Commentary

Why Netflix Will Never Become Ad-Supported

by Joe Mandese , July 16, 2019

On the eve of Netflix’s second-quarter earnings report Wednesday, it’s worth reviewing some of the important milestones the over-the-top video platform has achieved, as well as speculation about where it might go next. And if you ask me, it will not be into the advertising marketplace.

Yes, there has been much speculation that Netflix will soon unveil an ad-supported strategy -- possibly introducing hybrid models that defray the cost of its premium subscriptions -- but if the past is prologue, it’s not going to happen. My reasoning is the pay TV services marketplace.

When I began covering multichannel TV in the early 1980s, there was virtually the same speculation -- and almost the same kinds of consumer surveys -- speculating that seminal pay TV service HBO would eventually introduce advertising, or hybrid ad/subscription models. Nearly four decades later, it sill has not.

The reason is simple: Why in the world would you trade an engrained, dependable, residual subscription model for something as volatile as advertising demand? If your goal is building equity and a return on shareholder investment, you wouldn’t.

The big difference between HBO and Netflix today is its ubiquity. Netflix is the most distributed subscription OTT service by a wide margin: half again as big as Amazon Prime, and about twice the size of Hulu, according to eMarketer’s current U.S. viewer estimates.

And in addition to how much it has penetrated in the U.S., Netflix has tremendous upside internationally. Nearly three-quarters of its coverage comes from the U.S. and western Europe.

While there is also considerable speculation that Netflix’s share of the OTT marketplace will begin to founder as traditional media companies begin ramping up marketing of their own subscription OTT services, Netflix has attained a status that will be hard to usurp: It is the water-cooler conversation of the direct-to-consumer video marketplace.

The biggest impact of traditional media companies into the OTT subscription marketplace, says eMarketer Forecasting Analyst Eric Haggstrom, is that they likely will pull popular licensed content that they own from Netflix’s library.

“This will cause Netflix to add new U.S. subscribers at a lower rate than it has historically,” he speculates, although, he adds, “Netflix’s investments in significant quantities of high quality, original content and its AI-powered user interface should keep engagement high and subscriber churn low.”

advertising, digital, earnings, netflix, ott, television, video

13 comments about "Why Netflix Will Never Become Ad-Supported".

Check to receive email when comments are posted.

Ed Papazian from Media Dynamics Inc, July 16, 2019 at 10:33 a.m.
Joe, I respectfully beg to differ. If HBO had tried to sell ads in the early 1980s most TV advertisers would have not seen a great need for this move as the three broadcast TV networks dominated the TV scene, rating fragmentation was only being hinted at and younger, affluent consumers, while watching less than low brows and old folks, were easily reached by many network TV buys. Also, I don't believe that HBO was carrying anything like the debt load that Netflix is now burdoned with.

There are many examples in the TV business of seemingly dominant brands being threatened and toppled by competitors---which may well be the case with Netflix, not only as it faces Disney and others but also as it loses a vast amount of its programming---reruns of fare created by others, including many of its about-to-be SVOD rivals. Also competing for the viewers' attention will be "linear TV", which has been reduced in terms of total audience volume by about 15-20% over the past five or six years but still captures 75% of all viewing time.

You may be right, especially if Netflix is able to grow at a very fast rate in overseas markets, however, launching an ad-supported platform in the U.S. would not cost Netflix the loss of a single "angry"subscriber, if all were given a choice of ads or no ads---at different prices. We will shortly tell our subscribers that such a move---in the U.S. alone could net Netflix almost $2 billion annually once a reasonable subscriber base was established. So what's to lose?

THe danger, in my view, arises if Netflix waits too long and starts to lose subscribers in the U.S. Then, all bets are off.
Reply

Douglas Ferguson from College of Charleston, July 16, 2019 at 10:49 a.m.

Does this mean MediaPost will stop reporting stories about how many subscribers might accept advertising in a self-report survey item? Another industry survey appears every couple months. Or will there be no more stories on how some industry guru believes Netflix simply must cave in? I guess if your whole world revolves around advertising, it's hard to imagine a different revenue model (or that it could endure).

Joe Mandese from MediaPost Inc., July 16, 2019 at 10:58 a.m.

@Douglas Ferguson: You are welcome to stop reading any if we do report on them. This column was my opinion, based solely on what I've observed covering the business for 40 years. My opinion has often been proven wrong.

Doc Searls from Customer Commons, July 16, 2019 at 8:31 p.m.

All correct, Joe.

Question: How many subscribers would bail if Netflix had ads?

Answer: Probably more than $2b worth.

