Decoding the Netflix AVOD model – Part One

It’s official. Netflix’s lower-priced advertising-supported offering will launch in early 2023. The streaming platform, in its letter to the shareholders after the Q2 results, revealed that the ad-supported offering would “likely start in a handful of markets where advertising spend is significant”. This means that the AVOD model will debut only in select markets, to start with.

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“Over time, our hope is to create a better-than-linear-TV advertisement model that’s more seamless and relevant for consumers, and more effective for our advertising partners. While it will take some time to grow our member base for the ad tier and the associated ad revenues, over the long run, we think advertising can enable substantial incremental membership (through lower prices) and profit growth (through ad revenues),” says the letter.

The streaming giant has tied up with Microsoft and started renegotiating content deals with leading studios in order to integrate advertising into the content. Though it has not revealed the pricing details, indications are that there will be more than one tier. The streamer, however, has indicated that the AVOD version will not be showcasing the full content library.

“If we launch the product today, the members in the ad [tier] would have a great experience. And we will clear some additional content, but certainly not all of it. So, we are looking, but I don’t think it’s a material holdback to the business,” said Netflixco CEO Ted Sarandos.

Yes, Netflix is sitting on a virtual goldmine. An analysis by LightShed Partners pegs Netflix as having a potentially $4 billion-plus ad revenue opportunity in the US alone, thanks to its dominance in connected TV.

And the market is conducive.

A recent DeepIntent survey points to increasing consumer affinity for cheaper ad-supported models. According to a Comcast Advertising report released on July 21, free ad-supported streaming TV (FAST) penetration among households has more than doubled YoY. Today, six out of 10 households who have connected TVs are using FAST. The report highlights the rise of FAST and its value to advertisers as a complement to traditional TV and streaming advertising plans.

Adgully seeks to understand the Netflix AVOD model in this two-part series.

India: A price-sensitive market 

So, how will Indian consumers accept a lower-cost, ad-supported Netflix subscription? Indians are not averse to ad breaks. But how will they take ads on a premium platform like Netflix? What kind of an AVOD model will work in India, because frequency of ads, duration of the ad breaks matter here?

India has always been one of the major targets of Netflix and Netflix has been actively adjusting its prices and enriching its content offering to grow in the market, says Orina Zhao, Senior Analyst at Ampere Analysis. 

“We are less inclined to believe India will be one of the primary markets where Netflix is mulling a new ad-funded hybrid tier. In it Q2 earning released the other day, Netflix said it expects its less expensive, ad-supported option to launch in early 2023, starting in a handful of markets where advertising spend is significant. India generated $2.6 billion revenue from online video advertising in 2021. Dividing that number by India’s total 1.4billion population, each Indian contributed to about $1.86 (INR137) per year, which equals to around $0.16 (INR11.8) per month (as compared to $212 in the US, $259 in the UK and $94 in Germany). To put that into context for India, Netflix’s popular mobile plan is priced at INR149 (~$2) per month, which is already historically and globally Netflix’s cheapest pricing point. Thus, it is unlikely Netflix launches a new ad-funded tier that would need to be priced even lower than the mobile plan,” she adds.  

Indian users are extremely cost-conscious; therefore, an ad-supported tier should resonate with all users, asserts Paolo Pescatore, analyst at PP Foresight. According to him, cracking advertising is no feat as subscribers have been accustomed to an ad-free service.

While this is all about attracting new sign-ups, he warns that Netflix needs to tread carefully not to cannibalise its own base, while working closely with brands to serve relevant ads.

“This is all based on Netflix taking a more open approach to the wealth of data it has built on customer behavioural patterns. For now, ad seems like a reality in light of the changing economic factors. This is in stark contrast to a few years ago when everyone was jumping on to the Netflix’s bandwagon. Ultimately, subscription is the preferred pricing model as it follows the traditional approach of selling programming to users. The Internet provides much flexibility and no one has successfully followed in YouTube’s footsteps. Premium programming will always command a premium and brands do not want to give their content away for free with ads,” Paolo Pescatore explains.

A diversified business model for a pureplay streaming-only business will be key during these uncertain times, adds Pescatore. According to him, efforts to curb account-sharing and encourage sign-ups with new ways will provide the much-needed armoury to grow over the months ahead.

“The macro-economic environment is gloomy with recession set to hit most countries. In no part thanks to inflationary pressures as this is set to be one of the company’s challenging years in its history. It needs to weather the storm. For now, the company seems to be better placed longer-term, provided it can weather this storm in the short-term. It must replicate the Disney model of creating successful franchises and monetising through exclusive IP,” says Pescatore.

The freemium model is an established model for OTT platforms in India, points out Uday Sodhi, Senior Partner, Kurate Digital Consulting. “Hotstar, SonyLIV, Voot, Amazon Prime and even YouTube follow this model. Even PayTV in India is partly ad-supported. Netflix will have no issues in growing their business with a freemium model,” he maintains.

“Netflix has tied up with Microsoft for ads. They will customise ads and ad solutions for each market. Obviously they will test various options over the next couple of quarters,” adds Sodhi.

Karan Taurani, Senior Analyst at Elara Capital, feels that Netflix AVOD model will attract a large number of Indians. According to him, India’s AVOD market is very small as compared to the global market. It is somewhere close to a billion dollars for digital advertising.

“For video, the Indian market size is somewhere close to three or a billion dollars, which is 30%, 1/3 of the overall ad market. So, it’s a very small market for India. And Indian consumers are more ad-friendly. So, what this will do to Netflix is that you can probably have a larger TAM or Total Addressable Market. The MAU (Monthly Active User) numbers of AVOD platforms like YouTube, MX Player, or a Hotstar, have been phenomenal. The conversions of paid subscribers would be only 10% to 20% of this MAU number. But broadly, the number has been phenomenally high. So, it can actually attract a larger user base for Netflix, in terms of people wanting to watch it with ads,” explains Taurani.

