How Netflix Works


There's nothing quite like the anticipation of receiving that red Netflix envelope in the mail.
There's nothing quite like the anticipation of receiving that red Netflix envelope in the mail.
Image courtesy of Netflix

When Reed Hastings launched Netflix in 1997, his idea didn't make sense to a lot of people. DVD players had only been on the market for a few months, and many families were still using VHS tapes to watch movies. In spite of that, Netflix's movie inventory consisted exclusively of DVDs. Naysayers also doubted that people would want to wait for home delivery when video rental stores seemed to be everywhere. Critics wondered whether Netflix's unlimited subscription plans, launched in 1999, would be profitable.

By July 2011, more than a decade after opening its virtual doors, Netflix had more than 25 million subscribers in the U.S. and Canada [source: Netflix]. For the first half of 2011, the company's total revenue exceeded $1.5 billion. Netflix also enjoyed a tremendous increase in subscribership in early 2011, up from just 15 million a year before. Netflix attributes much of this growth to increased amounts of online streaming content, availability on a wide range of electronic devices and strong word-of-mouth recommendations [source: Netflix].

Even before it began unlimited content streaming to subscribers in 2008, Netflix was well-established as a rent-from-home DVD service. Part of that success could be attributed to its breadth of movie offerings; its library had about 75,000 after its first decade, and that number is constantly growing. It's also likely that Netflix has been successful because it has attracted customers who want to watch a variety of movies rather than just new releases. In 2007, only about 30 percent of Netflix rentals were newly-released DVDs, but at most video-rental stores, 70 percent of rentals were new movies [source: Business Week].

By its 10-year mark, Netflix recognized that Internet services and video streaming technology had become better and easier to obtain for the average viewer at home. Keeping up with that trend, the company started offering online streaming content. Netflix also added Blu-ray disc rentals as a service upgrade, acknowledging the increasing attraction and growing market for the Blu-ray media format [source: Netflix].

There's a lot going on, both on the Netflix Web site and behind the scenes, to allow Netflix to deliver so many movies to so many people. In this article, we'll look into how Netflix delivers both discs and online content, and how it decides which movies to recommend to you. We'll also explore the company's competition, growing pains and outlook for the future.

Netflix Web Site and Envelope

The Netflix queue
The Netflix queue

The two most visible parts of the Netflix enterprise are the red mailing envelopes and the Web site. The patented envelope is essentially an ordinary mailing envelope with an extra long, removable flap. This extra length of paper is what lets DVDs make the round trip from the Netflix distribution center to your home in just one envelope. When the envelope travels to you, the flap displays your address while covering up the shipping center's return address. You remove the flap when you seal the envelope to return it to Netflix, so only the shipping center's address remains.

The envelope has been through several revisions as Netflix has refined its shipping methods and tried to become more profitable. These include the following:

  • the addition of advertisements on the back of the flap
  • the addition of a small slot that displays the barcode of the disc inside
  • the removal of instructions on how to place the disc in the mailer

The Netflix Web site has been through numerous revisions as well. The company has made major changes to the site as often as every two weeks, constantly evaluating how the changes affect the business. Numerous features have come and gone, but for the most part, the site has looked a lot like other online retail stores. The available movies appear as thumbnail images, sometimes in conjunction with a brief description. When you hold your mouse pointer over a selection, the site pulls a lengthier description from a database and displays it on the screen. This description includes information about the movie's plot, cast and MPAA rating. Clicking on a title takes you to a separate page with cast and crew information, technical specifications. Rating information from Common Sense Media, a separate company with its own Web site, is also displayed.

You can browse the section by genre, check out the Critic's Picks and Award Winners, or use the Netflix Top 100 to decide which movies you want to see. You can also use the Friends feature to see what your friends are watching and compare which movies you like. When you find a movie you want to see, you add it to either your DVD or your Instant queue. If you want to see a movie that Netflix doesn't have in its inventory yet, you can save it for later. Netflix ships DVDs in the order in which they appear in your DVD queue, and you can change the order or remove items in your queues as often as you want.

