In the pantheon of management theories, the Pareto Principle--better known as the 80-20 rule--has always been on a pedestal. Seventy years after the phrase was coined (in honor of the Italian economist Vilfredo Pareto), it has been used to describe many aspects of business--most notably the idea that 80 percent of a company's sales come from only the top 20 percent of its products. Many CEOs have embraced 80-20 as a way of life, focusing resources on their elite merchandise.
But there's strong evidence that on the Internet, the 80-20 rule no longer applies. The skepticism began four years ago, when researchers at the Sloan School of Management at the Massachusetts Institute of Technology wrote about the rise of niche products on the Internet, noting, for example, that obscure book titles not even carried on retail shelves accounted for almost 40 percent of revenue at Amazon.com. After that, Chris Anderson, editor of Wired magazine, developed his Long Tail theory. He wrote that, collectively, the 80 percent of products that usually get short shrift in the 80-20 world could, on the Internet, rival the sales volume of all the mainstream hits. (Anderson's best-selling book The Long Tail was published last year.)
Now researchers from Sloan are back with a new study called "Goodbye Pareto Principle, Hello Long Tail: The Effect of Search Costs on the Concentration of Product Sales." The authors looked at several years of sales data at a private-label women's clothing company that offered the same merchandise through its catalog and its Internet store. The data showed that while catalog sales adhered perfectly to the 80-20 rule, customers purchased a significantly wider variety of clothing online. After discovering this, executives (who wish to remain anonymous) revamped their marketing efforts, sending fewer printed catalogs to top online customers.
A company called Niche Retail sees itself as the vanguard of the philosophical shift away from Pareto. Based in Sylvan Lake, Michigan, the company was founded in 2001 on a business plan that anticipated today's long-tail principles. Today Niche Retail runs 25 different consumer e-commerce sites, each stocking a comprehensive product line in a narrow area--jogging strollers and car seats, for example. The company also develops websites for manufacturers to help them build online sales. "To me, the 80-20 rule is dead," says co-owner Tyler Smith. "The public is demanding choice, so it doesn't make sense to train employees on only a few products."
In practice, breaking the 80-20 mold often means politely ignoring the advice a manufacturer gives you. When Suunto, maker of the Vector altimeter watch, first partnered with Niche Retail, it wanted to build a site featuring only the popular black-and-green models that make up the top 20 percent of its product mix. But Niche Retail found that Web customers wanted harder-to-find colors, offbeat shades such as champagne--which wound up selling briskly for two years. At another Niche Retail site, Elitecarseats.com, a cow-print model that the manufacturer's rep had written off became an instant hit. At most of Niche Retail's sites, the sales-to-product ratio is incredibly fluid. "There's no historical top 20 percent, and the top sellers move quickly and change," Smith says.
In fact, whenever sales become consistently 80-20 at one of the company's Internet stores, Smith sees a red flag. He believes that it's hard to be profitable with a small number of products. It won't be long before Wal-Mart or Target starts carrying your top 20 at a discount, killing your business. Niche Retail actually sold a marginally profitable site that marketed radar detectors because sales of the bottom 80 percent were so sluggish.
In the old 80-20 world, bestsellers were so lucrative that there was little incentive to invest in risky new products. The long-tail approach, by definition, requires you to be constantly on the prowl for underdog and underexposed offerings. SkinStore.com, a Gold River, California, company that sells about 5,000 products on the Internet (and about 400 of those by catalog), demonstrates the lengths some companies will go to find those unique products. To gain access to specialty items sold only through spas, SkinStore bought a day spa, which it now operates on the side, so that it can sell spa-only items online. "One question that's always going through our mind is where's the product that is No. 595 on our list but is No. 1 on someone else's list?" says John Crisan, SkinStore.com's chief financial officer. "We want to pursue those." With the expanded inventory, the top 30 percent of the company's products account for only 35 percent of total sales.
The post-Pareto world also tests a company's customer service abilities. Eight years ago, when Tony Hsieh became CEO of Zappos.com, the biggest online seller of shoes, he didn't know what to expect for sales patterns. "I thought 80-20 might apply," he recalls. Instead, many customers came to Zappos looking for offbeat styles. The more variety the company put online, the faster it grew. Today the company sells more than three million products across 1,000 brands. The top 20 percent of products account for half of revenue, the bottom 80 percent, the other half. "It varies from brick-and-mortar quite a bit," says Hsieh.
This "wide and shallow" strategy, as Hsieh calls it, is a massive logistical challenge. Zappos' warehouses are the size of 17 football fields. Customer service reps have to be trained to indulge a customer's whims. "Our customer loyalty team may spend an hour trying to help" someone find a shoe, Hsieh says. Though it sounds expensive, Hsieh maintains that by embracing complexity, Zappos has actually reduced its exposure to the vagaries of fickle fashion trends. "We don't have to take a lot of risk on any one product," he says.