Long tail business models sell small quantities of a very large number of items. They are the antithesis of blockbuster business models, which sell large quantities of a few items. The idea, first popularized by the authors Clay Shirky and Chris Anderson, has been exemplified by the book retailing of Amazon.com. As an Amazon employee once stated, "We sold more books today that didn't sell at all yesterday than we sold today of all the books that did sell yesterday." (Amazon was never known for its pithy marketing).
This week, Amazon took its long tail strategy in a totally new direction, offering its Prime customers (those who pay a $79 annual fee for free 2-day shipping) a wide selection of streaming movies and television shows, for free. The move is a direct slap at Netflix, a company that started with a focus on renting hard-to-find, long tail DVDs but which has moved increasingly toward popular blockbusters as its video streaming operations ramp up. Amazon will not have nearly as many recent and popular releases in its free offer as Netflix, but for people who are open to Amazon's viewing suggestions it's hard to beat free.
Amazon can make this model work because its long tail selections are much less expensive to license than blockbusters. It also has a totally different business model than Netflix, gaining a substantial bump in sales of physical products from people who sign up for Prime. The video offer entrenches Prime with customers and entices new customers to sign on to Prime. It targets people who may not watch enough videos to justify a monthly Netflix subscription, or who just haven't gotten around to signing up for a video service. It is a classic disruptive innovation -- catering to people over-shot by existing offerings with an inexpensive and highly accessible service that excels on a totally distinct set of performance criteria.
While Amazon plays this creative offense, it finds itself ironically on defense in its core book retailing business. Even as traditional rivals such as Borders implode due to antiquated business models, the sleepy public library poses a threat. E-books are continuing their rapid ascent in publishing, and public libraries are moving quickly to offer patrons this option. Because the number to be lent is limited, library e-books are a poor alternative to Amazon for reading hot new releases, but they may be a cost-effective way for libraries to offer patrons access to hard-to-find books. Tellingly, Amazon refuses to make its Kindle e-book reader compatible with the format used for most public library lending. Public libraries do not have marketing muscle to make readers aware of this option, and they may move more slowly than Internet giants, but as Amazon knows with its video offering, it's hard to beat free.
There are three morals to this story:
- Long tail business models create new markets, especially if they can make experimentation with unfamiliar purchases easy and if they can leverage new purchase occasions. Amazon is doing both these things with its video offering, thereby expanding the overall size of the video streaming industry.
- Disruptive innovation occurs in unstoppable waves. Just as Netflix disrupted Blockbuster, Amazon disrupts Netflix. Just as Amazon disrupted Borders, public libraries disrupt Amazon. Market incumbents can try to delay disruption, as Amazon has done with its Kindle, but ultimately the new business model wins over a set of foothold customers that empower its further growth.
- To avoid being swamped by waves of disruption, companies should watch out for becoming vulnerable as they march up-market into blockbuster territory. As Netflix became increasingly focused on big hits, it exposed a flank for attack. The company is now facing a tough choice -- it can ignore Amazon's advance on the theory that it does not appeal to Netflix's most important customers, or it can create a parallel business model to defend itself. Given that Netflix's CEO Reed Hastings is a fan of disruptive innovation, we might expect the company to choose the latter course, but there are many executional and positioning challenges to overcome in the dual-track approach.
Long tail business models are compelling territory for disruptive innovation, but like any other business model they have a life cycle. If it does not stay fleet-footed and watchful, the disruptor can become the disruptee.
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How could a hero of market creation become so staid?
This question has been asked frequently of Starbucks, which once up-ended traditional assumptions about coffee. From 1993 to 2006, the company rose from obscurity to ubiquity, in the process driving a stock price appreciation of 80,000%. It proved that people would pay vastly more than historical prices for coffee, because it was selling an experience as much as a beverage. In the process, the company claimed an important space for itself on the landscape of jobs that consumers are trying to get done (Harvard's Clayton Christensen originated this way of examining the market, and applied it to Starbucks here). When people are looking to fill time or be productive outside of the home or office, Starbucks gets the job done exceedingly well. Similarly, if people are looking for a morning treat to make themselves feel special, an ultra-customized Starbucks beverage does the trick. Although the company's coffee ranked lower than Folgers Crystals in a Consumer Reports blind taste test, Starbucks' success was driven not by superior flavor, but through deep understanding of what jobs people want to get done in their lives.