As you browse, you have three options for each movie you see on the site. You can give it a star rating, add it to one of your queues or tell Netflix that you're not interested in it. The choices you make dramatically affect which movies Netflix features on the site when you visit. Next, we'll take a look at the Netflix recommendation engine and how it works.

Netflix Recommendations

Netflix's Top 10 and other suggestions for you are based on your viewing habits.
Netflix's Top 10 and other suggestions for you are based on your viewing habits.
Screenshot by Stephanie Watson for HowStuffWorks

The Netflix Web site makes these recommendations automatically using a recommendation algorithm. This algorithm instructs Netflix's servers to process information from its databases to determine which movies a customer is likely to enjoy. The algorithm takes these factors into account:

  • The films themselves, which are arranged as groups of common movies
  • The customers' ratings, rented movies and current queue
  • The combined ratings of all Netflix users

The first algorithm behind these recommendation was called CineMatch. The CineMatch algorithm had a long run and proved fairly successful at predicting movies that subscribers would like. According to Netflix, these predictions were accurate within half a star 75 percent of the time, and half of Netflix users who rented CineMatch-recommended movies gave them a five-star rating.

Recognizing that there's always a better way to do something, Netflix launched a contest in 2006 to find an algorithm that could beat CineMatch. The contest, called the Netflix Prize, promised $1 million to the first person or team to meet the accuracy goals for recommending movies based on users' personal preferences. Netflix also released the test data for algorithm developers to follow: 100 million movie ratings, ranging from one to five stars, from anonymous users. Three years later, the $1 million prize was awarded to BellKor's Pragmatic Chaos, a seven-member team which included two AT&T researchers. BellKor's Pragmatic Chaos submitted its winning algorithm only 24 minutes before another team, The Ensemble. Each of these algorithm submissions demonstrated 10 percent improvement over CineMatch [sources: Netflix, Hoffman].

The recommendations system updates itself constantly, making thousands of recommendations every second based on more than 5 billion movie ratings. Netflix reports that the average Netflex user has rated about 200 movies, and new ratings come in at about 4 million per day. About 60 percent of Netflix subscribers select movies based on these recommendations. You can find these in the "Suggestions for You" section on the site, and you can refresh the suggestions as you rate more movies [source: Netflix].

Making good movie recommendations may seem like something that would require instinct or emotion. For example, if you recommend a movie you've seen to a friend, you take into account how the movie made you feel, your tastes and your friend's tastes. Netflix recommendations, on the other hand, are all math. Netflix matches your viewing and rating history with people who have similar histories. It uses those similar profiles to predict which movies you are likely to enjoy. That's what these recommendations really are -- predictions of which movies you will like.

These predictions rely on algorithms and statistics. It starts by matching movies to each other rather than matching people to movies, since there are far fewer titles in the library than there are Netflix subscribers. To make matches, a computer:

­

  1. Searches the CineMatch database for people who have rated the same movie - for example, "The Return of the Jedi"
  2. Determines which of those people have also rated a second movie, such as "The Matrix"
  3. Calculates the statistical likelihood that people who liked "Return of the Jedi" will also like "The Matrix"
  4. Continues this process to establish a pattern of correlations between subscribers' ratings of many different films

Often, these predictions make logical sense. A Netflix customer who gives two movies in the "Lord of the Rings" trilogy five stars is likely to enjoy the third film as well. However, Netflix users who spend a lot of time rating their movies and looking at their recommendations may find some surprising correlations. This is because the algorithms that keep the recommendation system running don't necessarily have anything to do with the plot or cast. Instead, they have to do with other subscribers' rental and ratings histories.

According to one article in the "New York Times," this recommendation system has significantly changed people's movie preferences. It has given independent releases and films that did not succeed at the box office a wider distribution [source: New York Times]. As more Netflix subscribers see and rate these lesser-known films, the system recommends them to more people.

Regardless of whether someone is renting a classic movie, an independent film or a new release, the Netflix distribution system handles it in the same way. We'll look at how movies get to your home and back to Netflix in the next section.

