6 min read

The Inescapability of Digital Advertising

The Inescapability of Digital Advertising
Photo by Thibault Penin / Unsplash

Taking a closer look at NFLX’s Ad-Supported Subscription

Streaming services were the pioneers of subscription-based, ad-free entertainment.

Rather than spending 20 minutes of every 60 minute traditional pay-per-month cable television, streaming services were the first to do away with advertising.

Yet, the ad-free business model is facing a significant stress test. Netflix and Disney+ recently announced ‘ad-supported’ versions of their popular streaming platforms, as subscriber counts have been on a declining trajectory.

With economic conditions continuing to worsen, it is understandable that consumers are scaling back their subscriptions. Gone are the days in which we have subscriptions to five different streaming platforms, each charging over $15-a-month.

Netflix is launching a $6.99 subscription with four-to-five minutes of commercials per hour of streaming. This is a notable decrease in price from the base subscription of $9.99, bringing its customers’ annual bill down from $120 to $84, a 30% decrease.

Netflix is joining a host of other streaming platforms which similarly offer ad-supported subscription options.

The rationale for this subscription option is two-fold:

  1. Retention - incentivise customers to retain their Netflix subscription (even if they believe that other streaming platforms have better quality content);
  2. Attraction - attract new customers at the more affordable price point; and
  3. Diversification - diversify the company’s revenue sources and provide greater revenue certainty

Subscriber Retention

As a business seeking to break free from traditional ad-supported television models of the past, Netflix’s valuation was heavily linked to subscriber count.

The goal here is clearly to incentivise customers who would otherwise leave the platform, to switch to the ad-supported model. Although Netflix has claimed they are “not trying to steer people to one plan or the other”, this is a smart move for a company facing growth challenges.

As at 30 Jun 2022, Netflix had 220.6 m subscribers worldwide, down from 221.8 m at 31 Dec 2021. This was largely driven by a fall in subscribers in North America and Europe. Reporting Q3 earnings recently, Netflix appears to have bucked the trend, adding 2.4 m subscribers from Jul–Sep 2022.

Providing a cheaper ad-supported subscription allows Netflix to both (a) retain existing customers, and (b) provide a more affordable price point for new customers to sign on.

Revenue Diversification

The second, and less discussed, benefit of this strategy is that it diversifies Netflix’s revenue streams. By opening the platform to digital marketers, Netflix can make revenue from advertisers looking to promote their products on the platform.

This is an intelligent tactic, considering the way it’s being marketed.

Imagine Instagram or TikTok charging you to use the platform and then still shoving advertising down your throat. Sounds ridiculous, yet this is precisely how Netflix is marketing the new model – a more accessible and affordable option for consumers. But it’s the same as traditional cable TV!

Genius, or exploitation? I’ll leave that for you to decide…

The long and short of it is that advertising now provides Netflix with an alternative revenue source. While this revenue is undoubtedly linked to subscriber count, it diversifies Netflix’s revenue.

Let’s discuss why this revenue is still highly correlated with subscriber count. Netflix will likely charge advertises a fee based on the number of views an advertisement receives. The company has stated an initial $65 per 1000 views. The more people who are shown the ad, the greater the bill to the advertiser. As Netflix’s subscriber count fluctuates over time, the platform can show more unique users a given advertisement. In this way, advertising revenue is correlated with subscriber count.

However, there is another interesting way that Netflix benefits even if subscriber counts remain flat. A cost-per-view model does not necessarily require unique viewers. By scaling the frequency of advertising (even if these ads are shown to the same subscribers), Netflix can boost ad revenue without additional customers. While, of course, there is a trade-off as the ‘advertising minutes-per-hour’ increases, flexing this number can significantly move the needle on revenue growth.

Revenue Certainty

Finally, an advertising model is highly beneficial to improving revenue predictability and certainty. The difficulty with Netflix’s ‘pay-per-month’ business model is that revenues are highly unpredictable and vary month-to-month as subscriber counts change.

Netflix is planning to charge a whopping $65 per 1000 views of an ad, which is notably higher than other streaming services. Individual advertisers will also be capped at $20m to prevent companies from dominating advertising on the platform.

With this advertising model, Netflix will likely lock in longer-term advertising contracts with companies seeking to advertise on the platform, and incentivise them to do so. This allows Netflix to demonstrate greater revenue predictability to investors, which in turn supports valuation and share price.

To give an example of how this works in our day-to-day lives, we can take a look at NordVPN’s subscription model:

  • 2-Year Plan – around $96 ($3.99 per month)
  • 1-Year Plan – around $60 ($4.99 per month)
  • Month-to-month Plan – $11.99 ($11.99 per month)

NordVPN pricing sourced from safehome.org. I am currently in Denmark, so my geo-blocking diverts me to Danish prices, and I wanted to provide approximate US pricing. Please excuse if these numbers are slightly off, the example is simply to illustrate the concept of revenue certainty.

A two-year plan costs more upfront, but significantly less on a monthly basis. From NordVPN’s perspective, this provides revenue certainty over a two-year period (even if accounting principles only allows them to book the revenue on a monthly basis).

This is highly preferable to a model where the customer pays month-to-month, so NordVPN adjusts its pricing to incentivise longer-term plans.

For Netflix, the process works similarly. By locking in longer-term contracts with advertisers (i.e. anything greater than 1 month), they offset the uncertainty of their consumers’ month-to-month payments.

The Issues with Social Media Advertising

The real question on my mind is whether social media advertising still has a leg to stand on. It’s simply too difficult for digital marketers to track the impact of their advertising across social media platforms.

The WSJ interviewed Kelly Metz, managing director of advanced TV at Omnicom Media Group, who made some interesting points.

Accountability and transparency are probably the biggest challenges in streaming ads. There is little transparency to where the advertiser’s ad will appear and, in many cases, limited reporting on where the ad actually did appear…
… As an advertiser’s agent, we would know where our client’s ads were running on traditional TV. With the broadcast networks, we can buy ad schedules against programming that align with our brand, comply with an advertiser’s safety guidelines that could include a list of shows or channels to be avoided, and provide the right environment for ads to appear.

While I find it difficult to believe that traditional broadcast networks are any better than streaming platforms, the ROI on digital advertising is very difficult to assess.

Advertisers simply use platforms like Google, Facebook, YouTube, TikTok (and now the streaming platforms) because they are significantly better than the alternative physical-world advertising options.

Advertisers will continue to face challenges measuring the true impact of their advertising on these platforms. We have all become experts at skipping through ads at lightning pace.

On Instagram stories, TikTok, Facebook and even Spotify podcasts, I skip straight past the ads. On YouTube, I’ve been using an ad-blocker for years.

For advertisers sinking thousands of dollars on daily ad-spend, it is hard to see the ROI. Or maybe I’m simply too naive to the influence that advertising is having on me. Who knows?

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