Netflix Must Take Ads or Die

By Rob Medved, CEO Cannella Media DTC

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In early June of 2021, HBO Max announced the availability of a new ad-supported tier to make the service even more accessible to consumers at just $9.99 per month.

HBO has long been touted as a “premium” network and has historically been averse to taking ads. Now they are leading the charge with the new HBO Max ad-supported plan, setting themselves apart from other streaming providers who still refuse to adapt to the change.

HBO has taken an approach that makes the ads as non-intrusive as possible, limiting the ad load to just four minutes per hour. According to HBO Max GM Andy Forssell, this new ad-supported service could increase its market reach by 20%.

If a historically ad-averse service like HBO Max is moving to an ad-supported model, what’s stopping Netflix?

Why Netflix Needs to Move to an Ad-Supported Model

Netflix’s core business model profits from subscriptions and subscriptions alone. Its profit and loss depend on what people pay each month and how many subscribers they acquire. This makes it different from other ad-free streaming services like Disney+ and Apple TV+, which are smaller parts of big brands. Disney, for instance, has multiple ways to monetize successful content beyond the Disney+ streaming platform, thus providing less urgency to migrate to an ad-supported model.

Great content is the driving force behind subscriptions for streaming services and Netflix’s failure to adapt to the shift towards advertising could leave them lagging in content creation and retained talent due to the missed revenue provided by offering an ad-supported model. While Netflix has been highly successful in building the largest streaming service in the world, with nearly 222 million global subscribers, in order to retain or grow their market share, they must remain competitive from a pricing and quality of content standpoint.

Let’s do the math. By Netflix increasing their subscriber cost by $1 in 2020, they increased their revenue by $500M. They were expected to spend nearly $17.5 billion on new content in 2021. By comparison, Disney was estimated to spend $30.5 billion on new content between their Disney+, Hulu, and ESPN+ services. Aware of this, Netflix has already begun looking for ways to increase revenue, like raising prices and ending their 30-day free trial for U.S customers, whereas their competitors continue to offer lower price points. However, if subscriptions are the primary profit source for Netflix, they need to do more than produce good content, begging the question: How low (or high) can Netflix go when competitors like Disney+ already cost just $7.99 per month? The point being Netflix will have to find other sources of revenue to remain competitive on the content front.

With the lure of lower-priced, ad-supported tiers and continuously growing content budgets, Netflix needs to adapt to the ever-growing and competitive streaming market. While they may still hold their place as one of the largest streaming services today, others could start catching up as their subscriber growth slows.

Assessing the Netflix Business Model

While Netflix has produced numerous original hits, the service still lives and dies by evergreen content. This has begun to prove problematic as network and brand-specific services like Disney+, HBO Max, and Peacock enter the streaming space and pull their content from Netflix. Friends, Parks and Recreation, and The Office are a few prominent examples of programming that has exited the platform in the last year alone.

The impact of these changes is noticeable, and Netflix’s subscriber rate has begun to stagnate. While services like HBO Max and Hulu added about 10 million new U.S subscribers between 2020 and 2021, Netflix only managed to add 440,000.

Netflix Subscriptions Worldwide from 2013 at 41 million to 2021 at 221 million

Netflix remains a powerhouse amongst streaming providers, mainly due to their global subscriber growth rate over the past two years. In 2020, they added 36.57 million new subscribers, owing largely to the worldwide pandemic which forced many people indoors. However, even their global growth has slowed down dramatically, with just 3.98 million new subscribers in Q1 of 2021, far below the 6 million expected and only 2.5 million predicted for Q1 2022.

To remain competitive, Netflix needs to continue to produce “binge-worthy content” to attract and retain subscribers. However, that’s easier said than done, as high-quality TV shows featuring A-list talent are extremely expensive to produce. The Crown, one of Netflix’s most popular shows, costs about $13 million per episode to produce. Whereas A-list actors like Jason Bateman, who stars in their smash hit Ozark, command $300,000 per episode.

This puts Netflix in the difficult position of spending about $17 billion per year on original content, which is more than double what it spent five years ago. This calls into question the sustainability of their current business model; how to keep producing binge-worthy original content when they are already outspending many competitors in annual content costs?

Without much incremental revenue coming in and acknowledging that some of their largest competitors, like Disney and Amazon, have far deeper pockets, it is no longer viable for Netflix to rely solely on subscription revenue, especially when there aren’t many subscribers left to acquire.

How Netflix Can Stay Competitive

The most promising alternative is to adopt an ad-supported model to increase revenue while combating rising content spending and stagnating subscriber growth. This will allow Netflix to increase actionable ad dollars, which can be invested toward content production and enable the service to stay competitive.

Moreover, Netflix has access to a robust dataset on customer viewing habits and demographics, meaning they know precisely who their subscribers are and what they like, putting Netflix in the perfect position to drive higher ad unit costs to sustain its business.

A Way Forward for Netflix

In an increasingly competitive streaming market, Netflix’s existing business model will soon prove to be unsustainable. It can no longer run away from advertising if it’s going to stay ahead of the competition:

  • Although Netflix remains one of the leading streaming services, its competitors are quickly catching up with deeper pockets and better subscriber growth
  • Netflix is losing big shows to competitors while outspending them in content production costs
  • Advertising is the best way forward for Netflix to sustain revenue growth and stay competitive

With its recent move to ad-supported content, HBO Max is blazing a trail that Netflix should soon follow. As the streaming market evolves, Netflix needs to adapt by embracing an ad-supported model to continue attracting and retaining subscribers while driving revenue growth

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