Why Netflix Needs You to Quit Searching its Catalog

Demitri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you are coming to the Netflix (NASDAQ: NFLX) website looking for a particular movie or show to stream, you will probably be disappointed. Netflix doesn't have all - or even most - of the popular selections.

Yet Netflix users streamed over 2 billion hours last quarter, at an average of 30 hours per subscriber. In a similar fashion as its DVD-only service, Netflix is actually driving usage of back-catalog titles.

But without a deep new-release selection to fall back on, the stakes are now much higher for the company as it tries to help users navigate its large - but limited - selection.

Less Selection

This kind of limited selection isn't the norm for Internet companies. Ebay boasts on its website that customers can buy and sell "practically anything" through its service. Amazon (NASDAQ: AMZN) bragged in its latest shareholder letter (pdf) that the selection it offers wouldn't even be "possible" in an actual store.

If Amazon was a physical store, though, the company estimates that it would "occupy 6 football fields."

Apple (NASDAQ: AAPL) tells prospective iTunes customers that its virtual store has "everything you need to be entertained," including "millions" of TV shows, movies, and songs that help deliver on that expansive promise.

Netflix, meanwhile, makes much less sweeping commitments on its sign up page, pointing to a mere "thousands of movies and TV episodes." For a new-economy, Internet-centered company, that pitch seems a bit underwhelming.

What's more, Netflix's management readily admits the catalog's limitations. “At $7.99 a month, we can’t provide unlimited content,” CEO Reed Hastings has said. "We don’t have everything, but we have a great bargain," Hastings said. "That’s what we want the brand proposition to be."

The company's limited offering is why Netflix needs you to browse, surf, peruse - anything but search - its catalog of streaming titles. The odds are just too high that the company won't have the particular title you're looking for. And after a few failed queries, you are likely to end up unsatisfied with the service, and ready to spend your $8 some place else.

But if searching isn't helping users choose those 30-plus hours of streaming time per month, the company's recommendations engine is. And in the new streaming-only model that Netflix has bet its future on, that engine is more than a service enhancement, it is central to the company's success.

Higher Stakes

Back when Netflix was building its DVD empire the company held a $1 million data mining contest, offering an award to the first engineering team that could improve its recommendations algorithm by 10%. After thousands of hours of work, a few teams were able to collaborate and finally cross that threshold.

The result was an even better 5-star recommendation engine that simply worked to juice Netflix's margins by drawing usage away from expensive new releases while also improving users' satisfaction with the service. It worked brilliantly, driving demand for cheaper back-catalog DVD shipments that helped keep expensive new releases to a minority of Netflix's usage.

In the new streaming model, though, Netflix's costs are mostly fixed and the content catalog is anything but comprehensive. That means the consequences of a failure for the recommendation engine are much more severe.

Instead of just choosing a costlier new release and dinging profits a bit, customers that aren't swayed by recommendations have nowhere else to go. Either they like what Netflix recommends, or they become ex-customers.

Last week, at the company's blog, Netflix opened up about how the recommendation engine has been evolving and the results are encouraging:  

"Now 75% of what people watch is from some sort of recommendation. We reached this point by continuously optimizing the member experience and have measured significant gains in member satisfaction whenever we improved the personalization for our members."

According to the post, the recommendation engine is also getting more sophisticated, taking into account diversity, freshness, and similarity across movies or members.

And with Facebook integration now working its way into the service, it should be getting even easier for users to find something in the catalog that they want to watch, even if they don't seek it out themselves.

Bottom Line

By splitting out the DVD service, Netflix has jettisoned its safety net of a comprehensive new-release selection that could catch unsatisfied subscribers before they choose to opt-out of the service. But as long as Netflix can keep you watching with its improved recommendation engine, you'll stay engaged and the company won't lose your business. 

Just don't hit that search button, Netflix begs you.

Demitri writes about stocks and investing at his blog, Sigma Swan.


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