The Economics of the "Long Tail" Is Transforming Business Models

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The Economics of the "Long Tail" Is Transforming Business Models

Most people have heard of the 80-20 Rule. It was formulated in 1906 by an Italian economist named Vilfredo Pareto. In its original form, it states that 20 percent of the people will hold 80 percent of the wealth in any free economy. Further research has shown that it applies to many other aspects of the economy.

For instance, it predicts that 20 percent of a movie studio’s films will produce 80 percent of its income. The same rule applies to books, TV shows, clothing, and other businesses where the free choice of a lot of individuals determines a product’s success or failure.

The flip side of this rule is the Power Law Effect. Power laws have been observed in nature for a long time. One of the first careful observations was by scientists who study earthquakes. They noticed that lots of small earthquakes happened all the time, but big ones occurred a lot less frequently.

They came up with a mathematical formula that described the relationships between frequency and magnitude, which they called a power law. It turns out that the frequency of a given type of earthquake varies as the three-fourths power of its magnitude — which is just a fancy and quantitative way of saying that the big ones happen a lot less frequently.

If we look at a graph of those earthquakes, we’ll see a few really big ones bunched up on the left side, and then a gradually diminishing tail stretching down to almost nothing toward the right. This graph shape has recently come to be called “the long tail.”

More recently, researchers have discovered power laws in almost everything from the weather to social and economic systems. One of those socio-economic systems is the Internet. It turns out that the popularity of blogs is ruled by a power law. So is the popularity of any given movie that Netflix rents, or any book that Amazon sells. In fact, anything you can rank in a system where people choose freely turns out to follow a power law and to have a graph that looks like a big head with a long tail.

The mathematics of this isn’t complicated. The value for the Nth position will be one-over-N. In other words, the value of the second place item is half that of the first place. The 100th item on the list will be one-one-hundredth the value of the first place, and so on.

Another effect of power laws in this type of system is that most of the items or events are going to rank below average. In other words, if you look at a system of hit movies and rank them all to get an average number for earnings, the largest number of movies will rank below the average earnings, and there will be a lot of them...

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