Netflix With Ads Might Not Be Worth It, Even With Potential Revenue of $9 Billion

  • Netflix co-CEO Reed Hastings said the company will explore an ad-supported tier “in the next year or two.”
  • The announcement came after Disney announced its plan to bring ads to a cheaper version of Disney+.
  • But industry experts say licensing content would take years, and Netflix’s advantage may be limited.

Netflix

shocked the entertainment industry when, on the heels of an already harrowing Q1 2022 earnings report that included a predicted decline of 2 million subscribers in Q2, co-CEO Reed Hastings revealed in the earnings call that the


streaming

service would explore creating an ad-supported tier “in the next year or two”.

“Anyone who follows Netflix knows that I’m against the complexity of advertising and I’m a big fan of the simplicity of subscription,” Hastings said Tuesday.

“As much as I’m a fan of it, I’m a huge fan of consumer choice,” he continued. “Allowing consumers who would like to have a lower price and are tolerant of advertising [to] getting what they want makes a lot of sense.

His remarks caught industry watchers off guard, despite Netflix’s recent softening of its “never ads” stance to “never say never” amid stagnant subscriber growth in the US and Canada. Disney+, which launched in late 2019, announced on March 4 that it will add an ad-supported tier.

Still, as industry experts told Insider in the weeks leading up to Netflix’s earnings, even if the technology is easy to implement, the economics don’t necessarily support a foray into ad-supported subscriptions.

Netflix could be losing up to $9 billion a year in ad revenue

Needham analysts estimated in a Jan. 21 investor note that Netflix was losing $9 billion a year in potential revenue from not introducing ads. That number is based on the $40 per user per year in ad revenue that Needham estimates Roku earns, multiplied by Netflix’s 222 million global paid subscribers at the time. (Netflix now has 221.6 million subscribers after losing 200,000 in the first quarter of 2022, and expects to drop to 219.6 million by the end of the current quarter.)

Of course, Roku doesn’t have the global presence of Netflix, so this estimate might be generous. CPMs are generally lower internationally than in the US.

Still, Needham suggests that adding even a lower price option with ad support could make Netflix more competitive against rival streamers. Analysts recommended in the note a tier that would cost $5 to $7 a month and have 5 to 6 minutes of ads per hour.

“Almost all of its streaming competitors have already introduced this two-tier pricing strategy,” the analysts wrote. “We believe this price would generate higher revenue for ‘ad-light’ subs compared to the current NFLX ad-free level.”

While Hastings did not comment on the price of a possible ad-supported offering,


hulu

The company’s ad-free service costs $12.99 a month versus $6.99 a month for the ad-supported version.

“I think it’s pretty clear it’s working for Hulu. Disney is doing it, HBO has done it. I don’t think we have too many doubts that it works, which all these companies have figured out,” he said on the call. . “I’m sure we’re going to go in and find out, rather than test it and maybe do it or not do it.”

He acknowledged that an ad-supported tier would not be a “short-term fix”.

“Once you start offering a lower price plan with ads as an option, some consumers take it, and we have a large install base that is probably very happy where it is,” he said Tuesday. “Think of it as it would be in a few years in terms of volume of material.”

He also alluded to being open to allowing a third party to implement targeted advertising on the platform.

“In terms of profit potential, the online ad market has definitely advanced,” he said. “So that we can be a direct publisher and get other people to do all the fancy ad matching and integrate all the data about people, so we can stay out of that and really focus on our members, creating a great experience and being monetized at a first rate by a number of companies offering this service.”

However, the company’s infamous secrecy around its metrics and data can be an obstacle.

“Netflix is ​​also super stingy with their data, and to be an ad-supported company, you would have to convince your advertisers of the effectiveness of those campaigns,” Steve Shannon, CEO of Swerve TV and former Roku executive, said in March. “They would have to give up their data to be good ad salespeople… They would have to change that mindset.”

‘It would be a monumental elevation from a content licensing standpoint’

From a technical standpoint, several senior executives in the ad-supported video-on-demand space told Insider that they believe Netflix is ​​more than capable of building an AVOD layer through its own engineering team. The biggest challenge for the streamer is in their current licensing agreements for programming in their library.

“It would be a monumental elevation from a content licensing standpoint,” Shannon said.

Netflix may have the subscription window rights to “Seinfeld” and other non-original series, for example, but it doesn’t have the contract rights to an ad window, which may not even be available to some of them.

“When CBS or Turner or anyone else unlocked their library for Netflix, it was on the condition that it was not ad-supported because they didn’t want to sharpen the knife that would cut their own throat,” said one. senior-level AVOD executive told Insider in March. “If all of a sudden the Netflix engine had the exact same library content running on their platform, and they could sell advertising, the only thing that allowed these companies to make money evaporates overnight.”

One analyst said the value of an ad-supported tier is about $10 per month per user.

Getting into the ad-supported business might not be as profitable for Netflix as some might think.

“The only real obstacle to achieving this, besides [Netflix co-CEO] rush [Hastings]The company’s reticence in doing so is that the value of an ad-supported tier” – that is, the revenue it could generate – “is probably only about $10 [per user] per month,” Wedbush analyst Michael Pachter said last month, believing such a foray would generate subscriber growth but not significant revenue growth.

Netflix’s current US prices range from $9.99 a month for a single plan to $19.99 for a four-screen plan. Its default level is $15.49 per month.

“The real risk is that they convert $15.49 paying customers to $5.99 plus ads, and they don’t make more money,” Pachter said – with $5.99 being a hypothetical price (the level supported by Hulu ads is $6.99; Disney+ has not announced a price for its ad tier).

And even if Netflix followed this strategy outside the US, the overseas ad market isn’t all that attractive.

“The thing about the international advertising business is it’s small compared to the US,” Shannon said. “It’s small and super fragmented and not as good a business as it is in the US… The advertising business in the US is a freak of nature. It’s really a unique thing in the world.”

Netflix could test demand for an ad level by licensing shows for broadcast or cable – but hasn’t yet

While Hastings dropped a bombshell on the earnings call, that doesn’t mean Netflix is ​​committed to seeing the development of an ad-supported tier for customers.

A senior AVOD executive who spoke to Insider in March said that if the company wanted to, it could first test the AVOD waters by distributing Netflix originals to linear cablers for a secondary window, i.e., renting shows and movies that have already been streamed. on Netflix to re-play on other platforms.

“I think there are buyers for that,” the executive said of a secondary window. “And as far as I know, that conversation didn’t happen. I strongly believe they’ve received requests for it.”

This would likely test the market, as well as prompting the streamer to format its library — no small feat for its growing backlog of original series, whose total lengths vary widely — to the half-hour limits of 22 minutes or 42 minutes. -Long linear TV format.

Either way, Netflix is ​​now tinkering with a space it had previously avoided. And this will likely take some time to resolve.

“That’s something… that we’re trying to figure out in the next year or two,” Hastings said. “But think of us as quite open to offering even lower prices with advertising as a consumer choice.”

Natalie Jarvey contributed reporting.

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