Small Business Labs

The Long Tail and Small Business

Harvard marketing professor Anita Elberse has caused a stir with her Harvard Business Review article "Should You Invest in the Long Tail."  The article argues that several parts of Chris Anderson's popular Long Tail theory are wrong.  Key quote:

"It was a compelling idea: In the digitized world, there’s more money to be made in niche offerings than in blockbusters. The data tell a different story."

The article has an excellent summary of the long tail theory, so I won't bother covering it here.  But the bottom line of Elberse's research is that for the two markets she studied - online music and home-video sales - the long tail effect as described by Anderson did not show up.  Her data indicates that hits may even be gaining relative share instead of losing share as predicted by Anderson. 

We've spent a lot of time looking at niche markets, small businesses and industrial structures.  Interestingly enough, we think Anderson and Elberse are both right.  Our research shows that the long tail is happening and the number of niches able to support small businesses (or niche products from big companies) is rapidly increasing.  The two main drivers of this are:

1.  Reductions in the cost of doing business in many niche markets.  Technology, outsourcing and access to third-party services are making it easier and cheaper to create niche or highly customized products and services. 

2.  The Internet has made it cheaper and easier for buyers and sellers of niche products and services to find one another.  This means the producers of niche products can cost effectively attract enough customers to create viable niche businesses. 

These two drivers are combining to shift demand curves and create many new niche opportunities - for both digital and physical goods - as shown in orange in the chart below.  This chart is taken from the HBR article.

While the long tail theory and Elberse's article focus on companies aggregating long tail demand, we are seeing a growing number of successful small businesses that serve narrow long tail niches. An example is My Beating Heart, a pillow company we've profiled in the past.  They serve a very narrow specialty niche way down the US pillow market long tail. According to their founder, the company wouldn't exist without the use of Internet based marketing to reach their customers.  They also would not be able to make their product at a price low enough to attract customers without outsourced manufacturing and services.  They are a long tail small business.   

At the same time we agree with Elberse's research showing that hits will continue to be important.  We think this is true for both digital and physical goods.  So while economically viable niches will grow in number, hits and highly successful products will continue to garner large relative market shares. 

The market share losers, in our view, will be products caught in the middle.  These are products that aren't hits, but also aren't unique enough to be niche products.  We see customers moving away from these products on a relative basis, creating in many cases an even steeper demand curve than shown in the chart above. It is important to note that while mid level products will lose relative market share, the overall growth and size of the global economy means these products can still be successful. 

The growth of long tail niche markets is creating many new opportunities for small businesses.  We also are seeing a strong trend towards large corporations partnering with small companies to serve niche markets, instead of trying to aggregate long tail demand on their own.  We cover these trends in more detail in The New Artisan Economy research report.

 

   

The Beer Industry and Small Brewers

The beer industry continues its global consolidation with Belgium based InBev making a $46 billion offer for US brewer Anheuser-Busch.  It is expected the bid will be rejected, but regardless of the outcome of this corporate battle, most beer industry analysts expect to see more mergers.

While the global beer giants merge, small craft brewers are having a greater competitive impact on the industry.  MSN has an interesting article on this topic called Will microbrews kill the King of Beers.  The gist of the article is the growth of craft brewers (small, independent brewers that produce less than 2 million of barrels of beer per year) is putting a lot of competitive pressure on big beer companies. 

In our most recent forecast report we use the beer industry as an example of an industry moving to a barbell structure comprised of relatively few global giants, lots of small firms and very few mid-sized firms.  In 1980 the US beer industry had fewer than 20 craft brewers with a negligible share of the US beer market.  Today there are over 1400 and combined they own about 6% of the US beer market. 

In 1980 there were roughly 35 national beer companies that controlled about 70% of the US beer market.  By the end of this summer, 2 companies (Anheuser-Busch and the combination of SABMiller and Molson Coors) will control over 85%. 

We're seeing this structure happening in almost all industries.  The need for global scale and investor and competitive pressures are driving big companies to get bigger (see our recent post Will Large Corporation Survive).  And small firms are exploiting the growing number of niche opportunities either too small, too specialized or not attractive to the giants.

We expect this trend to continue over the next decade with more industries having a barbell structure.

 

IBM Buys Cognos; Software Industry Dominated by Giants

Businessweek has an article covering IBM's recent acquisition of business intelligence software company Cognos.  The article points out that IBM has made 23 software acquisitions since 2006 and points out that the software industry is is now dominated "by a handfull of giants".  Key quote:

"The software industry, once populated by hundreds of so-called best-of-breed companies, is now dominated by a handful of giants, including Microsoft (MSFT), IBM, SAP, and Oracle, with vast portfolios of products. It's very difficult for midsize companies to compete against the giants because large corporations prefer to buy their technology from a few strategic suppliers rather than a lot of smaller companies."

