After nearly a decade of avoiding the ad business, Netflix (NFLX -1.54%) is starting an ad business.
Co-CEO Reed Hastings had long dismissed the idea, arguing that the simplicity of Netflix’s ad-free subscription model was an advantage, but the market finally forced his hand.
Netflix stock fell 64%, with much of that decline coming after the company reported a surprising drop in total subscribers in the first quarter and lost another net 1 million members in the second quarter.
The most obvious conclusion based on these numbers is that Netflix has reached maturity faster than expected, especially in its main North American market, where it lost a net 1.9 million subscribers in the last two quarters.
Since the service already counts more than half of the broadband households in North America among its subscribers, its growth potential is limited. If it can’t grow its subscriber base, its only real options for increasing revenue in North America are to raise prices (which it has done several times in recent years) or sell ads. The company is also starting to give customers the option to “pay to share,” or pay to add extra users to a household account in an attempt to cut down on password sharing, but advertising is its best idea for the Top line to grow.
Why advertising could be huge
Hastings is right that Netflix’s simplicity has historically been a strength that has helped attract subscribers. To see also : What’s up for Amazon Prime Video in August 2022?. In fact, its simple subscription model dates back to its days as a DVD-by-mail company, when it promised a simple flat monthly fee and no late fees.
By now, however, it has become clear that sticking with it would mean leaving a lot of money on the table.
In its Q2 shareholder letter, Netflix revealed that its viewing hours, according to Nielsen, were far ahead of all of its competitors, including broadcast television networks. In the 2021-22 TV season, viewers watched 1.3 billion minutes of Netflix content. CBS was a distant second at 753 billion, and NBC was in third place with 597 million. Even combined, the two legacy broadcast networks had only slightly more hours of viewing than Netflix. Among streamers, Disney+ is in second place with 245 million minutes, which means people spend more than five times as much time watching Netflix as they did with its closest streaming competitor.
Given the sheer size of its content budget, it’s perhaps no surprise that Netflix is watching more time than any of its peers. The problem is that Netflix doesn’t monetize its audience at five times the rate of competitors, because this all-you-can-watch model doesn’t offer the business incremental benefits from the extra time spent with the service.
Advertising can fix this. With an ad-based tier, Netflix will earn revenue based on viewing times rather than just per subscription, taking advantage of that high level of engagement.
Ad tiers work
Probably the best example of a streaming service that offers a choice between an ad-based tier and an ad-free option is Hulu, which is now owned by Disney. Hulu currently prices its ad-supported service at $6.99 a month, while viewers who want an ad-free experience pay $12. This may interest you : The popular Nickelodeon series breaks into Netflix’s Top 10.99 a month. Hulu’s average monthly revenue per subscriber was $12.77 in its last quarter, meaning it makes about the same revenue from customers in both categories. Sometimes more money is made from ad-supported customers than ad-free.
In 2019, Hulu said that 70% of its viewers were on the ad-supported tier, which shows that streaming subscribers – at least in this case – prefer an ad-based tier with lower out-of-pocket costs. Hulu originally launched as an ad-based service, only debuting its ad-free tier in 2015. Netflix is unlikely to see its subscriber base reach the kind of mix that Hulu has, but the proportion of its users who have chosen the option with advertising is still revealed.
What it means for Netflix
In addition to the demand from the viewers, there should also be a great demand from the advertisers. After all, Netflix is a primary reason why the once highly profitable linear TV ecosystem has leveled off, and with it the huge TV advertising industry. Advertisers are hungry to replace those eyeballs. To see also : The Absolute Best Horror Movie on Netflix. Connected TV allows better advertising targeting than linear TV, because Netflix has detailed data on household and individual viewing habits. More broadly, digital advertising has already become a huge industry, delivering mountains of profits to leaders such as meta platforms and Alphabet (which owns YouTube).
Netflix will offer advertisers another platform with massive global reach. The streamer still needs to execute on his new business, but all the pieces are there for it to be a success.
Suzanne Frey, an executive at Alphabet, is a member of the Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of the Motley Fool’s board of directors. Jeremy Bowman has positions in Meta Platforms, Inc., Netflix, and Walt Disney. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., Netflix, and Walt Disney. The Motley Fool recommends the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool has a disclosure policy.
Suzanne Frey, an executive at Alphabet, is a member of the Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of the Motley Fool’s board of directors. Jeremy Bowman has positions in Meta Platforms, Inc., Netflix, and Walt Disney. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., Netflix, and Walt Disney. The Motley Fool recommends the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool has a disclosure policy.
