The Economics of the Long Tail

Anderson (2006) argues that e-commerce and other new technologies improve efficiency by encouraging the entry of new producers and innovations, creating a "long tail" of niche products while reducing the market share of previously popular products. We study the strategic interaction between hits and niches in their pricing, entry, and innovation decisions using a model of competition under product differentiation and generalized cost structure. In contrast to the popular view, we show that improvements in information and communication technology can lead to either the long tail effect or an opposite "superstar" effect (Rosen, 1981), depending on (a) how the structure (not simply the level) of producer costs changes, and (b) how disparate are consumer preferences. These two factors also determine whether there is excessive or insufficient product diversity. Post-entry product and technology innovation incentives may be inefficient in the long tail market structure because producers can soften price competition by engaging in excessive product differentiation and adopting technologies with high variable costs. These results have implications for various competition-related policies.