Zillow relies primarily on public record information, like house size, assessed value, age, etc. It then uses a lot of proprietary formulas to come up with the zestimates. But these are things it doesn't use:
A) Road noise: Is your home noisy? Zillow doesn't know that. Buyers do.
B) Is your lot steep? Zillow has no way to evaluate the steepness of a lot, other than the town assessment info, and that's not very reliable.
C) Floorplan: Buyers like certain floor plans, and dislike others. This can be a 20% swing in home value alone, and there's no real mathematical way to capture this. A recent sale would, but even that isn't reliable.
There's other "intangibles" that make things difficult. You'll find Zillow does very well in dense areas where the housing is similar, but in rural areas, where the housing is less uniform, it can miss market prices by 25% or more.
Simply stated, all you need is an understanding of the general location to determine many Zestimates are based on inappropriate comps. generally associated with location of the homes.
When dealing with this site it is important to take care using the information that is provided. It's a great site....when used in combination with your personal information about the location.
As zillow states and Matt implies in his post, a zestimate is just a starting point, and nothing more.
It also says my house is about 11k higher than I paid for it in November. The price I paid was a pretty good comp to the others in the area.