What if Netflix moved into advertising? – report

Monday, December 14, 2015

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Ampere Analysis’s latest report proposes and discusses three possible future scenarios if Netflix moved into advertising. The streaming video company has been at pains to point out it has no plans to make such a move, but Ampere Analysis anticipates that Netflix’s consistent 15% YoY revenue growth over the last two years will inevitably slow as subscriptions hit saturation point, especially in its core developed markets of the US and Europe.

At this point, it will come under pressure from shareholders to look for alternative revenue sources. Advertising will be one of the options considered alongside additional paid tiers.

Ampere Analysis has explored three advertising scenarios:

1. Pre-roll - The simplest option, and the least invasive for the existing customer base, would be to deliver a pre-roll commercial product. Assuming a $15 average CPM rate for the 30-second pre-rolls, on current subscriber numbers and viewing volumes Netflix could increase revenues by 17% and make approximately $270 million per quarter. At over one billion dollars extra per year, that’s roughly half of Netflix’s entire international quarterly revenue, and about one quarter of its domestic subscription revenue.

2. Broadcast-level ad-load - A full broadcast-level ad-load would have even greater impact at current subscriber numbers and viewing volumes. Even with a reduced CPM of $8 (equivalent to a large broadcast channel’s annual average), Netflix could technically achieve quarterly revenues of nearly $2 billion – relative to a combined quarterly domestic and international subscription revenue tally of $1.6 billion – assuming its subscriber numbers and streaming volumes were maintained. Richard Broughton, research director at Ampere Analysis, said: “Netflix has a magic ingredient that makes it the envy of many of its competitors: what we call ‘Dream Demographics’. Netflix’s audience is younger, wealthier and predominantly comprised of the higher earning ABC1 socio-economic group.  The relative rarity of an audience like this means Netflix could charge a premium for advertising and brands will willingly pay it. And because Netflix knows a lot about its subscribers, it’s perfectly placed to maximise its ad inventory and well-suited to programmatic advertising.”

An Ampere Analysis study of 7503 Internet users in Western Europe and the US revealed:

  • 75% of Netflix subscribers were 44 or younger, vs. 57% of adult internet users.
  • 63% of Netflix customers are ABC1, compared to the average polled of 54%.
  • Netflix subscribers are wealthier, with 14% more likely to be in homes earning $60k-$90k, 23% more likely to be in homes earning $90k-$100k, and 43% more likely to be in homes earning $120k-$150k.

3. Free ad-funded tier - The third option is to leave the current subscription as it is and add a free ad-funded tier. In this scenario Netflix could tap into a new pool of low-spend customers and avoid angering existing subscribers with unwanted advertising. This would involve renegotiating rights, as well as restricting the availability of tent-pole titles and brand new releases to the paid tiers. This small, low-spending audience may not be that attractive though, particularly in a market like the US where, according to Ampere’s calculations, only 19%-30% of Internet users watching online TV regularly would be addressed by such a move. However, where there is real potential for this free tier model is in markets in which Netflix might struggle to persuade users to pay, where Netflix has recently launched its subscription streaming service, or CEE and the MEA, where Netflix has yet to roll out.

The impact of subscriber churn were advertising to be introduced

These figures assume no net impact on subscriber numbers or streaming volumes in response to advertising, but given the social media furore over Netflix’s move to deliver pre-roll trailers of select shows, Ampere Analysis believes carrying advertising will impact on the subscriber base, particularly if broadcast-level ad-loads were introduced. In the pre-roll scenario, if churn related to the introduction of advertising increased to much more than 10%, Netflix would make a net revenue loss compared to a subscription-only model.

Considering the additional costs for selling and delivering advertising, Netflix would ideally have to keep advertising-related churn to less than 7%-8%. In the full broadcast advertising model, even if it suffered 50% churn, Netflix could make more money than a subscription-only model. Taking the additional costs into account would likely net out the calculation, but this does suggest that, were management of the impact possible, it would be a viable, if risky, strategy for the streaming giant.

Richard Broughton continued: “Netflix is still growing its subscriber base and expanding into new international markets. However, we expect it to see subscriber growth slowing in 2017-18 and, at that point, numerous options such as diversification of content, pricing and subscription tiers – as well as advertising – will need to be considered. For now, this is very much a ‘what if’ piece of analysis. However, one thing is certain. Netflix’s ongoing expansion and per-subscriber viewing gains mean that it competes for eyeballs and will have an effect on incumbents, whatever it does in the future.”

 www.ampereanalysis.com

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