Netflix and...advertise?

In a Q1 2022 earnings interview, Netflix Co-CEO Reed Hastings confirmed that the granddaddy of streaming video will now consider offering advertising-supported subscription plans.

You can view the relevant portion of the interview below:

Mr. Hastings says he has been against the complexity of advertising and is a big fan of the simplicity of subscriptions. But I am sure he is also a big fan of money, and Netflix stands to earn truckloads of incremental revenue if they offer advertising inventory for sale.

The Netflix foray into advertising comes at a conspicuous time given the steep drop in the company's key business metric: subscribers. The company reported a loss of 200,000 subscribers in Q1 2022, its first quarterly subscriber loss in more than a decade. The stock dropped 26% in after-hours trading and closed down 35% in the day following the earnings release.

Netflix blames password sharing, competing streaming services, data costs, and even the war in Ukraine for the subscriber decline. The fact is that Netflix may be reaching market saturation, at least in its core market of the US & Canada.

Year over year, quarterly revenue rose 10% to $7.87 billion. But how much additional revenue would Netflix stand to gain if they began to offer advertising?

Netflix can activate a multi-billion dollar a year revenue stream by enabling advertising. If Netflix began advertising, it would join most of its peers like Hulu, Peacock, Paramount+, and HBOMax, who offer some advertising components to their services.

Later this year, Disney+ will also join the advertising fray with a lower cost ad-supported tier. The House of Mouse faces the same growing pressure as Netflix to boost subscriber numbers amid increased competition and easing pandemic restrictions, leading more consumers to spend less time on the couch.

With more options than ever, subscriptions to streaming services are stacking up for consumers. Disney and Netflix have realized that offering a lower-cost ad-supported tier might be the only remaining path to boost subscription growth significantly.

According to the Wall Street Journal, Disney cited a study from the advertising agency Publicis that may have swayed their decision to offer an ad-supported tier. The study found that 83% of users paying for ad-free streaming services said they were willing to try an ad-supported service to save money.

Luckily, Netflix does not have to forge a new path in advertising; it can follow in the footsteps of its streaming contemporaries. Some of its largest competitors have already established massive advertising businesses. The top 4 streaming platforms collectively earned $3.5 billion in advertising revenue between September 2020 and September 2021.

Here is the breakdown:

• Hulu: $2.1 billion

• (ViacomCBS) Paramount+: $822 million

• (NBCUniversal) Peacock: $279 million

• (Fox Corp) Tubi: $250 million

How much advertising revenue could Netflix earn?

So how much will Netflix make if it begins selling advertising inventory? In 2019, a TripleLift employee told TheStreet that they estimated Netflix could earn around $3 billion per year but did not share their methodology for arriving at that figure.

Let's look at some data from the top ad-supported streaming platform, Hulu, to guess how much advertising revenue Netflix could earn. As a warning, this is all pure speculation based on available data and many assumptions. Take these estimates with a heaving grain of salt as I did not account for many possible variables, but we can at least attempt to arrive at a ballpark figure.

The last time Hulu shared specific advertising figures was in 2019, when they boasted that 70% of their viewers were on an ad-supported plan.

Even though Hulu said 70% of viewers and not accounts, it's the best data we have to estimate their current total number of ad-supported subscriptions. Hulu now has 45.3 million accounts, so if they still have 70% of users on an ad-supported plan, we can guess that Hulu has 31.71 million ad-supported subscriptions.

At $2.1 billion in advertising revenue per year and 31.71 million ad-supported accounts, we can estimate Hulu earns about $66 per account per year in advertising revenue. It is worth noting that Hulu is only available in the United States, where advertisers typically pay elevated rates relative to other countries, whereas Netflix is available globally.

Netflix currently has 221.64 million subscribers, the largest subscriber base by far. Netflix does not break out subscriber numbers by country, but eMarketer believes Netflix has around 178.5 million viewers in the US. eMarketer did not estimate US subscribers alone but instead guessed that there are 74 million paid Netflix memberships between the US and Canada.

If we assume Netflix has the same viewers per account as Hulu (2.9), that will equate to around 61.5 million US paid accounts from 178.5 million US viewers. Let's suppose half of them chose to go with an ad-supported tier. Then Netflix could earn $2.03 billion in the US alone if they earned a similar amount of ad revenue per account ($66) as Hulu and $2.84 billion if, like Hulu, 70% of accounts were on an ad-supported tier.

Global ad revenue is a bit tougher to estimate, given the lack of comparable data. But even if Netflix earned $12.50 per ad-supported account outside the US with 50% (160 million accounts outside the US - so 80 million) on an advertising subscription, that would be an extra $1 billion.

So Netflix could earn between $3 billion to $4 billion in advertising revenue per year. That would amount to around 10% to 13% of their total yearly revenue ($30 billion in 2021).

It is also reasonable to assume that an increase in subscriptions would occur when Netflix offers a lower-priced ad-supported subscription tier. The overall increase in paid subscribers could create even more revenue from subscription fees, but an ad-supported tier could also cannibalize higher-priced no-ads subscriptions.

