NetFlix 2008 Annual Report Download - page 19

If we are unable to effectively utilize our recommendation service, our business may suffer.
Based on proprietary algorithms, our recommendation service enables us to predict and recommend titles
and effectively merchandise our library to our subscribers. We believe that in order for our recommendation
service to function most effectively, it must access a large database of user ratings. We cannot assure that the
proprietary algorithms in our recommendation service will continue to function effectively to predict and
recommend titles that our subscribers will enjoy, or that we will continue to be successful in enticing subscribers
to rate enough titles for our database to effectively predict and recommend new or existing titles.
We are continually refining our recommendation service in an effort to improve its predictive accuracy and
usefulness to our subscribers. We may experience difficulties in implementing refinements. In addition, we
cannot assure that we will be able to continue to make and implement meaningful refinements to our
recommendation service.
If our recommendation service does not enable us to predict and recommend titles that our subscribers will
enjoy or if we are unable to implement meaningful improvements, our personal movie recommendation service
will be less useful, in which event:
• our subscriber satisfaction may decrease, subscribers may perceive our service to be of lower value and
our ability to attract and retain subscribers may be adversely affected;
• our ability to effectively merchandise and utilize our library will be adversely affected; and
• our subscribers may default to choosing titles from among new releases or other titles that cost us more
to provide, and our margins may be adversely affected.
If we do not acquire sufficient DVD titles, our subscriber satisfaction and results of operations may be
adversely affected.
If we do not acquire sufficient copies of DVDs, either by not correctly anticipating demand or by
intentionally acquiring fewer copies than needed to fully satisfy demand, we may not appropriately satisfy
subscriber demand, and our subscriber satisfaction and results of operations could be adversely affected.
Conversely, if we attempt to mitigate this risk and acquire more copies than needed to satisfy our subscriber
demand, our inventory utilization would become less effective and our gross margins would be adversely
affected. Our ability to accurately predict subscriber demand as well as market factors such as exclusive
distribution arrangements may impact our ability to acquire appropriate quantities of certain DVDs.
If we are unable to renew or renegotiate our revenue sharing agreements when they expire on terms
favorable to us, or if the cost of obtaining titles on a wholesale basis increases, our gross margins may be
adversely affected.
We obtain DVDs through a mix of revenue sharing agreements and direct purchases. The type of agreement
depends on the economic terms we can negotiate as well as studio preferences. We have entered into numerous
revenue sharing arrangements with studios and distributors which typically enabled us to increase our copy depth
of DVDs on an economical basis because of a low initial payment with additional payments made only if our
subscribers rent the DVD. During the course of our revenue sharing relationships, various contract administration
issues can arise. To the extent that we are unable to resolve any of these issues in an amicable manner, our
relationship with the studios and distributors or our access to content may be adversely impacted.
As the revenue sharing agreements expire, we must renegotiate new terms or shift to direct purchasing
arrangements, under which we must pay the full wholesale price regardless of whether the DVD is rented. If we
cannot renegotiate purchasing on favorable terms, the cost of obtaining content could increase and our gross
margins may be adversely affected. In addition, the risk associated with accurately predicting title demand could
increase if we are required to directly purchase more titles.
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