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The Power of Recommendation

The retail video rental business and the pay-TV service provider pay-per-view model have a common connection -- they’re both heavily dependent upon new movie releases. Here in the U.S. market, that strategy is now being questioned -- as the two largest video rental retailers struggle to remain solvent, and as cable companies unite with media companies in an attempt to revive their VoD services.

In contrast, Netflix key performance indicators continue to outperform expectations. They have recently reported that their 2010 first quarter revenue rose by 25 percent, and gross margins by 10 percent -- as total subscribers increased by 35 percent year over year. Netflix total number of subscribers (13,967,000) is just behind two major U.S. MSO’s total video subscribers (even though this is not an apples to apples comparison).

consumer video subscribersNetflix offers a monthly subscription-based service. Access to the Internet is an integral part of their offering, since customers must go to a Web site to select from a library of 100,000+ DVDs, which are then delivered via first-class mail. Subscribers can also watch movies and episodes of TV shows (currently over 17,000 titles) streamed online as often as they want.

A significant difference of the Netflix service is how it is designed -- by intent -- to proactively encourage subscribers to choose from the “full catalog” of quality video content instead of just new releases. Netflix focuses on good vs. poor content instead of new vs. old.

Currently, approximately 90% of rentals from video retail stores and pay-TV pay-per-view are new releases, while Netflix new releases rentals are just about 30%. Let’s not forget that rights to new content are often more expensive than catalog content. Netflix has been very successful in promoting its full catalog, and it is thanks to its sophisticated recommendation engine.

Netflix intelligently applies the power of informed recommendations to guide their subscribers to content. Netflix suggestions are based on a number of factors -- including member pre-selected content “taste preferences” and individual member’s ongoing ratings, fine grained common themes, movie data, local favorites, and inventory levels. Their approach is focused on finding the content that best suits each subscriber -- and by doing so, they’ve effectively changed consumer behavior.

The effectiveness of Netflix’s recommendation engine was well demonstrated during the 2009 Academy Awards ceremony. During the 3-hour broadcast Netflix subscribers added 2 million rentals into their queues. Understandably, “Slum Dog Millionaire” was the most added title in the queue, since it won so many Oscars, but at the same time another 56,000 related movie titles were added through the suggestions of its recommendation engine.

And, Netflix continues to influence change. Netflix subscribers who watched streamed content in the first quarter of 2010 reached 55%,  from 48% in the fourth quarter of 2009. Instant video streaming will likely continue to reduce the company’s DVD shipping costs, and further improve its gross margins.

Streaming has become very central to Netflix service as it offers instant gratification for subscribers and cost savings for Netflix. Most of the titles available for streaming are from its catalog instead of new releases.

What’s the lesson learned for traditional pay-TV service providers? That growing broad-based consumer demand and maximizing the utilization of available content libraries is possible by harnessing the power of recommendation engines. Instead of consumers finding the content, content now has to find the consumer. Now, that’s a compelling trajectory to an improved and sustainable return on investment.

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11 Comments.


  1. No question that recommendation is powerful — in traditional cultures, word of mouth, esp from a trusted source is ‘sacred.’ Sounds familiar? However, consumer usage data from pay-TV, Netflix, video rental stores and IP-video streaming may not be comparable. We chanted market segmentation, segmentation, segmentation”” in B-schools. Netflix subscribers are likely to be movie buffs or parents of young children. Video-rental users are probably more occasional consumers or those with less disposable income (don’t want to pay for subscriptions). Online video streaming consumers are likely to be skewed toward early adopters and web-savvy young folks.”

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  2. Pankaj Gupta

    Maria, thank you for taking the time to share your thoughts. While it’s true that the initial users of the Netflix Instant play online video streaming were early-adopters, the latest quarterly results seem to indicate that mainstream consumers are the next wave of service users. Those who already use Netflix fully appreciate how content recommendations enhance the experience — current customer referrals are therefore likely one of their most effective marketing channels. Internet streaming is mainstream now. As per ComScore, more than 174 million U.S. Internet users watched 28.1 billion online videos in February 2010 across all the video sites.

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  3. Pankaj Gupta

    Grace, thank you for reconfirming the power of recommendation as a consumer.

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  4. My family is an avid netflix fan and we certainly appreciate the recommendations made on the website. It’s true that we don’t necessarily cue up new releases at the top of our list, but rather, we pick out what is recommended in different categories and go from there.

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  5. The problem with Netflix is they don’t have access to any proprietary streaming technology. Any compentent start-up with 20-30m of funding can replicate what Netflix did by purchasing turnkey solutions from companies such as MatrixStream or even from Cisco or Microsoft. That is a scary thing for shareholders with a company with market cap of $5b.

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  6. Pankaj Gupta

    Jimmy, Agreed, standards-based technology has many benefits. Given their choice of standards-based streaming technology, Netflix supports many types of end user devices, which in turn drives more use of streaming by their subscribers. However, Netflix has also created differentiation on several fronts. A cutting edge recommendation engine, large catalog of streaming content, convenience, and packaging of their offer are some of examples. Also, Netflix is very popular among its subscribers, due to its excellent service and pricing strategy — and that’s very important, with their growing customer base.

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  7. Hope something like Netfix comes in my place,India. But don’t know if it will be feasible as people are still addicted to traditional TV concept.

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  8. Pankaj Gupta

    Sunu Mariam,FYI, in late 2009 Netflix CEO, Reed Hastings, revealed they plan to launch a streaming-only service to be targeted outside the U.S. market. Their new international efforts are apparently scheduled to launch in the second half of 2010, starting in one pilot market and then expanding into other countries.

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  9. Hi Pankaj,Makes you wonder how much more successful and profitable Hulu.com (a website offering commercial-supported streaming video of TV shows and movies) could be if it were NOT always shooting-itself-in-the-foot”” by constantly taking offline great TV show episodes as well as great movies!http://www.hulu.com/In my opinion, Hulu is its own worst enemy!Sincerely,Brad Reese”

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  10. The business model used by Netflix is probably achieving great user satisfaction by delivering all time quality content.

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  11. Pankaj Gupta

    Nathan and Brad, yes quality content matters – it’s the essence of what people seek when they subscribe to a video service. Plus, a user experience that simplifies the process of finding that desired content is a big value-added bonus. As you also know currently, Netflix and Hulu have different business models, but both have grown their subscriber base significantly in the last few years.

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