My advertising revenue estimate assumes that Netflix could monetize accounts at the same rate as Hulu, which means they would also have a similar ad load and maintain the same take rates/ad tech fees, amongst other variables.

If they want to strive for the lightest ad load out of all the big players, they must match Peacock. The NBCUniversal streaming platform is leading the pack here with the lowest ad load at 4.6 ads per show and 8.7 commercials per hour compared to Hulu, with 7.4 ads per show and 12.0 ads per hour on original content and 10.1 ads per show and 13.8 ads per hour on licensed programming.

Take rates and fees would all depend on if Netflix would build, acquire or outsource ad tech solutions.

Will Netflix build, acquire or outsource ad technology?

Netflix does not sound too keen on the prospect of creating or running a proprietary ad tech solution. Here is a quote from Netflix CEO Reed Hastings, pulled from the Q1 2022 earnings call:

Sounds like Reed don't want no part in that there fancy ad-matchin'!

Jokes aside, I do wonder if Netflix may have jumped the starting line on their ad announcement as a way to quell some investor fears without carefully considering the drawbacks of being a "straight publisher."

The more of the ad stack you own, the more revenue you stand to retain. Advertising is not a Netflix core competency, but it could be! Building anything from the ground up is a tall order, but we have seen other large firms acquire pieces of ad technology to cut out some obstacles (and fees) between them and their customers.

Roku purchased the DSP Datxu back in 2019 to give buyers a more direct path to their inventory enriched with Roku first-party data. Microsoft acquired Xandr at the end of last year, which immediately gave them both buy and sell-side technology and a roster of ad tech talent. If Netflix did decide to acquire or build in-house, I imagine there would be no shortage of talent willing to work for such a notable household name.

But maybe Netflix does want to stay out of ad tech and focus on their core product. If so, there will be a line of ad tech companies willing to service the needs of Netflix with matching sweetheart deals.

If this saga were an episode of Bridgerton, Netflix would certainly be the diamond of the season — attracting a deep yearning from the most notable companies of ad tech royalty. Landing a deal with Netflix would mean massive amounts of premium video inventory — much of which is that oh so alluring connected TV inventory.

But Netflix would be crazy if they did not consider building a walled garden since they could retain more revenue and prevent data leakage. If Netflix offered proprietary buying tools, they could avoid sell & buy-side rev shares imposed by a third-party SSP and DSP.

Maybe Netflix can take a middle road and have The Trade Desk stand up a reskinned version of their DSP, similar to their deal with Walmart. If Walmart, with its $431 billion market capitalization, decided partnering was the right move over building or buying, Netflix may think similarly with its continually decreasing market cap of $99 billion.

Buying, building, or partnering with someone to stand up a siloed buying interface would also allow Netflix to protect its precious audience and context data.

Netflix audience and context targeting

I don't want to be a stickler and try to parse out precisely what Reed Hastings meant by this:

Hastings implied that they would not incorporate user information in targeting but then immediately said he could have other companies integrate user data in ad matching. I am not sure what he meant here, but prospective Netflix advertisers will want to target based on user information.

Netflix does have an advantage of launching an advertising strategy now in that they can consider user privacy and first-party data protection from the ground up. Safeguarding user data gives Netflix a competitive advantage and shields them from an increasingly strict regulatory environment.

Eliminating data leakage should be top of mind for Netflix. Anytime a user identifier enters an external system, Netflix relinquishes technical means of preventing others from building data sets based on Netflix data. Netflix could avoid data leakage if they stood up a proprietary buying platform since they would not have to share any user identifiers in a programmatic bid request outside their proprietary ecosystem. If Netflix unleashes user information in third-party systems, they will have to rely on contractual protections of data rather than surefire technical means.

There is also the question of how Netflix would handle third-party data. Will Netflix permit universal email-based identity solutions like Unified ID 2.0? With device identifiers and cookies going the way of the dinosaur, universal IDs could still allow advertisers to connect Netflix users to an entire ecosystem of audience data based on their hashed email addresses. Offering advertisers the capability to target based on third-party data would make buying on the platform even more attractive.

Will Netflix permit IP address data targeting? Targeting audiences using IP addresses is popular on connected TV when the environment lacks a persistent identifier. However, IP addresses do not provide the same level of targeting precision since they are household-level identifiers rather than user-level identifiers.

Netflix could still run into user-level targeting issues with email-based ID solutions since there is ultimately one single account holder email. Netflix may have an incentive to require emails for each user profile on a single account in this case.

I would say with supreme confidence that Netflix will offer targeting based on contextual signals. If Netflix makes these signals available, advertisers could target users based on the series, movie, genre, or individual episode.

Netflix should stay mindful of both audience and context data leakage if they include device identifiers/universal IDs and contextual signals in programmatic bid requests to external systems. Anyone receiving a Netflix bid request could tie user IDs to content preferences and buy those same audiences off Netflix.

Hastings mentioned that advertising would "phase in over a couple of years in terms of being material volume." Netflix has many new questions and strategies to consider, but for now, I will be sitting back with my popcorn and watching how this story will unfold.

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