Outsourcing Innovation

Disclosure: I am an ecstatic Netflix customer.

This morning, Netflix came through on their promise and awarded $1 million to the team that developed an algorithm for calculating viewing suggestions that substantially bested their in-house CineMatch system.

Three years ago, instead of expanding their staff of computer scientists and statisticians, Netflix offered a seven-figure prize to any person or team that could improve by a measurable margin, their CineMatch movie recommendation software. Initially, over 40,000 teams began work, ranging from groups of top-level scientists to individuals working from home. In fact, one person working alone, a statistician in England, was able to improve the algorithm by 5%. But the prize was only paid if the recommendations were 10% more accurate along with a speed increase. There were teams that topped the 8% mark, but as they approached 10%, it seemed an impossible task, in large part because the teams had to address a 100-million element dataset.

After two years of work, it was apparent that no single team had the requisite skills to win the award, so teams started merging spontaneously. The winning team, BellKor's Pragmatic Chaos, was a merger of tw separate groups and consisted of scientists, statisticians, and researchers from Australia, Canada, Israel, and the United States. The resulting algorithm, which Netflix now owns, offers a much better customer experience with regard to movie recommendations. A second team, Ensemble, was able to best the 10% mark within 30 days, which triggered an in-depth review of the algorithms. In the end, BellKor was declared the winner.

What does all this mean? First, Netflix was able to advance the science of recommendations research, which has tremendous potential to change the personalization experience of many companies doing business on the Internet. Second, it was able to do this without adding any corporate resources and for the paltry sum of $1 million - a bargain. The potential license revenues would pay for this many times over. Third, they have demonstrated just how important customer satisfaction is to it - and at a time when competition is heating up from numerous venues ranging from RedBox to Hulu. And finally, Netflix has shown that innovation can be outsourced successfully, thus changing the playing field for everyone.