In a country like India, where the audience is price-sensitive, it makes all the more sense to lower the pricing further for customers, opines Taurani. “Netflix right now, in terms of pricing, is somewhere close to what a Hotstar would be in terms of your basic plan. Hotstar typically has other compelling content, cricket, when people pay for it. But Netflix is streamlined to just web series and movies, and the audience may not be comfortable paying that ₹ 8,000 or ₹ 2,000 for annual plan,” he adds.

Taurani feels that it makes all the most sense to reduce the pricing for the same and have an ad-supported model, wherein there’s an opportunity for growing the ad revenue as well as there is an opportunity for acquiring customers as well. There could be some minor cannibalisation of the paid customers opting for the low-end ads, he adds.

He, however, believes that the Netflix premium customer base, the ones who are paying close to ₹ 200 to ₹ 2,500 on a monthly plan, will not move to this ad-supported model. “But the lower end of the pack, the ones who are probably customers acquired through partners, customers who are given this basic mobile-only plan, will transition to this ad-supported model.”

Orina Zhao says: “We believe for the short term, Netflix main focus in India will still be developing its cheaper mobile-only subscription plan, and continuing strengthen its partnership with mobile and broadband providers, especially Reliance Jio, to enable bundling and reach more customers. The goal of Netflix in India is still to increase subscription uptake and scale up its market share, from where it can better monetise its subscribers, rather than improving profitability, as it is trying to do in more saturated markets by charging extra on account sharing - or retaining customers by launching ad-funded tier.”

Putting Netflix in the context of APAC, most OTT services in APAC adopt a multiple tiering strategy, including a free ad-funded tier, subscription ad-free tier and sometimes a pay-per-view transactional tier, says Orina Zhao.

“Such strategy is often the best way to maximise revenue and reach for most OTT services in APAC. However, it is highly unlikely Netflix launches a completely free ad-funded tier, and will continue putting its content behind a pay wall (thereby still requiring a billing relationship), and the mobile and mobile+ plans and its three-pronged pricing tiers have been dropped multiple times to fit with locality. It is, therefore, more likely that Netflix continues to promote the mobile and mobile+ plans which fit the best with the Indian consumer’s viewing preference and allow streaming without advertising disruptions,” she adds. 

“Overall, we believe the ad-funded hybrid tier and additional charges for account sharing are more likely to be first carried out in markets where Netflix has hit saturation of subscription numbers and are facing severe churn, especially in the US, LatAm and part of Western Europe. However, in India, Netflix still has a massive potential in growing customers and expanding its coverage, particularly with the newly launched much more affordable, ad-free mobile and mobile+ subscription plans,” Orina Zhao asserts.  

“India is one of the world’s largest content markets as well as a price-sensitive country, where people seek value for money rather than being provided with ‘free content’, with more consumers opting for paid content. Consumers will subscribe to lower-cost ad-supported version as long as the material provided for them entertains them,” remarks Ssoftoons COO Hansa Dangaich Mondal.

According to Mondal, with its new hybrid membership plan, Netflix has ensured success in India and can attract a large number of viewers. Above all, she adds, Netflix must collaborate with Indian studios to add more regional content relating to Indian culture and localisation in order to establish a more firm foothold in India. This will help them gain the consumers that they have been losing since the pandemic.

Ad model needs to change

Netflix shifting to an ad-based model can turn out to be a great accelerator for the digital video ad industry, says Streamfire CEO Niklas Trenkler.

“In the short term, competition for ad dollars may increase. However, ad spending for traditional TV in the US still accounts for $68 billion in 2022. A player such as Netflix will build up more trust for digital and may result in TV ad dollars moving online more quickly,” Trenkler says.

The purpose of advertising ultimately is to engage consumers and old-style broadcast advertising is no longer an option, says Teresa Cottam, Chief Analyst at Omnisperience.

According to her, engaging Gen Z is one of the biggest challenges – they represent around 40% of worldwide consumers and are concentrated in regions such as Asia and Africa. In a market like India, addressing Gen Z’s advertising expectations is essential, affirms Cottam.

“They’re already overexposed to advertising, are impatient, and have distinct expectations. But they’re also the generation most willing to consider sponsored or ad-subsidised content because they’re young, time-rich and cash-poor. If brands can get it right, they can create a win-win: transforming advertising from a tiresome interruption to an engaging and integral part of the experience, and thereby adding value rather than detracting from it,” Cottam adds.

Innovative ad experience 

To succeed, advertising needs to be short, more personalised, more contextualised, and something that really resonates with the intended audience, asserts Cottam. Streaming helps, she adds, because the streamer has more data about their customers, which provides far more accurate targeting and tailoring of adverts, but this does mean that much of the value lies in the data to truly understand what individual customers like, watch and want.

There is a huge market that is currently not well addressed because old-style bundles and subscriptions aren’t flexible enough and don’t meet people’s needs, says Cottam. The question is, is advertising the panacea to this problem?

“Engaging young people and getting around their ad blockers requires more than just personalisation though. Gen Z desires authenticity in brands. They want to see real people, not paid actors, in scripted adverts. They’re content creators not passive viewers; so interactive and co-created advertising resonates better with them. But it has to be short. There is a well-known stat that Gen Z has an eight-second attention span. That’s somewhat misrepresentative but the underlying point is that short-form is king, because this works better on mobile and is what Gen Z is used to due to platforms such as SnapChat and TikTok,” Cottam adds.

(Tomorrow: How will Netflix likely fashion its AVOD model? Will it be more transparent with data in order to rope in advertisers?)