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In-depth: Will ads take the chill out of Netflix?

“For us, it’s not like we have religion against advertising, to be clear,” said Netflix CFO Spencer Neumann at the Morgan Stanley technology, media & telecom conference. Then we heard ex-Disney executive and TikTok CEO Kevin Mayer predicting that Netflix will have ads within the next two years.

Well, it has been a while since this will-Netflix-have-ads-in-future debate has started doing the rounds. Netflix and ads might look like an oxymoron, as the ad-free experience has been at the core of its DNA – the distinctive factor that distinguishes it from the rest. Its subscribers may not stomach the very idea of ads.

CEO Reed Hastings has always sought to protect Netflix’s vaunted premium position. “We don’t offer pay-per-view or free ad-supported content. Those are fine business models that other firms do well. We are about flat-fee unlimited viewing commercial-free,” says one of its investor pages. Its active monthly churn rate is the lowest among the premium players at 2% or so.

All that is fine. But rivals like HBO Max, Disney+, and Apple TV are spending tons of money building competitive content pipelines. Disney+ and HBO Max provide customers the choice of selection: ad-supported and ad-free. Disney plans to add an ad-supported AVOD tier later this year, with the hope of reaching 230-260 million subscribers within the next two years.

Competition is growing. Let that sink in. Netflix stock tumbled 25% this year. The streamer sits on an estimated debt of $16 billion. It spends billions of dollars building robust content every year. Last year alone, Netflix pumped in $17 billion for making content.

Can Netflix survive so long riding on its premium position alone? Can it remain the clear winner for so long? Should it embrace advertisements?

Laura Martin, senior internet and media analyst with Needham, minces no word when she says that unless Netflix adds a $5 ad-supported tier or includes sports and news as new genres, which she feels are important, it can’t win the streaming war.

“There’s way too much money chasing content,” she said during a live CNBC television programme, in an apparent reference to the streamer’s huge spend on content.

According to her, competition is growing globally with Disney+ doing good work, adding streaming subscribers. She says that others like Comcast, Viacom, or Amazon will have an edge. Martin sees Amazon Prime as a clear winner in the game, because it never made any money from streaming, by bundling many other services together.

Sharing Laura Martin’s view about Prime, analyst Paritosh Joshi says that in contrast to Netflix, many streamers are not solely dependent on only one source of income.

“Amazon Prime is the best example; for them, it is only the supplementary income source, not the primary one. Their business is AWS. And this is just an interesting way of ensuring that they get traffic into Prime. These are either broadcasters or technology companies. And they make money. Now Netflix is in the awkward position that they have all their eggs in one basket, whereas everybody else has some eggs elsewhere and one egg is over here. And that one egg need not necessarily be the biggest egg. They are much deeper in terms of their funding,” says Joshi.

Likelihood in distant future

A survey by Civic Science among 1,600 US adults revealed that more than a third of non-Netflix subscribers are likely to sign up for a free or lower-priced version. And, more than one-third of current subscribers say they would downgrade to a free version.

“Netflix must and should advertise. But differently,” says Harish Bijoor Consults founder Harish Bijoor.

“An OTT channel is the ‘best-purpose-vehicle’ [as I dub it] to serve custom-built advertising to a specifically defined niche customer. The OTT player has a rich viewer-diagnostics to use. This potential stands underutilised to date. I do believe Netflix could use it if it wants. Netflix sits on a pile of unsorted data. Sort it and you have sorted your future!” says Bijoor.

 

Karan Taurani  senior VP - research analyst at Elara Capital feels that there could be a likelihood of an ad-supported version, but not in the near future. “In terms of content, I would place Netflix a notch above Disney+. Netflix has reinvented itself from being a platform to a content company. There could be a likelihood of an ad-supported version, but not in the near future. Because the near future will be driven by SVOD. They won’t be able to achieve that scale as far as SVOD is concerned in many emerging nations. In the US, subscriber growth has plateaued. But there is still growth to pick up in the emerging nations. Once the growth plateaus globally then probably they will be able to leverage the ad model better. Otherwise, SVOD is the way to go,” Taurani explains.

N Chandramouli, CEO, TRA Research, a consumer insights and brand analytics company, believes in the possibility of an ad-supported OTT. He points out that, globally, OTT is now seeing traditional production houses, technology companies, and others giving the likes of Netflix a run for their money.

“Ad-supported content is probably the way OTT is likely to go in the future; but having gotten used to ad-free content, customers will be looking for the next innovation, which will combine ad-free content, yet provide revenue to the OTT platforms,” he says.

Losing monopoly

Paritosh Joshi feels that Netflix can longer claim the dominant position. He says, “I don’t think Netflix has the luxury of being the only climber on the mountain. They are not the Edmund Hillary or the Tenzing Norgay. There are many people atop; it is like Everest in 2022, not the Everest of 1954. I am not even sure whether Netflix is a clear winner in every market in which it is present. In the US where Netflix is almost synonymous with OTT, the reality is that you have HBO Max, Hulu, and now Prime, all big players. In a sense, Hulu had been there before Netflix as a subscriber-based OTT model. The problem with Hulu was that it was a joint venture of multiple entities. They never had the ability to single-mindedly do what Netflix could single-mindedly do.”

His theory is that Netflix will not be able to survive as an independent entity beyond 2030.