Then the company seemed to lose the plot. In the pursuit of operational efficiency and incremental sales, Starbucks automated processes, pushed Point of Sale items like stuffed "Bearistas," and generally succeeded in ekeing out gains quarter by quarter. Simultaneously, the company gutted the experience that had created such loyal customers, losing the labor-intensive elements of "coffee theater," reducing coffee aromas, and seeming more and more like the massive corporation it had become. Patrons ultimately defected.
Starbucks also fell victim to the same malady that had afflicted coffee shops prior to the company's ascent: it defined its business too narrowly. While Starbucks focused on pumping out sales through its famous shops, competitor Green Mountain Coffee Roasters attacked from a totally different direction. The company generally avoided coffee bars and emphasized a vast array of other institutions trying to get a piece of the lucrative action: gasoline stations, supermarkets, restaurants, and more. It also purchased a once-obscure company called Keurig that helped to pioneer a new business model of renting a low-cost brewing machine for homes and offices, while selling high-cost single-serve coffee cartridges that offered both convenience and customization. Keurig's revenues were $728 million in 2010 -- not bad for a company purchased for just $104 million in 2006. The purchase has helped power Green Mountain's tremendous ascent. Since the start of 2007, Starbucks shares are down 6%, while Green Mountain has gained over 1100%.
Starbucks announced this week a partnership with a rival to Keurig that focuses on hotel properties, and it is facing pressure from analysts to buy Keurig or Green Mountain. Perhaps, however, the company should be looking to pioneer more new markets. How else can the company bring the concept of morning treat to the home or office? Can it spruce up morning commuting time with in-car equipment? What other jobs are people trying to get done where the Starbucks brand has a right to play? In all the talk about trying to regain the Starbucks appeal of the past, or of buying a rival, there seems to be little focus on the future. Yet creatively defining new markets is how Starbucks and Green Mountain succeeded to begin with.
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Minute Maid Pulpy Super Milky may be not only the world's most awkwardly-named consumer product, but also one of its worst tasting. This glutinous, fruit-flavored milk sits heavily on the tongue. In China, it's a hit. Consumer products in emerging markets can baffle people with Western tastes, yet they represent enormous potential. For instance, there are 420 million consumers in India's cities alone, spending $160 billion a year on consumable items, a figure that is growing by over 5% per annum. For consumer products companies, cracking the code that makes Pulpy Super Milky a success is a business imperative.
Five rules, corresponding to the five elements of a business model, offer guidance:
- Customize the offering -- It hardly seems necessary to say that offerings for emerging markets need to be re-thought from the ground-up, yet countless firms keep making the same mistakes. They target a thin strata of the richest consumers with Western products and hope that demand trickles down. It doesn't. Not only are these products often poorly suited for local tastes, but consumers in some of the most critical emerging markets are increasingly nationalistic and eager to buy quality local brands. Coca-Cola seems to have learned this lesson with its Pulpy Super Milkly. True, its flagship soda is consistent worldwide, but the 64 flavors on offer at Atlanta's World of Coca-Cola illustrate that even this iconic firm knows how to shape-shift to succeed locally.
- Adapt competitive strategy -- While consumers embrace novel entries in some categories (such as beverages), in many areas it can be fiendishly hard to build share against entrenched local brands. Consumers spending a relatively large amount of disposable income on a purchase want reliability. It may be easier to create a new category. For instance, shop shelves will frequently carry local brands of toothbrushes, but Western brands do far better in mouthwash. The challenge then is to displace non-consumption, which is an entirely different task. Brands still matter, though in a different way; they help make an unfamiliar purchase seem less risky, and they create staying power against the local upstarts that are likely to emerge once a category becomes significant.
- Invest in partnerships and distribution -- The role of distributors in emerging markets can be vastly different than in the West. Where goods move inefficiently, the power to get them to widely-dispersed retailers is key. Distributors can also provide critical assets to retailers, such as refrigeration units, signage, and even stock on consignment. For retailers chronically short of capital, these partners are essential. Distributors can also drop retailers for stocking a rival's goods, and in a weakly-competitive distribution sector such a move can be devastating to a shop. Firms such as SABMiller, Coca-Cola and others make ironclad control of distribution a fundamental building block of their success with consumer products in emerging markets.