Netflix Shipping and Receiving

Netflix mailers being sorted
Netflix mailers being sorted
Image courtesy of Netflix

In the early days of Netflix, the company had one major advantage over its rent-by-mail competitors. While other companies had one central distribution center, Netflix had several scattered around the United States. This cut down on the amount of time that customers' DVDs spent in transit. Today, Netflix has distribution centers strategically located throughout the United States and Canada. This allows 90 percent of subscribers to get their DVDs the day after Netflix ships them. The return trip takes the same amount of time.

Netflix also processes nearly all of the DVDs it receives on the day they arrive. Each weekday, the United States Postal Service (USPS) delivers thousands of DVDs to each Netflix shipping center. Employees open the envelopes and scan a UPC barcode on the sleeve contained the DVD. The Netflix inventory system automatically updates the subscriber's queue and sense an e-mail message reporting that the DVD has arrived. An employee then inspects the DVD to make sure it isn't broken or too damaged to play and returns it to the shipping center's inventory.

For the most part, this process, with its one-day delivery and same-day processing, is fairly efficient. It allows Netflix to deliver 1.5 million DVDs through the USPS every day; Netflix delivered its billionth DVD on February 25, 2007. However, a number of factors can affect which DVDs you get and when you get them. One is the rarity of the DVD. If there aren't copies in the system, Netflix may have to ship one from a center that is far from where you live. Another is the popularity of the movies you want to watch. For newly-released films, Netflix may have fewer copies of the film than there are people who want to see it. In some cases, new releases have wait times of days or weeks.

If you watch lots of DVDs from Netflix every month, it may also take longer for you to get to the top of the waiting list for extremely popular movies. According to Netflix, this is to give the best possible service to all customers. However, critics of the practice refer to it as throttling and say that it puts Netflix's best customers at a disadvantage. Although Netflix claims it has always given its least-frequent renters the highest priority for new titles, it didn't always disclose this fact in its terms of use. For this reason, the throttling debate led to a class-action lawsuit -- Frank Chavez v. Netflix Inc. -- by users who accused the company of wrongdoing.

In the 2005 settlement of the case, Netflix provided a month free service to members, and it added appropriate language to its terms of service. Today, the "DVD Terms of Service" includes the following language: "In determining priority for shipping and inventory allocation, we may utilize many different factors, including the number and type of DVDs you rent through our service, the membership plan you select, as well as other uses of our service by you."

Subscribers have also questioned the quality of the Netflix shipping process. DVDs travel to subscribers' homes and back in plain, unpadded envelopes, and many discs spend a lot of time being handled and shipped. For these reasons, some people receive broken, scratched or otherwise unplayable DVDs. Critics claim that Netflix uses inadequate packaging to improve its bottom line and even accuse the company of willfully distributing defective discs. However, Netflix has been a member of the Better Business Bureau since 2001, and it's currently a Better Business Bureau Accredited Business with an A+ rating.

Though the red envelopes have been the heart and soul of Netflix since its inception, online content streaming has transformed the business. Let's check out Netflix streaming and device availability next.

Content Streaming on Netflix

Netflix offers an ever-increasing collection of commercial-free content to subscribers who pay for unlimited streaming services.
Netflix offers an ever-increasing collection of commercial-free content to subscribers who pay for unlimited streaming services.
Screen capture by Stephanie Crawford for HowStuffWorks

By 2007, high-speed Internet access from home had become more affordable and more common. At the same time, home Internet use included an increasing amount of downloading and streaming of media content. Netflix got a jump on that market by adding unlimited online streaming as one of its subscription options starting in January 2008.

To stream content from Netflix, you need a subscription that includes unlimited streaming. As of fall 2011, you could have unlimited streaming only for $7.99 per month. Unlimited DVD rental service runs an additional $7.99 per month.