While mid-sized software companies are becoming rare, there are thousands of small software companies - many based on Web 2.0 technologies.  As with other industries, the software industry is developing a barbell structure with a few very large companies, lots of small companies and very few mid-sized companies.  We will covering this trend in more detail in our next Future of Small Business forecast report.

Defining Small Business

Anita Campbell's Selling to Small Business Blog has a post on size definitions for small business.  While this is a rather arcane topic, it is actually is quite important.  Many times I've seen people get very confused because they use differing definitions of small business.

We define small business as less than 500 employees.  We do this mostly to be consistent with governement statistics.  We define mid-sized as between 500 and 10,000 employees.  We use personal businesses to mean single person companies, or what the governement calls "businesses without employees".  We chose not to use the government's name because it is too long and too confusing. 

We use micro-businesses to refer to businesses with 5 or fewer employees.  Our usage includes personal businesses in the micro-business category. 

On a pretty much unrelated topic, I was recently on Anita's Small Business Radio show.  It was great fun and my 86 year old mom listened in live.  She was told me I was "just like Jack Benny except he was funny".  Not sure what this means, but I am taking it as a compliment.

Supercapitalism

Former labor secretary Robert Reich has a relatively new book out called Supercapitalism.  Reich describes supercapitalism as global capitalism that is:

"turbocharged, Web-based, and able to find and make almost anything just about anywhere"

One of his key points is that we as consumers and investors have gained power, while we as citizens have lost power.  My favorite quote from the book:

"The last several decades have involved a shift of power away from us in our capacities as citizens and toward us as consumers and investors."

The book does a great job of describing how this has happened - and I agree this has happened.  I'm less on board with Reich when it comes to his ideas about what to do about this.  Basically Reich suggests more governement regulation of business.  But whether you agree or disagree with Reich, the book is well worth reading.   

 

Industry Consolidation and Decentralization

One of the trends we are following is the continued consolidation of most industries.  Oracle's recent bid for BEA in enterprise software, and the SABMiller - Coors merger are two recent examples. 

We are also seeing a growing number of small businesses in most industries.  Seeing both consolidation and decentralization happening at the same time is somewhat counter intutitive.  The beer industry is a good example.  In 1980 there were only 44 commercial brewers in the US, and the top 5 brewers had about 70% of the market. Today there are roughly 1400 commercial brewers in the US, and the top 2 own roughly 78% of the market.  There are also many, many thousands of hobbyist brewers.  The industry is both consolidating and decentralizing.

This pattern is playing out in most industries, and we expect this to continue on a global scale.

Small Business Volatility Decreasing

I recently posted on an interesting study called "Entrepreneurship and Job Growth".  In addition to information on the role small and personal businesses play in the creation of jobs, the study also covers business volatility.  The paper references an earlier work on business volatility, and the National Bureau of Economic Research wrote about the earlier study in their journal.  Key quote:

"The authors' main finding is that the employment-weighted mean volatility of firm growth rates for all U.S. businesses has declined by more than 40 percent since 1982. LBD data confirm that volatility rose among publicly traded firms. However, this trend is overwhelmed by declining volatility among privately held firms, some large, but many as small as mom-and-pop shops. Although the level of business volatility is relatively high at privately held firms, it has trended downward. In contrast, the level of business volatility is relatively low at publicly traded firms, but it has trended upward. This pattern of "volatility convergence" holds in every major industry."

While volatility is not a clean proxy for business or employment risk, it is an indicator of risk.  It is interesting that our research shows that employees see working for big companies as increasingly risky, and small business ownership and employment as less risky than it used to be.   Because of this, small business employment or ownership is seen as a viable alternative to large company employment by more people.   It is starting to look like the data at least in part supports this view.

Social Networking Sites - The Big Get Bigger

A couple of interesting data points on social networking sites.  Hitwise data shows that MySpace has 80% of the US traffic market share for social networking sites, and FaceBook has 11.5%.  Traffic to both sites has grown substantially over the last year, with Facebook (up 106%) growing faster than MySpace (70%).

Paul Kedrosky's Infectious Greed blog has a post referencing a Barron's story on the traffic growth of user generated content sites.  Key quote:

"aggregate percentage of U.S. Internet traffic accounted for by the six top user-generated content sites (i.e., Facebook, Myspace, Youtube, Wikipedia, Blogger, and Digg):
2004: 0-1%; 2005: 7%; 2006: 13%"

Both data sets point to an increasingly common industry structure - a small number of very large firms, few or declining numbers of mid-sized firms, and a large number of small firms.