Can Netflix Continue To Resist Advertising?

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January 26, 2012 – 5:38 pm

netflixNetflix has long said that it has little interest in exploring advertising as an additional revenue stream alongside its main subscription model, but even the largely positive numbers the company posted yesterday suggest that eventually, the company will have to take that option more seriously.

By most accounts, Netflix’s Q4 earnings results pleased investors and analysts, as the video streamer and DVD renter managed to pick up more subscribers and exceeded revenue expectations.

Subs Return: The numbers certainly showed a quick resilience in the face of last fall’s subscriber uproar over efforts to rebrand and separate the streaming and DVD businesses. Netflix may well continue to drive higher subscriber growth throughout the year. But as AdAge’s Jeanine Poggi reported ahead of the earnings, the company will be significantly challenged as it looks to build up its streaming business while winding down its DVD side.

Netflix Squeezed: According to a research report by Wedbush analyst Michael Pachter, the acquisition of more subscribers is costing Netflix deeply and he expects the company to post losses for the year as a result. For Q4, Netflix saw profits fall 13 percent. At the same time, the streaming business had margins of just 11 percent. AdAge, citing Janney Capital Markets analyst Tony Wible, noted that Netflix would have to sign up four to five streaming subscribers to make up for the loss of one DVD subscriber who canceled because of last year's price hike.

At the same time, content acquisition costs are also getting more expensive, especially as its users are showing a greater demand for TV show streams. Some Netflix subscribers may find their choices reduced as the streaming deal with Starz expires due to the inability of both sides to come together on terms for a renewal. Netflix hopes to make up for the loss of Starz’s content by developing its own, including creating new episodes for the canceled Fox cult series Arrested Development sometime next year.

In February, Netflix will pull the streaming curtain up on its first original series, Lillyhammer, starring Sopranos alum and Bruce Springsteen E Street Band guitarist Steven Van Zandt as a mobster that turns federal witness and is relocated to a Norwegian town of Lillehammer.  Netflix has ordered eight episodes of the series and if it decides to produce more, things are likely to get more expensive for the company.

The Ad Question: When asked about the possibility of Netflix taking a more serious look at advertising – whether through a Hulu-like15/30-second ad per break, series sponsorships, or pre-rolls – most analysts dismissed the notion. “I don’t think advertising is something on their radar,” Wedbush’s Pachter told TVExchanger. “Highly unlikely,” Citi’s Mark Mahaney told us. And BTIG's Rich Greenfield said in an e-mail, "I simply do not believe they will go there…the best part of Netflix is never watching a commercial during a full season of Mad Men."

Netflix representatives did not respond to a request for comment.

The introduction of advertising is almost certainly out of the question for at least the next several months, as Netflix strives to make up the goodwill it lost on the part of customers who were severely put off by the PR blunders CEO Reed Hastings admitted to in a Netflix blog post in September.

But looking further out, say some time in 2013, once the name Qwikster (the proposed identifier for the DVD business that was abandoned after the consumer outcry) is a very distant memory, Netflix may find itself faced with the question of whether or not to embrace advertising in some small form.

For example, advertising hasn’t hurt Hulu. The streaming joint venture recently said revenues rose 60 percent from 2010 to approximately $420 million in 2011. Also, the $7.99 per month (same as Netflix in the U.S.) Hulu Plus subscription service now has more than 1.5 million users.

The cost of acquiring customers and content is only going to keep rising. And then consider more aggressive competition from other streaming sites on top of cable companies’ own "TV Everywhere" broadband video efforts all beg the question: Can Netflix remain ad-free? If so, what other options does Netflix have besides raising subscriptions?

Selling downloads of programs and movies seems even more unlikely than selling ads against TV shows or placing ads on the main screen while consumers peruse their titles. At the very least, it’s hard to see what Netflix would have against a tiered service that resembles music streamer Spotify, which offers a free, ad-supported version and $10.99 month no-ads option. The ability to offer a wider array of fresher, high quality content would seem to balance out consumers’ annoyance at being barraged with advertising.