When you subscribe to Netflix streaming, the following Netflix features are available to you:

  • an "Instant" queue alongside your "DVD" queue
  • "Play" buttons in both your DVD and "Instant" queues if the content is available for streaming
  • options throughout the site to "Play" or "Add to Instant Queue" in addition to the red "Add" and green "Save" options for the DVD queue
  • streaming access via more than 200 different devices, including game consoles (the Wii, Xbox 360 and PS3), mobile devices (iPhone, iPad and iPod touch), and Apple TV and Google TV

The first generation of Netflix streaming used Microsoft Silverlight, a platform that software developers can use to drive user interaction on the Web and mobile devices. Since Netflix required Silverlight, streaming was limited to computers and devices that could install and run the Silverlight software.

When Netflix transitioned its Web site to Amazon's cloud services in 2010, the company took that opportunity to incorporate the latest Web technology. This included HTML5, the new and continually developing standard for interactive Web content. By switching from Silverlight to HTML5, Netflix hopes to deliver content to more devices simply based on whether the software on that device was standards-compliant with HTML5. This means opening up Netflix streaming to more Web browsers, consoles and mobile devices [source: Caincutti, StrategyEye].

Though online streaming on Netflix is convenient, it does have a few disadvantages. First, not all Netflix content is available online. Netflix has continually expanded its online content selection, but there are still thousands of films you can only view on DVD. Second, not all DVD content is available online. For example, a foreign TV show on DVD may have both subtitles and English dubbing available, but Netflix might only stream the original language with subtitles. Easter eggs and other special DVD features are also limited through Netflix streaming.

So far, we've looked at the two side of Netflix's business, DVD rental and online streaming. Next, we'll look how Netflix's competition has changed over time on both of these fronts.

Netflix's Competition, Then and Now

When it comes to Netflix, the story of market competition has an interesting twist. In the beginning, the company's primary competition was Blockbuster. In the 1990s, Blockbuster was the largest name in home video rental service in the U.S., with thousands of stores nationwide. By 2004, though, the Netflix brand was gaining popularity as DVD renters developed a growing interest in its rent-by-mail service. That year, Blockbuster launched its own rent-by-mail service called Total Access to complement its in-store service and hold on to the customers that Netflix had appealed to [sources: History.com, SeekingAlpha].

In the first quarter of 2007, Netflix reported that Blockbuster's new program had caused its growth to slow. However, some analysts suggested that Blockbuster's focus on following Netflix's rent-by-mail model would be its undoing. Those predictions proved correct. By 2009, Blockbuster had closed about half of its stores nationwide, with hundreds more to follow. Then, in 2010, Blockbuster filed for Chapter 11 bankruptcy protection [sources: SeekingAlpha, AP, McCarty, Sandler, and Kary].

Around the same time, another video rental model presented competition to both Netflix and Blockbuster. Redbox is a video rental service operated by Coinstar, a company known for its coin-counting vending machines often found in grocery stores. Like Coinstar, the Redbox service is provided through an automatic vending machine. Redbox launched its services nationwide in 2002, and by late 2011 it had more than 27,800 kiosks in grocery stores, drug stores and other retail establishments across the U.S. [sources: AP, Redbox, Redbox].

So, what's the twist in Netflix competition? With the introduction of online streaming content, that competition shifted dramatically. No longer were Blockbuster and Redbox the only threats, especially since Netflix was well-established as the market leader in the disc rental market. Potential threats to their market share also came in the form of online streaming services like Hulu.

When Netflix launched unlimited streaming in 2008, Hulu had nearly a year of experience in that market. The two companies had notably different markets, though: At the time, Netflix focused on movies by subscription only, and Hulu focused on television with both free and subscription-only content. Gradually, their content selections have overlapped, with many TV shows on DVD available commercial-free through Netflix. Also, other streaming services from Amazon and Time Warner have kept Netflix on alert for possible threats in the future [sources: Netflix, Hulu, Carr].

Throughout this article, we've looked at how Netflix recommendations work and how you can enjoy Netflix both through the mail and online. We've also examined some of Netflix's competition and how that's changed over its first 14 years. For even more information about Netflix, flick over to the next page.

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