Seriously, Netflix Should Think About an Ad-Supported Tier | The Motley Fool

While most of its rivals are tinkering with their business models, streaming giant Netflix (NASDAQ:NFLX) thus far has steered clear of airing advertisements through a lower-priced tier of its service. But perhaps it should entertain the idea.

At least, that’s the big takeaway from a recent market study performed by Hub Entertainment Research. A survey of around 3,000 U.S. consumers by Hub found that 58% of them would prefer an ad-supported streaming service if it lowered the monthly price of that service by $4 to $5. The other 42% indicated they were fine paying the higher price for an ad-free experience.

There’s a curious detail buried in Hub’s findings though: Even among Netflix subscribers — who are plenty accustomed to paying some of the streaming world’s highest fees — 46% of them would be willing to tolerate ads at the beginning of a video for a lower-cost option. Moreover, 39% of these Netflix customers would even accept mid-video advertisements to save some money on their monthly bill.

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That’s a telling, new dynamic for the streaming media business.

Crunching the numbers

Injecting television commercials into Netflix’s streams was unthinkable just a few years ago. Much has changed in the meantime. Namely, ads are more palatable than most anyone imagined they might be. Hub’s report determined that 95% of the survey’s respondents watch some sort of ad-supported programming, while only 79% said they’re subscribers to an ad-free service.

Image source: Getty Images.

Sheer costs associated with ad-free services have much to do with this shift. Recent numbers from Ampere Analysis show that more than half of the United States’ households now enjoy three or more streaming video-on-demand (SVOD) services, while 39% subscribe to four or more SVOD platforms. That can quickly get pretty expensive, even if those consumers have already canceled cable — one of the key purposes of cutting the cord is reducing costs.

The funny thing is, the hyper-competitive streaming market is ultimately making ad-supported platforms more profitable than ad-free ones.

David Zaslav, CEO of Discovery, provides some of evidence to this end. Speaking at an investor conference last month, Zaslav explained that the company’s Discovery+ streaming service produces average monthly revenue per user (ARPU) that’s “30 to 40% higher” than what’s generated for the company by traditional cable customers. More notably, the ad-subsidized version of Discovery+ that costs $4.99 per month ultimately generates more revenue than the ad-free version of Discovery+ that retails for $6.99 per month.

Bob Bakish, CEO of ViacomCBS, pointed to a similar dynamic at another event earlier this month. Regarding the company’s newly rebranded Paramount+ streaming service, he said, “As we look at this product and the dynamics of the ad market, we actually believe analytically that the $4.99 version can actually generate higher ARPU over time than our $9.99 product.”

AT&T hasn’t been as forthcoming about HBO Max’s marketability as an ad-subsidized offering. But the fact that it chose to develop a lower-cost version of the service that includes advertisements speaks volumes about the reach of such services versus the increasingly limited reach of ad-free, premium-priced alternatives.

Never say never

The idea has come up before, of course, and Netflix has eschewed it every time. And for good reason. As Rick Munarriz put it, “There is room for advertising on Netflix, but you can’t lament the upside without considering the downside.” He added, “Netflix didn’t become the leader among streaming service stocks by following everybody else.”

Just because it hasn’t been done in the past, however, doesn’t inherently mean it shouldn’t be done in the future.

The marketplace itself is changing. Great ad-supported platforms are starting to draw a crowd that in the past would have otherwise gravitated to Netflix’s service. The company itself is calling for the net addition of only one million subscribers for the second quarter, which would be one of its weakest growth rates in years. If that slow growth persists, the company may well decide an ad-supported version makes a great deal of sense.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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