Of course, the placement of advertising would make Netflix’s proposition less unique, less special. But unless the competition suddenly fades, Netflix will have to convince its shareholders to swallow another year of losses or continue offering old movies and past seasons’ TV shows.

How it might begin: So how would Netflix get into advertising without creating another major controversy and drive customers away again? It would probably have to do so very gradually.

For years, Netflix has had film studio advertisements on its DVD envelopes as part of larger content licensing deals. What it be much of a stretch to open those sleeves to consumer packaged goods, automakers or other major marketers, who would certainly pay for what could be considered a form of contextual advertising related to a comedy, romance, action title. (A very big thanks to Sara Livingston, who tweeted that idea earlier.)

At the very least, it would be a good way to draw more revenues and give  Netflix's declining DVD business a softer landing as it winds down over the next few years.

By David Kaplan


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January 26, 2012 – 5:38 pm
  1. 4 Responses to “Can Netflix Continue To Resist Advertising?”

  2. Netflix painted themselves into a corner with their awkward price changes, and then Hasting's ridiculous "no more raising prices" statement. I'd prefer higher-cost streaming to ads. But, somehow, by being so good and cheap to start (remember, streaming was free for a long time), they've made it difficult for themsleves.

    I just read that currently, out of the top 100 films of 2011, Netflix has 5 available for streaming. Last year at this time, they had 10. Only a small percentage of customers are that aware of the content to realize that, but 100% would realize if ads were inserted or if the prices were increased. So, if Netflix does anything to raise revenues besides adding customers, they'll take another huge hit from their customer base.

    They created this story, and they are stuck with it.

    [Reply]

    By Mike on Jan 26, 2012

  3. Netflix should hire Mr Kaplan; he could continually provide summaries of the company to the clueless executives, and then perhaps they'd see their choices more clearly.

    [Reply]

    By Mike on Jan 26, 2012

  4. Netlix will not throw in additional advertising because it is a subscription service that people pay money for. There are a ton of streaming sites like "Crackle" which are free, but have the annoying ad's. Youtube also free, but now full of annoying ad's. If Netflix went this route they would lose a good chunk of their consumer base. People pay for a reason, they don't want commercials shoved down their throat.

    [Reply]

    By Nick on Mar 5, 2012

  5. Mike and Nick, good points all.

    As I say, I don't think Netflix is close to opening up its service to ad support. But I think one day, it very well could offer that as an option -- much like subscribers have the option of choosing to pay separately for DVDs and streaming. I wonder if there would be as much outrage and defection if, after a few price hikes over the next few years, Netflix decided to offer a free, ad-based version, while still providing a paid subscriber version that is ad-free.

    This is something that streaming music companies like Spotify offer and it doesn't seem to suffer. Meanwhile, Hulu has a monthly subscription option that still requires viewers to sit through ads and it too doesn't seem to be doing that badly.

    Certainly, Netflix needs money if it is going to pursue more original productions. At the moment, it looks like Netflix will pursue the HBO model, and this Reuters piece appears to suggest that's the direction it's headed to: http://www.reuters.com/article/2012/03/06/us-netflix-cable-idUSTRE8251U520120306

    In the story I just mentioned, Netflix may be talking to cable providers about placing it on the set-top box -- that would be a direct threat to the existing networks that Netflix also looks to for its growing library of TV shows. So far, the MSOs haven't shown much interest in aligning with Netflix, which up to now, has been regarded as a burgeoning over-the-top threat.

    The bottom line here is that business models have to continuously evolve to current market circumstances. Today, it's unthinkable that Netflix would insert ads into its streams. And it's just as inconceivable that the major MSOs would give Netflix a position as an "on-demand" channel. But things do change. I'd be interested to see how dubious these ideas seem a year or two from now.

    [Reply]

    By David Kaplan on Mar 6, 2012

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