- Rethink financials -- Cost structures of course need to be kept thin in a market with price-sensitive consumers, but there is a broader need for financial innovation as well. While the gross profit on items may be relatively low, operating margins can be acceptible given inexpensive media costs and low staff overheads. Return on assets (ROA) can be quite high given the labor-intensive nature of these economies. Alternatively, a manufacturer can extend working capital to its distributors, lowering ROA but enabling higher price points. Of course, the challenging pre-condition for that latter model is an ability to get repaid, but new technologies such as mobile payments enable B2B commerce with same-day value, hitherto a real challenge in these settings.
- Value new competencies -- The art of brand building is important, but practical problem-solving may be the most critical skill in many emerging markets. When Zimbabwe's railways stopped functioning, Coke's bottler in Zambia lost its supply of glass. Sales screetched to a halt. Creative sourcing of alternatives saved the day, as scrappy approaches have countless times when the things Western firms take for granted suddenly go awry in these settings.
It is not easy to master any of these five rules, let alone all at once. However they provide a roadmap for how companies can triumph in the lands where Pulpy Super Milky can rule.
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Niche environments create space for new life forms. Like an undersea volcano surrounded by bizarre creatures, commercial niches enable new types of business models and enterprises to flourish. The niches also provide a foothold from which these businesses can step into larger and more competitive markets.
The challenge about niches is that they are abundant, and some will be as eternally isolated as those undersea volcanos. Picking your niche is a critical discipline. Four rules illustrate how to do this in a rigorous way.
- Target Customers Overserved yet Undershot by Existing Offerings -- One Medical Group is a new concept in primary care medicine. For a few of a few hundred dollars a year, it enrolls patients in exclusive practices that provide extensive personal attention, same-day visits, lengthy consultations, and excellent customer service. But it is not for everybody. If you have a bevy of chronic conditions requiring tight coordination of a team of specialists, go somewhere else. One Medical is a great proposition for relatively healthy people who do not want to wait three hours for a 12 minute appointment. It may not scale to serve millions of patients, but its niche is plenty big to be attractive. Not only does the model offer an answer to over-stretched primary care physicians facing a wave of newly insured patients, workflow changes, and an older, sicker population, but it may also offer a route for small health insurers to escape an increasingly commoditized industry in which they have fundamental disadvantages.
- Target a Simple Buying Decision -- Don't try to be too clever. When I started one of the first mobile marketing companies in 2000, we fervently believed that we had a great way to market retail special offers to consumers. It was a pretty good idea, but 10 years too early. Retailers would have to align staff from a wide range of functions to give the proposition a try. A rival firm targeted radio stations that wanted to give listeners a way to interact with the DJ. This was an easy decision. It may not have held out promise to be a large market, but it was a fast place to get started that also legitimized the then-new idea of sending text messages to a company rather than an individual. Similarly, healthcare IT firms struggled for years due to the complexity of selling to medical practices, and the ones who gained traction first were those who focused on sending prescriptions electronically to pharmacies -- a simpler idea that the pharmacies could help turbo-charge.
- Avoid Network Effects -- Zopa had its first office next to my mobile marketing start-up. Like that company I founded, Zopa is still around but it never really scaled up. It was one of the first firms to pioneer peer-to-peer lending, where people with a bit of money to invest could lend funds directly to consumers who were scored according to their credit rating and other factors, bypassing all the overheads of banks and credit cards. This is an interesting idea, but it faced a chicken-and-egg conundrum. Does it build its list of borrowers first, or its lenders? Will it attract the worst borrowers? Eventually businesses can surmount these challenges, and the company is now lending over GBP 5 million per month. But it is not a great business strategy, particularly for a firm that is already established, seeks to re-position itself, and has an existing cost base it needs to cover.
- Embrace Small Competitors but Avoid Big Ones -- Small competitors can help to educate a marketplace about a new category, and they provide reference points for competitive bids which supply new buyers some reassurance. Big competitors seize the limelight, give away free trials to show they have customers, and are often the first choice of purchasing managers who do not typically love to take risks. Competition can be good, provided that it is the right type of competition that creates new market space.
Picking a niche is an endeavor where patterns of success are invaluable. In addition to the principles laid out above, consider who has succeeded and failed in creating niches in your industry. What rules can be discerned?
There is seldom one right answer to picking a niche, but there are definitely wrong answers. Thoughtful attention to these dynamics up-front can create large payoffs down the road.
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