“I read somewhere a quote by Reed Hastings that the streamer gets an offer every week. Netflix is going to face some growing battles. There will be hostile as well as friendly bids for mergers and acquisitions. It will happen in the times to come for sure,” Joshi asserts.

According to him, Netflix occupied the subscriber base model during the first decade of its existence as an OTT. “If you go from subscription to an ad-supported model you are actually taking a step back,” he argues.

“In a pure-play subscriber model,” according to Joshi, “you set your prices in such a way that it actually covers your costs and makes some margins on each consumer you attract.” He maintains that the cost of acquisition is high.

“In that process, you don’t really start making money on a subscriber on the day that the subscriber enrolls. You start making money later. Conversely, one advantage of the ad-supported platform is that because it is free to consume, the rate of consumer acquisition, in terms of the number of people who will start subscribing particularly if it is a familiar brand, will be high. After that, you are asking them to watch so many minutes of advertising. Globally, the largest ad-supported platform is YouTube, which is way ahead of everyone else. Not only is it ad-funded, but it does not even create the content. YouTube is very happy to give you the skid-ad button because it doesn’t want you to waste time on ads. There is a viewability standard users have to hit. If you want to grow subscribers there is a natural limit to how many subscribers you can grow on a pure subscriber model,” elaborates Joshi.

He asserts that those who are upset by advertising will remain in the pure subscriber base model. “Such demanding customers, who don’t want ads, will continue to pay. The old addicts of Netflix will remain committed to the model because they can afford to pay. Indeed, if the ad model for Netflix were to grow then Netflix may find it feasible not to keep increasing prices for the subscribers because they have a supplementary source of income. It might eventually at one level work favourably for the paying subscribers because they will realize that there won’t be continuous price increases. It could play like that,” he explains.

The Indian scenario

Will a price-sensitive market like India be receptive to an ad-supported model from the house of Netflix? It is a fact that Indians want their content at a dirt-cheap price.

“Many Netflix subscribers are anti-ad because they have been trained that way; Netflix as a platform is perceived that way,” says Taurani.

“People are not used to watching ads on Netflix. In the medium to long term, in this price-sensitive Indian market, if they are able to offer prices at a further lower rate to the audience it can augur well. India is a very huge market; we have 600 million smartphones. Out of this, Netflix’s subscription rate is very low. It is almost 5-10 million-odd numbers. So, there is a huge potential for scale; if the streamer can bring freemium or an ad-and-SVOD model, something similar to Disney+ Hotstar has done. Disney’s is a phenomenal case study and example of a successful freemium model,” explains Karan Taurani.

In India, feels Paritosh Joshi, the ad model will be accepted because all other platforms are ad-supported. Consumers are used to it. One such ad-supported platform everybody is familiar with here in India is Hotstar because of the IPL.

Kalpana Rai Menon, Head of Department - Mass Media at SM Shetty College, however, believes that Netflix consumers are unlikely to accept ad-filled, free, or low-priced versions.

She says, “The major advantage of OTT platforms is uninterrupted shows. Customers pay for the subscription because the platform offers ad-free entertainment. Ad inclusion will shift customers towards competition, which is ad-free. People who have shifted to Netflix have done so, because there is no advertising. People have moved away from Cable TV programmes, which are plagued with too much advertising. Five minutes of a story is covered in 30 minutes, with multiple ad breaks. Also, the content is very different from that on OTT, and the TG is different.”

Customer loyalty

Will customer loyalty take a hit in the event of such an ad-supported tier?

Not really, says Karan Taurani. This, he adds, is due to the possibility of a freemium model. “Customer brand loyalty will not take a hit, because even if they start advertising it won’t be pure advertising or pure SVOD. I think it is going to be a freemium model. They may charge the ad-supported model with a lower subscription fee for those who want to watch with ads and the SVOD subscription will come at a premium. That is the model many platforms have adopted. Whatever originals are shown, for example, by Amazon Prime or Disney are without ads. Except for sports content, you need to have advertisements because the cost of the content is so high,” he maintains.

Chandramouli does not believe that brand loyalty will take a hit. “It should be the other way around”, he says, “OTTs should try and be loyal to the customer.”

“As long as ads are not intrusive, consumers will continue to watch their screens, but when the ratio of ad-to-content rises, as it will most likely do, viewers will migrate to the best option. Viewer loyalty is a misnomer, it must be the OTTs who should try and be loyal to the customer,” Chandramouli adds.

Personalisation

Netflix’s personalisation infrastructure contains everything needed for serving personalised ads, and Netflix’s personalisation engine is already generating tremendous value for the company. Could it be cross-utilised for serving third-party advertising?

Taurani says that personalisation is seeing a lot of issues globally in terms of data privacy. They can use personalisation for customer profiles. But there are constraints on it as well. All major tech companies, like FB, have a privacy policy. Recently Google has also said they won’t be sharing too much of consumer data to advertisers.

According to Chandramouli, if Netflix goes ad-based, it will have to use third-party ad networks for the personalisation. “That said, ads on any platform are nothing short of an irritation to the viewer and an impediment to the viewer experience. Personalisation is great value for the advertiser and has the opposite effect on the viewer,” he adds.

Menon adds here that eventually, the cross-utilisation of personalised advertising, serving third-party, is inevitable as it is a revenue-generating model.

“We can see the trend on all social media apps too. Be it LinkedIn or Instagram there is more sponsored content than organic. Like the quote “if you are not paying for it, you are the product,” she concludes.

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