Disruptive innovation in practice

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Long tail business models -- Amazon on offense and defense

  
  
  
  

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 slapLong tail business models 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.

Click for more of New Markets' thinking on business models.

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