, and stands to gain from RSS on its news pages. But she might not be right, because Yahoo's readership might fall as people discover niche content web sites that more precisely address their interests.

In fact, the competitive impact of The Long Tail might be noticed fastest in online and offline media stocks. Large media companies have focused their publications on the most popular topics and stories. But four factors are fueling the rise of niche content web sites:

  1. The cost of online publishing is plummetting;
  2. Search engines are making it easier to find niche content;
  3. RSS makes it easier to read content from niche web sites;
  4. Self-service contextual advertising services make it economical for publishers to support their content sites with ads.
These factors have led to an explosion in the number of web sites focused on narrowly-defined topics. And the question is: will those web sites in aggregate steal readers from mainstream content sites?

Take this web site as an example. It's focused entirely on Internet stocks, and as a result covers a larger array of small-cap and micro-cap Internet stocks than TheStreet.com, Marketwatch or The Wall Street Journal. It also contains more analysis and often "breaks" Internet stock-related stories earlier. Will it take readers from those sites? It's certainly plausible that readers focused on Internet stocks will apportion some of their time to reading The Internet Stock Blog, perhaps at the expense of the larger mass-market financial news sites.

The same is probably true of technology content. The proliferation of new, niche content sites is particularly apparent in technology publishishing. CNET now competes (in various content categories) with Engadget, Gizmodo, Phone Scoop, Mobile Tracker, MobileBurn and thousands of other narrowly-focused technology web sites. Will they, in aggregate, take readership from CNET? It would be remarkable if, over time, they didn't.

To use Jeff Jarvis' phrase: the mass market is dying, to be replaced by a mass of niches. Until now, discussion of The Long Tail has focused on the revenue potential of "the mass of niches". But investors will need to be equally mindful of The Competitive Impact of The Long Tail - namely that "the mass market is dying", and with it the prospects for companies that focus on the most popular products, content and services.

Full disclosure: at the time of writing I'm short CNET and TSCM.
Originally published January 18th 2005, since updated (see date at foot of post).