Tuesday, September 4, 2012

Selection, Demand and Amazon’s Long Tail

The Long Tail 

Chris Anderson of Wired.com popularized this metaphor with a thought-provoking piece in 2004, The Long Tail. He followed it up in 2006 with a well-received business book of the same name. Both are worth reading. 

(We introduced the idea in the last article, Walmart’s Selection and Long Tails.)  

The key points are these: 

1. Store-based retailers fall victim to what Chris calls the “tyranny of physical space.” They are limited by real estate location and a finite amount of shelf space. As he puts it: 

An average record store [for the young readers, this breed went extinct about two months after Chris wrote his article] needs to sell at least two copies of a CD [likewise extinct] per year to make it worth carrying; that’s the rent for a half inch of shelf space…retailers will carry only content that can generate sufficient demand to earn its keep. But each can pull only from a limited local population – perhaps a 10-mile radius for a typical movie theater, less than that for a music and bookstore…

2. Web-based stores, by contrast, are “demand aggregators.” They don’t have that 10-mile radius limitation for drawing shoppers. When you pull from a national (or international) market of customers, you effectively pull together all potential buyers for a particular product or piece of content. 

3. Although it’s fractured into tiny individual sales, there is still tremendous demand for products even as you push into the narrowing part of the long tail. Chris uses the following example, pitting Barnes & Noble against Amazon in a story with which we’ve all become very familiar: 

The average Barnes & Noble carries 130,000 titles. Yet more than half of Amazon’s book sales come from outside its top 130,000 titles. Consider the implications if the Amazon statistics are any guide, the market of books that are not even sold in the average book store is larger than the market for those that are…the biggest money is in the smallest sales.

That long tail demand – fractured as it may be – makes for a good business opportunity for web retailers. Their lower operating costs allow them to turn a profit offering products in lower demand that consumers won’t find in a traditional store. 

The Long Tail in Perspective 

Retailers attempt to match their selection to the demands of their customers. Despite all the statistics and MBA-level analytics at their disposal, the process of picking a store’s assortment is as much an art as it is a science. There remains a vibrant market for hiring retail buyers that possess that mystical merchant touch; those employees able to divine the desires of shoppers and put together the right mix of assortment to pry open their wallets. 

Walmart has dedicated itself to being the one-stop shopping destination by offering the widest array of merchandise of any traditional retailer. Its supercenters stock, on average, about 150,000 unique items meant to draw customers that want to consolidate their weekly shopping excursion from multiple store visits to just one. They know that Walmart will have the vast, vast majority of what they want to buy. 

And when compared to Costco, for example, Walmart satisfies that goal. Costco offers somewhere in the ballpark of 4,000 items per store. It clings tightly to the narrow-selection, high-demand portion of the curve. 

4,000 to 150,000 is a big difference, and that delta brings a lot more customers through Walmart’s doors than Costco’s. Walmart’s wide selection makes up for Costco’s lower per-unit prices and earns the retail giant a much larger chunk of that broad middle of the shopping market. 

But that difference in selection is dwarfed when you introduce Amazon into the mix. I haven’t been able to track down a good source for the number of items Amazon offers in total, but I’ve pieced together some thumbnails to come up with what I believe to be a very conservative guess…two million. (If any readers have a better number they can provide from a trustworthy source, please share!) 

I think Walmart would love to offer much more than 150,000 items. It is committed to being the one-stop shopping destination, but it must balance that with remaining realistic about the limits of its economic model. It is constrained by, to borrow Chris’ term again, the tyranny of physical space. If something cannot sell quickly enough, Walmart simply cannot justify renting out its shelf space to that product. And its potential customer market for selling that product is limited to (I’m guessing here) a 25-mile radius around its supercenter. 

Even though Walmart dominates the selection game for store-based retailers, its 150,000 SKUs can’t hold a candle to what Amazon is able to do. Not only does Amazon aggregate demand by providing access to any couch-surfing shopper with a tablet on his lap, but it also has significantly lower operating costs in offering those products. You can run build and run a fulfillment center at a much lower cost per item sold than that required to operate an extensive network of retail stores. 

The Best Place to Buy, Find and Discover any Product 

The economics of Amazon’s model allow it to move aggressively down that long tail curve; to build its selection to meet the most niche demand; to realize the potential that all those individual low-demand transactions – when aggregated – amount to a lot of sales…for the company whose economic model allows them to chase after it. 

Amazon has not been shy about stating its intentions on the selection front. Amazon has stated loud and clear for many years that: “The Company’s objective is to become the best place to buy, find, and discover any product or service available.” (From it's 1998 10-K filing.)