Netflix: Some Ad-Supported Math
I've been spending some time studying Netflix's ad-supported tier opportunity. I think this has a decent chance of being a big business that most people are overlooking.
First, let's establish that ad-supported streaming tiers monetize better than ad-free tiers. Here is Kevin Mayer, Disney's former head of streaming discussing how Hulu's ad-supported tier had higher ARPU than its ad-free tier.
And here are the thoughts of a former head of programming strategy at Hulu on Netflix's ad-supported tier opportunity (via Tegus):
"So I think it makes a lot of sense. I think on the earnings call, they probably came out a little bit early in that this has always been an opportunity in Netflix's back pocket for quite a long time. I think their pathway to market needs to be very deliberate, but it definitely is a massive revenue opportunity for them. The connected TV advertising business as a whole is white-hot right now. Hulu saw a tremendous amount of success on the ad side of our business, to add ARPU for lower priced plans plus ads was actually making more money on a per-user basis than the no ads plan. And I think that trend should translate to Netflix as well. So say they come in at like a $5 price point, I think they could easily get to a $15 to $20 monthly ARPU by being in this business... When we had a customer come in the door, we actually preferred it if they were ad-supported."
Another former VP of DTC at Disney said Hulu's ad-supported tier makes "quite a lot more" than the ad-free tier. Even Peacock, which has a fraction of Netflix's engagement and therefore a fraction of the impressions, has a higher ARPU on its $5 per month ad-supported tier than it's $9.99 ad-free tier.
Here’s one take of several I’ve read supporting the idea that advertiser demand for Netflix ads should be robust (via Tegus):
“I know when I was at Viant, I ran a campaign one time where I want to say it was probably sometime in the fall, like September or October. The client was interested in running on Hulu inventory and Hulu was like, ‘No. We're sold out for the rest of the year.’ They didn't have anything available just because that's how in-demand it was. It's still a similar case right now. Hulu inventory is very hot. Just basing it off of that, I'm like, ‘Oh, wow. Netflix is going to be the same thing, if not even crazier,’ just because it's such a popular streaming service that it's definitely something I think advertisers would want to spend the money on. Yeah, I could absolutely see that being a big opportunity and driving a lot more advertising dollars and seeing a lot of advertisers wanting to push their money towards that for sure.”
Netflix's Ad-Supported ARPU
Next, let's think about the variables that should drive Netflix's ad-tier revenue: engagement, ad load, CPM, and subscription price. These are some of my current thoughts on those topics and are always subject to continuous revision.
Engagement. How many hours per day will the ad-supported subscriber watch? Well, Netflix's former original content head Cindy Holland said the average Netflix subscriber watches two hours per day. I think ad-supported users likely watch more than ad-free users considering they tend to be lower income and lower income people tend to watch more TV. But let's call it two hours to try to be conservative.
Ad Load. How many 30-second ads will Netflix's ad-tier show? Well, Disney+ is targeting an ad load of 4 minutes per hour, Peacock's is 5 minutes per hour, and HBO Max won't have more than 4 minutes per hour. Hulu's ad load is 6-8 minutes per hour. Disney's ad head said its ad load is as low as it is because 65% of viewers are watching for movies, which don't lend themselves to ad breaks. I don't have that data, but Netflix should have a much lower mix of movie viewing than that given its strength in series. Still, let's assume Netflix's will be 4 minutes per hour, which is eight 30-second ads per hour.
CPM. Hulu's CPM is apparently $30-$45. Disney is reportedly asking for $50-$60 CPMs on Disney+, which is "in line with other top streaming services." Let's say Netflix's CPM is also $50-$60. One ad industry exec believes Netflix's CPMs will be considered premium because Netflix's viewing scale should allow it to slice and dice its audience in more ways than smaller AVOD services can, which should allow it to have higher CPMs. But let's call it $50-$60 CPM, which is $0.05-$0.06 per impression.
Ad-Supported subscription price. Hulu is charging $6.99 per month for its ad-supported tier. HBO Max and Peacock are charging $9.99 per month. Let's say Netflix charges $7.99-$9.99. It's possible they could even offer two ad-supported tiers—a free one with a higher ad load and a paid one with a lower ad load. That is what Peacock does. On one hand Reed has a history of championing simplicity, suggesting only one ad-supported tier is more likely, but on the other hand he also champions consumer choice, suggesting more than one is possible. For now, I'm going to assume they have one $7.99-$9.99 ad-supported tier, but I'm certain management will price to maximize revenue.
2 hours per day x 8 30-second ads per hour x $0.05-$0.06 per impression x 30 days per month = $24.00-$28.80 per ad-supported subscriber per month. Add on the subscription price assumption and the total ad-supported ARPU would be $31.99-$38.79 per month. These are just U.S. or perhaps UCAN assumptions.
There must be some leakage on that ARPU to the extent they partner with ad-tech partners. Still, it seems like Netflix's ad-supported tier could monetize extremely well relative to the company's all-in $14.91 UCAN ARPU and the $11.77 global ARPU.
On Comcast's fourth-quarter call in January, Brian Roberts said Peacock's ARPU was "approaching $10," including ads. That's interesting because Peacock had 24.5 million total users at the time, only 9 million of which were Premium (paying) users. And of those 9 million paying subscribers, the "vast majority" of them pay only $4.99 for the ad-supported tier versus the $9.99 ad-free tier. The other 15.5 million pay nothing. So doing the math, (15.5 million x $0) + (~8 million x $4.99) + (~1 million x $9.99) = $2.04 ARPU from the subscription price. That suggests another ~$8 ARPU just from ads.
Now consider Peacock's engagement: