As Streaming Shifts To Ad-Based Tiers, Is Netflix Still The One That Matters?

After an astounding 2020 of record-setting subscriber growth thanks to pandemic lockdowns, Netflix has settled into an era of modest growth. That, and stuttering share prices, has led some to wonder what its future will be as the world returns to something closer to normal.

On Tuesday, after the market closes, the company will disclose its latest quarterly earnings. Dampening expectations are the company’s own guidance of just 2.5 million net new subscribers for the quarter, adding to the roughly 222 million it already serves worldwide.

But questions have emerged about the company’s steadfast devotion to an ad-free experience at a time when other services are adding a cheaper ad-supported tier. Doing so could help it capture a broader array of consumers and reduce increasingly high levels of churn among its existing subscribers.

On his Stratechery blog, Ben Thompson reversed his long-held opinions on the matter and laid out a good case for adding an advertising tier. He gave one pressing reason to do it sooner than later: the company could use the dough. Various reports suggest the company is going through one of its periodic belt-tightening cycles.

But Thompson points out that what makes Netflix special these days isn’t that it has an ad-free streaming service. What makes Netflix unique are franchises such as Stranger Things and this last quarter’s humongous hit, Bridgerton season 2.

“Here Netflix’s biggest advantage is the sheer size of its subscriber base: Netflix can, on an absolute basis, pay more than its streaming competitors for the content it wants, even as its per-subscriber cost basis is lower,” Thompson wrote. “This advantage is only accentuated the larger Netflix’s subscriber base gets, and the more revenue it makes per subscriber; the user experience of getting to that unique content doesn’t really matter.”

An ad-supported option would expand Netflix’s audience base, make it easier to raise prices further on its ad-free tier, and jibe well with the relatively disposable “background-viewing” programs that are a significant portion of the Netflix portfolio, Thompson said.

Others are also pushing for an ad-based option.

TVREV contributor Evan Shapiro, in a keynote speech last week, pointed to the growth of ad-based streaming services. They include not only FASTs and AVOD services, but the hybrid tiers of otherwise subscription-based services too. Disney+ is just the latest to announce a cheaper ad-subsidized tier.

“Netflix is the biggest channel on earth, with 225 million subscribers worldwide,” Shapiro said, pointing to a new version of his media map that outlines the relative sizes and relationships of entertainment companies. “It’s going to be difficult to survive standalone if all they do is subscription. They’re thriving in the western world, but India, Africa they will not be able to satisfy audiences there without an ad product that’s free or nearly free. Most of the players in this economy will have to find a balance (between ad-supported/single sales and subscriptions).”

Despite Netflix spending $17 billion on content last year (with plans to spend $19 billion this year), some analysts suggest it still may not be enough, given broader options available from newer competitors.

“Originals and entertainment content is no longer enough,” said Laura Martin at Needham Partners. “Our thesis is that you must have news and sport. You must have breaking news because that brings in people when, say, Russia invades Ukraine or sports because when there is a really good game then people flock to you and stay there.”

At the same time, the company is cracking down on password sharing. Further complicating the short-term picture: Netflix walked away from both a batch of production deals and nearly 1 million subscribers in Russia after the Ukraine invasion.

That alone may make it difficult for Netflix to hit its target of 2.5 million net subscriber adds for the quarter, analysts at Baird said. Baird’s target price for Netflix is $420, while Truist calculated Netflix is worth $409 per share. BMO Capital analyst Daniel Salmon cut his first-quarter subscriber forecast to 1.76 million from 2.48 million net adds because of the Russia losses, though he remains upbeat about the company.

Venture capitalist and management consultant Peter Cohan predicts weak earnings on Tuesday will cause shares to drop further and called for co-CEOs Sarandos and Hastings to step down to make way for a new approach to subscriber and revenue growth.

“I think the shares are heading lower and after two mind-blowingly successful innovations (DVD distribution by mail, and online streaming) Netflix’s best days are in the rearview mirror,” Cohan wrote. 

Plenty of analysts still endorse the company’s direction and future. Bank of America and JP Morgan both reiterated buy ratings recently, with a $605 target, far above current share prices.

 “In our view, the story has not changed and we think the recent selloff provides a buying opportunity,” said Piper Sandler analyst Thomas Champion. He projects 2.3 million net adds and a $562 share-price target. Champion also noted a Piper Sandler study of Netflix consumers that found interest in an ad-supported tier for the service.

Netflix has avoided the worst of churn, becoming almost like a utility that many consumers expect to just be there, like water or power, studies have consistently shown. But if its prices continue to increase amid rising inflation, along with price sensitivity in overseas markets, that sensibility may wane.

Deloitte’s most recent Digital Media Trends report, for instance, shows that nearly half of Gen Z and Millennial video consumers have both added and canceled streaming services in the past six months. Meanwhile only about a quarter of the same groups neither added nor canceled service. While Netflix remains much loved, it’s not impervious to change.

Adding games and immersive live experiences to drive more engagement with its big franchises are smart initiatives, but hardly game-changers for the world’s largest streaming company.

Now comes the hard part: figuring out whether the company finally needs to change a fundamental part of its operation and self-identity as part of a changing streaming ecosystem.

LightShed Partners, always willing to stir things up, acknowledges that ad-supported tiers can generate more revenue, though it questions at what cost to broader brand strategy.

“There is no question that offering a lower-price subscription streaming service bolstered by advertising can expand an SVOD’s total addressable market (TAM),” LightShed said in a recent post the Disney+ ad-supported tier. “The far larger question is whether it is the ‘right’ long-term strategic decision in the intensifying war for time and attention.” 

Brian Weiser, global president of business intelligence at GroupM, however cautioned not to lose sight of the big picture

“Sometimes we lose a sense of perspective on these things,” he told The Guardian. “When you still have one of the most valuable media companies on Earth and you are still arguably one of, if not the, most impactful media companies because of how much you spend on content, were the last results really disappointing or was it about expectations being mismatched?”