Business and Product Strategy - Part 2, The Long Tail

I apologize for putting a graph at the top of this post.  I bet half of you will wince in pain upon seeing that. But those aren't just pretty colors; they help me to build on yesterday's post on strategy and risk. 

Can your business strategy or product development strategy be based on flexibility and variety?  Take a look at HitForge, a new web 2.0 start-up company in Silicon Valley.  I first ran across this company in Business 2.0 magazine, and then on a blog post by David Bayless, of EvergreenIP, a product capitalist company, entitled The Cost of Failure Falling...Success Remains Elusive.  Bayless notes the 80/20 Rule of Long-Tail Economics, which describes the phenomenon that 80% of the revenues made out there by start=up businesses seem to come from 20% of the offerings.  You hear this rule in many industries: 20% of the real estate brokers make 80% of the money, 20% of waiters make 80% of the tips, etc.  The point the rule is trying to make is that it's not a bell curve out there in terms of returns.  It's a long tail.  In addition to this phenomenon, Bayless notes observations by Guy Kawasaki, a notable Silicon Valley investor and entrepreneur, that the cost of starting up businesses has fallen dramatically.  Naval Ravikant, a Silicon Valley investor and entrepreneur, will be testing this model with his new company HitForge.  Bayless comments:

...the hit-and-miss nature of Web 2.0 companies is not unique.  The market outcomes of a host of other businesses, including movies, music, and books are subject to long-tail economics, where a small number of offerings account for the bulk of revenues...

In fact, research shows that a remarkably broad range of consumer products, from food to sporting goods, can be similarly described [3].

Secondly, the cost of failure is falling.  As Kawasaki puts it,  

During the dot-com bubble, you needed $5 million to do stupid ideas.  Now you can do stupid ideas for 12 grand.

The implication for these entrepreneurs is to predict less and experiment more.  To do that, Ravikant has launched Hit Forge:  

This is like a movie studio.  It's about milestone-based development, piloting concepts, access to distribution...The engineers have the freedom to experiment, but they have 90 days to ship a product.  The product has to grow organically without any marketing.

  Those that survive get more funding and access to distribution.  

We are going to build as many as 20 companies a year.  We need to find one hit to succeed.  We can do that.

Is this Michael Raynor's ideas on prozac?  Or crack?  HitForge might be an extreme test of this model, but Venture Capitalists have been doing this for years.  They always seem like geniuses after Google goes public or YouTube gets bought out, but the fact is that they invested in at least 100 other companies in each of those cases, just to hit upon the big payoff in Google and Youtube.

Perhaps the strategy might be to develop a variety of 10 low-cost products, test them in various specialty stores to see how they're received, take the winners to the tight shelf space in a large retailer, where they win you more shelf space?

In terms of products and supply, the driver of the long-tail phenomenon is the cost of inventory and distribution.  If these are higher, it only makes sense to stock your hottest selling items.  If these costs are lower, then it is cheaper to offer a greater variety.  Think about limited shelf space.  If a retailer has only 2 spaces for your 8 products, only the 2 hottest selling products will be shelved.   In addition, manufacturing 10 different products is expensive and creates a much more complex and expensive supply chain. 

So how does one capitalize on this strategy?