01/05/2011 04:25 pm ET | Updated May 25, 2011

Netflix Opens a Pandora's Box

The recent capitulation of Blockbuster video to Netflix has engendered a lot of ink. Most business writers seem to be getting no end of schadenfreude at the sight of the king of the late fees (Blockbuster collected half a billion dollars in late fees in its heyday) getting its comeuppance at the hands of an organization that seems to get the concept of customer service.

So the story we're hearing is that Netflix's ascendancy is the triumph of online retailing and technology over traditional retail stores and physical product. And sure, the facts are compelling. Netflix understood the revolution taking place in the global supply chain, particularly in the field of logistics which obviated the need to carry large inventories. While Blockbuster hung its hat on 5,000 stores nationally, Netflix operated 37 shipping centers located throughout the United States reaching nearly 92 percent of subscribers with generally one-day delivery. That's one million DVDs each day. And, like Zappo's, Netflix chased the good conduct medal, winning numerous customer satisfaction awards from places like ForeSee and Fast Company.

But the more interesting story, in my mind, is told through a socio-cultural lens. Some have described Netflix as a category killer but this seems wrong. It didn't make its fortune on bargain prices and stocking commodity products. Netflix actually did the opposite -- it gave the consumer more and better. A typical Blockbuster has 8,000 tapes covering 6,500 titles in its stores (a neighborhood video store generally has less than 3,000 titles); Netflix offers a collection of 100,000 titles on DVD. The mistake that business case-study scribes make is in thinking that films or music operate the way laundry detergent does. Netflix didn't win because it had more titles at cheaper prices but because its catalog reflected the growing reach of the American and worldwide consumer.

The top rental at Netflix when I last checked was Crash, a searing Robert Altman-esque film from 5 years ago about race relations in California. This is a powerful indicator of what's at play in the Netflix model. Clearly, Crash did not rise to the top of the charts because of advertising or the elephantine point-of-purchase displays one is accustomed to in a video store. Instead, the engine driving viewing tastes at places like Netflix is the Amazon-style customer-review model that has done more to break the stranglehold of advertising over buyer behavior than anything I can think of. Amazon, as we all know, sticks a cookie on your hard drive, so that you're on the receiving end of all sorts of useful features like recommendations based on past purchases and lists of reviews and guides written by users who purchased the products you're viewing. Netflix has now amassed more than 1 billion movie ratings from customers, and members select approximately 60 percent of their movies based on movie recommendations tailored to their individual tastes. For example, my recent browse of the description of the Werckmesiter Harmonies, an austerely beautiful black and white film by the Hungarian director, Bela Tarr led me via Netflix's Cinematch recommendation system to the Devil's Backbone by the Mexican filmmaker, Guillermo del Toro; a look at the terrifically exciting 60s thriller Blow Up led me to Nicholas Roeg's 70s thriller Don't Look Now. It's hard to imagine this skein of sound recommendations happening in a storefront. And that's what Netflix did -- it led us away from the 50 copies of The Hangover or Transformers along an associative path informed by all of our past choices. It wrote a database for serendipity.

Perhaps the company that's expanded on the customer-review idea in the most stunning way is the internet music service, Pandora. Started as a recommendation technology company, it was re-purposed in Fall 2005 as web radio service and today has more than 60 million registered users. Pandora's model is the next iteration of Netflix and Amazon. Called the Music Genome Project, it offers listeners a prompt to enter an artist or song and then constructs a playlist based on the song's distinguishing features. The difference is that Pandora has hired trained music analysts to categorize its entire inventory of music using up to 400 distinct musical characteristics, including melody, harmony, instrumentation, rhythm, vocals, lyrics (the typical music analyst has a four-year degree in music theory, composition or performance). My recent trip to Pandora on my iPhone which began with the 90s grunge heroes, the Pixies, led me to the French super group Phoenix and the even more obscure Edward Sharpe and the Magnetic Zeros, a buoyant California retro act which caught me by surprise. Again, I can't imagine being able to deep dive into the indie music scene that way on terrestrial radio. Pandora took off when it began offering apps for smartphones and other mobile devices and turned its first profit in the first quarter of 2009. With half of all radio-listening occurring in the car, Ford, GM and Mercedes have all expressed plans to put Pandora into their dashboards.

In the end Pandora and Netflix are winning because they reflect their customers in a way that old-line firms with their hegemonic ad campaigns and totalizing distribution channels never could. Time Magazine put it rather well: they "are attempting to second-guess a mysterious, perverse and profoundly human form of behavior: the personal response to a work of art." Pandora and Netflix know that customers today are smarter. And that roving appetite even for the obscure and the interesting is a function of how we've changed. By 2050, the world's urban population will be 6 billion, 300 million inside US cities. 2 billion people will enter the middle class by 2050 mostly in Africa and Asia. We're better educated and more curious about the world than big business gives us credit. And that's the lesson of Netflix. When given the choice of something interesting and exciting that sidesteps the mainstream, we will take it.