Let's remember that one big reason Netflix succeeded is because it had no ads. It's a blessing that needs no disguise.

Another difference between Netflix and HBO: Netflix grew as an alternative to cable, while HBO grew within cable as a premium cable service. And one of the biggest things that made HBO premium was its absence of ads.

Ed Papazian from Media Dynamics Inc, July 17, 2019 at 12:44 a.m.

Doc, if Netflix told its subscribers that they had a choice to keep their service without ads and pay a higher rate or to pay less and switch to an ad-supported service---why would anyone cancel? I'm confused. Netflix will have no alternative but to keep raising its sub prices so wouldn't those that wish to continue but not at a higher rate be perfectly OK with an ad-supported option?The real question is how many would opt for the ad-supported service and might this deal also appeal to those who are currently not subscribing to Netflix?

Doc Searls from Customer Commons replied, July 17, 2019 at 1:11 a.m.

Because people value their time, Ed; and to most people, most of the time, advertising is a waste of it. (And I say this as an ad business veteran who does see real value in advertising.)

Also, an ad-free experience has been a key part of what we might call Netflix' brand promise. If they start packing advertising into their goods, it'll be a worse than a value-subtract for them. That's why I think Joe is right. As he says, it's a judgement call; but I think it's a good one.

Dave Zinman from Drawbridge, July 17, 2019 at 2:36 a.m.

I agree with Joe but I can’t read this article and not share a piece I wrote on the same topic:

https://www.google.com/amp/s/adexchanger.com/tv-and-video/why-on-earth-would-netflix-launch-an-ad-supported-service/amp/

Ed Papazian from Media Dynamics Inc, July 17, 2019 at 7:19 a.m.

Doc, all a Netflix subscriber who hates commercials would have to do would be to stick with the current ad-free plan and not opt for the ad-supported one just to save two or three dollars per month. Why would such a subscriber cancel when he/she is not being forced to see those terrible commercials by Netflix?

Doc Searls from Customer Commons replied, July 17, 2019 at 7:46 a.m.

Ed, I think we're talking about two different things here. One is Netflix itself becoming "ad supported." The other is becoming two-tier, with the cheaper tier ad-supported. The latter might work if advertising on the cheaper tier is not interruptive (as are the non-premium cable channels), and similar to the way movies are presented on airplanes, where one has to watch a couple of :30 second ads before the feature rolls. Both would amount to a species change, but the tiered model less so. I doubt (with Joe) that they'll do either, because it's just not what they're about.

Joe Mandese from MediaPost Inc., July 17, 2019 at 9:52 a.m.

Wow, great comments here, especially from Doc and Ed Papazian. It's inspiring another column, which is actually another point I meant to make, but left our of this post: Which is that the No. 1 reason why Netflix should NOT move to an ad model -- either pure-play or hybrid -- is that it will denegrate the most important asset it has in the minds of all its stakeholders: that it is premium.

I love the word "premium," especially the way it is used on Madison Avenue, and I've written about it before, but the main point is that different people mean different things by it, and usually people in the ad biz think of it as a "premium" opportunity to either buy or sell the attention of consumers. That works, but I don't think it is what consumers -- or a consumer-centric brand like Netflix has in mind when it thinks about the word. I think Netflix thinks of the word premium as something its consumers consider a premium value they want in their lives. So much so, that they are actually wiling to pay money to have it in their lives.

And yes, I understand Ed's POV that offering hybrid versions of Netlix that defray the cost of that premium will be appealing to a segment of its consumers, but I think the reason Netflix will NOT do that, is because it will denegrate the value of it for its other consumers. And in a broader context, it will depreciate the value of Netflix's equity for its other key stakeholders, including financial analysts, investors, and even the suppliers of its licensed and original content.

It's an entire food chain and ecosystem that Netflix needs to consider in the balance sheet equation of: to advertise or not to advertise. And my main point that I left out of this column was that it would creating a "non-premium" version of Netflix will deteriorate the brand equity of the "premium" version of Netflix.

This balance sheet has a fair amount of "goodwill" valuation baked into it, and I don't think I could begin to apply a "tangible" metric for it, but I will tell you that working as the "chief product officer" of a B2B publisher who has been 100% ad-supported to date, it is a challenge to go the other way and introduce a "premium" service.

We've been doing that slowly with "Research Intelligencer" for about a year now, and it's working, but it's hard to demonstrate to people who have gotten you for "free" for years that they should not "pay" for something from you.

The truth is our readers have always paid for access to MediaPost. They paid by giving their time and attention to our content and we mined the value of their attention by loaning it to our advertisers.

