The Internet and the death of the 80/20

By Kevin Laws , Principal
The Internet and the death of the 80/20

The 80/20 rule is a rule of thumb every startup should know. Economizing on time, management effort, and money has to be second nature. They should constantly be going after the 20% of the effort that provides 80% of the benefit. They should constantly be focusing on the 20% of their products and customers that provide 80% of the revenues. Or should they? Entertainment has Discovered the Long Tail Chris Anderson’s observation in a recent Wired Magazine article is that the 80/20 rule exists in the physical world because you chop off the long tail. In music, for example, Britney, Santana, Madonna and a few others represent the very few artists (well, more like 1%) that account for huge sales. However, there are literally hundreds of thousands of smaller artists that have tiny sales.

Historically, these artists have never been carried in record shops (except maybe one or two local ones), were not featured on top radio stations, and were never promoted on big concert tours. Since they were in the tail and record companies were following the 80/20 rule, they never got exposure and a chance to increase their sales. The real world “chopped them off” of the long tail, since a record store only carries thousands of titles, not hundreds of thousands. This meant that the 80/20 rule was self-reinforcing. Because they weren’t promoted or available, they never moved beyond their few copies. Hollywood never saw their sales since they were all independent.

However, many of the Internet media companies are different. They started out just being a better way to shop (or rent movies). They sold the same things everybody else did, but at better prices. Then a funny thing happened suddenly they noticed that more and more sales were coming from the tail. That is, they were selling a lot of the items that physical stores didn’t carry. In hindsight this is completely obvious of course you are in competition with every single bookstore in the nation to sell Clinton’s “My Life,” but if you want Gerd Gehringer’s “The Adaptive Toolbox,” there’s only one place to go: the Internet. Chris cites numerous examples in his article: over 50% of Amazon’s media profits come from sales past the top 100,000 titles.

More than 50% of Rhapsody’s business is streaming songs past the top 10,000 tracks. Once they started focusing on the long tail, new recommendation tools appeared. They helped “push you down the tail” by bringing little known artists to your attention when you purchased the big guys. When tallied, all of those little-selling items and all those little customers across the nation can exceed the online sales from the biggest sellers. The Death of 80/20 on the Internet It’s not just media. Once you start to think of the world in those terms, it is clear that most of the successful Internet companies fall into exactly that category: business models aggregating the untapped tail. # Amazon makes most of their profit from the tail they receive a higher margin because they don’t have competition in that area. # Ebay does nothing but aggregate all of the tiny, single lot size items that were not being sold at all (or just through local classifieds). # Google and Overture are aggregating all of the advertising spending that was not happening because it could not be targeted well enough. Coke doesn’t go there in a big way, but Riley’s Trick Shop in Worth, IL, can target you if you’re looking for vampire teeth. The current crop of private companies include some doing exactly that.

CafePress aggregates all of the niche content on the Internet and makes it available as merchandise, books, and CDs. They are making millions in the areas the traditional publishers and music houses have ignored. (Full disclosure: we are investors in CafePress). The blogging phenomenon is all about the long tail in journalism, spawning tools like Technorati and Movable Type (by Six Apart, where Andrew is now working). Clay Shirky has noted that blogs are surpassing niche media in traffic (though he believes that 80/20 applies to blogs also). More opportunities? With Yahoo sitting on a pile of cash and needing growth engines to compete with Google, and Google sitting on cash from IPO, you can bet activity in the Internet sector is going to pick up again.

For the entrepreneurs among you, now is the time to start thinking about other businesses where the Internet could help aggregate the long tail. The next Ebay or Overture will be found there. Kevin Laws is an investor at PacRim Venture Partners, where he spends his time on software and services investments. Before crossing over to the dark side, he was at for several years where he headed up the product group. Prior to Epinions, he worked with the Media & Entertainment and Information Technology groups at Booz, Allen & Hamilton. In a pre business life, he worked at Computer Sciences Corporation's office in Heidelberg, Germany, heading up a team responsible for developing in-the-field prototypes of high technology applications for the U.S. Army in Europe. (This article was written in November 2004)