Streaming May Not Be Commercial-Free Much Longer | Analysis

Netflix has a way of pushing the entertainment industry in new directions, first reluctantly and then inexorably. Alarmed by its ballooning production budget, the studios barreled into big losses in streaming, even as Netflix started reporting billions in profits. Now, the streaming giant may pull the competition in a different direction, as it teased an eye-popping statistic about its still-nascent advertising business this week.

Wall Street wasn’t impressed with Tuesday’s business-as-usual, slow-growth earnings report: The stock dropped 3% Wednesday. But some investors seized on a buried tidbit of information promising revenue acceleration ahead: Netflix said it was making more money in advertising from its new, cheaper plan with commercial breaks than it was losing on the lower monthly price. That suggests Netflix might be making at least $8.50 a month in ads per member on the plan — more than the $6.99 a month it collects in subscription fees.

Netflix’s ad-based tier will be its “big story for the rest of 2023,” Heritage Capital founder and president Paul Schatz said. “People will accept ads for less in subscription fees,” he added, and that thinking will “filter through the rest of the industry.”

Most of the operations competing with Netflix in streaming have decades of experience in advertising-subsidized content thanks to their broadcast and cable arms. Even Amazon and Apple have built up substantial advertising businesses in recent years.

Copying the streaming leader, rivals designed their direct-to-consumer services with no or minimal ads. Now Netflix may encourage them to push cheaper streaming services loaded up with ads, or even completely free, ad-supported offerings like Fox’s Tubi or Paramount’s Pluto TV. If ads prove a better way to monetize, Netflix’s shift might even mark the beginning of the end for ad-free streaming.

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The value of a subscriber

Analysts aren’t expecting an overnight transition. Netflix and its streaming rivals — chiefly Disney+, Hulu, Max, Paramount+ and Peacock — are hardly going to speed-run into a new normal where all but the most expensive subscription options place ads before, after or even during shows and movies.

Gerber Kawasaki managing partner Hatem Dhiab pointed out that Netflix subscribers in ad tiers make up a tiny fraction of the user base: Bloomberg estimated that Netflix had signed up 1 million ad-based subscribers as of March, less than 0.5% of its global total. Ad-free tiers, Dhiab said remain Netflix’s “bread and butter.”

Many streamers already offer cheaper, ad-driven options. Peacock initially rolled out an entirely free, ad-driven viewership tier at launch to differentiate itself from the competition, though it stopped signing up new subscribers in January; parent company Comcast is now backing Xumo, a joint streaming venture with Charter that’s free and ad-supported.

The hope is that these new options will supplement, rather than supplant, the higher-priced, commercial-free subscription plans. For them to work, they’ll need to generate advertising dollars that make up for the lower subscription revenue.

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Money is money. If streaming services begin to make more revenue from ads, that will relieve pressure from an investor class demanding that entertainment companies produce profits rather than juice subscriber growth.

The message for cost-conscious consumers will be to either take a cheaper, substandard product at a lower price point, or accept ads and a better product, Morningstar senior equity analyst Neil Macker told TheWrap. Netflix has already signaled that it’s going to put some of its ad revenue to work improving its ad tier, upping picture quality and supporting multiple streams. That means its Basic With Ads service is better than its Basic service now.

Macker predicted more price increases for Netflix’s ad-free plans, particularly in the U.S.: “For those people who are not going to go on the ad plan, they’re going to have to continue to raise those prices to generate revenue, whether it’s explicitly by raising the price or implicitly by adding paid sharing. At some point, they’re going to price the plan in such a way that they’re indifferent to which plan you’re on.”

Ad dollars aren’t free money. Jamie Lumley, senior analyst at Third Bridge Group, pointed out that the advertising business comes “with the need for ad sales teams, development of tech stacks and other supporting infrastructure.” Big media companies have that in place already, while Netflix is relying on Microsoft for support as it builds its advertising capabilities.

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Consumer resistance to ads is softening

A quarterly survey conducted among 20,000 U.S. streaming households by Kantar’s Entertainment on Demand suggested a drop of 2.2 million ad-free subscriptions and an upswing of 2.6 million in ad-supported subscriptions in the first quarter of 2023.

“Netflix could expect to reach a reasonable market of about 25% of its subscriptions in ad-supported,” Kantar consumer insights director Hannah Avery told TheWrap, citing the experiences of companies that started without ad-based tiers and introduced them later. “However, roughly half of the subscriptions are ad-supported across services that entered the market with both ad-free and ad-supported. As stacking grows, and streamers look to cut costs by embracing ads, the realistic addressable market may also grow.”

Netflix hasn’t pushed its subscribers hard to opt for ads, but its rivals may not be as shy. For one thing, most are losing money on streaming and are facing heavy pressure to turn the profit picture around.

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Analysts like what they see from Netflix

Wells Fargo analyst Steve Cahall, who expressed his bullishness on Netflix’s ad tier in a Wednesday note to clients, estimated the effort could generate revenue of $1.5 billion in 2023 and $4.3 billion in 2024, which is more than a $3 billion long-term goal Netflix CFO Spencer Neumann set in January.

UBS analyst John Hodulik, who upgraded the firm’s rating on Netflix stock to a buy with a $390 price target, estimated revenue will grow 10% in the second half of 2023 and 12% in 2024, with advertising plans providing “tailwinds” alongside a crackdown on password sharing.

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Ads could change content, too

Producers initially reveled in the creative freedom of streaming, with no need to design around commercial breaks. But those structures may make a comeback. Streamers can make content that works with commercials, and those who pay for no ads will barely notice the switch-ups. Star producer Jeff Jenkins recently noted in an interview with TheWrap that the lack of structure in streaming “creates a whole new set of challenges” in getting viewers to sit through a 40-minute episode of an unscripted show without “micro-cliffhangers” timed to commercial breaks.

“I think that structure is really effective,” Jenkins said. “It gets the blood pumping in the viewer. And it works for advertisers.”

With Netflix’s move, almost every major streaming service, save for Apple TV+ and Amazon’s Prime Video, now has or will soon have ad-based tiers. And completely free, ad-supported television is growing, too. Warner Bros. Discovery is going all-in with FAST services, with some former HBO Max shows being licensed out to Roku and Tubi. Amazon and Apple may remain above the fray because they view streaming as a loss leader that generates sales of laundry detergent or smartphones, but even they may not resist the money-making opportunity for long.

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The new normal may be a reversion to the status quo

Screenwriter Zack Stentz (“X-Men: First Class,” “Jurassic World: Camp Cretaceous”) told TheWrap that while Netflix may be among the last holdouts, ad-supported viewing is the likely future.

“At some point, [Netflix has] to think about how much money a ‘Stranger Things’ FAST channel, to name one example, would make,” he said. “We’re going to see the streamers reselling their old programming or sticking them on dedicated FAST channels,” he added, turning “the ongoing cost of maintaining programming on your streaming service into an actual source of income.”

Stentz noted he “got a nice, fat, unexpected check” when Warner Bros. Discovery licensed some of its older content to FAST channels. “It turns out the way to make money from television is the way television has made money for 70 years.”

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