(1 of 2)

Joe Mandese from MediaPost Inc., July 17, 2019 at 9:54 a.m.

(Continued):

The biggest problem I've had covering the ad biz for 40 years is that is exclusively how ad people think about this value exchange. So it's natural when an HBO comes along -- or a Netflix -- that they will look ad the undeniable and irrefutable opportunity to monetize that attention.

It's a blunt instrument, and despite more than a decade of industry debates about "paid/owned/earned," "value exchange," and (not to Doc) consumer data sovereignty, the ad biz simply cannot look at the world that way, because of its vantage point.

If you have a hammer, everything looks as a nail to you. If you have an ad model, everything looks like an advertising opportunity to you.

The real reason Netflix will never move to an ad model, is it simply doesn't look at the world that way.

Look, I know this can change.

I remember the days when Netflix was an adaptation of Blockbuster Video that distributed DVDs through the post office. It adapted and understood that it was really operating in an on-demand consumer fulfillment world, and leveraged technology to meet that need. So far, they've done that better than anyone else.

The first time this model caught my attention -- even after I was long a subscriber of Netflix -- was during one of (now retired) CBS research chief Dave Poltrack's TV press briefings when he pointed out that Netflix had reached the point that it had the equivalent audience of a major ad-supported cable network. Dave didn't suggest this might represent an advertising opportunity, because he understood that in a world of infinite choice, being a differentiated channel fulfilling consumers' entertainment on-demand needs was a more valuable proposition. But Dave learned that lesson from tracking HBO, etc. over the years too.

In Dave's world -- or what ultimately became mine too -- it's all about "the magical number seven, plus or minus three," which is the principle of cognitive psychology he turned me on to that human beings can only consider a certain number of options, and in that consideration set, a certain number of them don't and will never include advertising. And if you ask me, those are the ones that truly merit the word "premium."

I can go on, but I think I've made my point (and basically rough drafted my next column here). But in closing, I'd like to ask Ed Papazian a question too. If the ad model -- pure-play, hybrid or otherwise -- is so compelling. Why is it that Media Dynamics charges a premium subscription and isn't supported by advertising? (2 of 2).

Ed Papazian from Media Dynamics Inc, July 17, 2019 at 11:32 a.m.

Joe, to answer your question about why my company doesn't take ads, rest assured that if we had an audience of 180 million---or even 1 million, and a debt of $10 billion we would surely try to sell ads as opposed to increasing our subscriber prices ten-fold or more just to stay afloat. Actually, you may remember a company I started with my late partner, Bill barlow, called "The Media Book" and, later, "Ad Forum". I know that Ken remembers as we sold our company to him and his "Ad Week" partners. There, we used the controlled circulation model, meaning that readers in the ad and media business got our publications free of charge---provided they asked for them----and media ads paid about 90% of our costs. That worked fine for about seven years but as it happened, the media, notably magazines, began to dramatically reduce their ad investments and the ad-supported model no longer worked for us. Many other publications using the same method--"Media&Marketing Desisions", for one--- also disappeared for the same reason.

Regarding my oft-repeated suggestion that Netflix attempt an ad-supported platform, this is not based on just taking a lazy approach and capturing easy money via ads. It's purely a business consideration as a solution to Netflix's evolving financial situation and the impending impact of major competition. Also, as you at MP have been telling us for years---and correctly so----unlike the early 1980s, TV advertisers today are seriously concerned about where their favorite medium is headed, yet they are wedded to TV's mode of communication---"sight, sound and motion". They have been put off by the many problems posed by digital media and are looking for new ways to continue reaching audiences, whether this be OTT, or whether it involves improved targeting methods or reduced ad clutter situations. So far, none of these alternatives has been refined sufficiently and lack of scale is a serious issue as well. However, if Netflix launched an ad-supported platform, with the promise of lower ad clutter and a quality audince and had , say, 30 million subscribers, this would represent the introduction of a fully programmed broadcast TV network to the ad market, in terms of viewing volumetrics and/or GRPs---and many advertisers would jump at the chance to participate---even at much higher CPMs. If, however, Netflix waits until its subscription base starts to erode under the weight of competitive inroads it may be too late to exploit this opportunity. Just my humble opinion. of course.

Joel Rubinson from Rubinson Partners, Inc. replied, August 20, 2019 at 7:15 a.m.

totall agree with Ed. The value of what Netflix knows about consumer entertainment profiles is enorous to advertisers. Why would they leave this on the table? Once the rise in subscriptions stalls, they would have to consider a two tiered model of ad free vs. ad supported. In fact, industry reports are that Hulu subscriptions are 70% ad supported.