Why Netflix Should Sell Ads

The Information reported over the weekend that Netflix executives have told employees to keep an eye on the bottom line:

In two separate meetings over the past few weeks, Netflix executives cautioned employees to be more mindful about spending and hiring, according to three people familiar with the discussions. The comments, made at an employee town hall on Monday as well as during a management offsite held last month in Anaheim, Calif., come as the streaming giant grapples with sharply slowing subscriber growth…

Netflix has also been pondering steps that could help offset the revenue impact of the subscriber slowdown, including cracking down on people sharing the passwords to their accounts. While Netflix has long allowed such password sharing, it has become more common in the U.S. and other parts of the world than executives anticipated, the people said. This effort has been underway for about a year, however, well before the slowdown became apparent.

These are presented as two different issues, but there is a connection between them: Netflix should be hiring more people — a lot of them — and those people should be building a product that increases subscriber numbers and revenue. That product is advertising.

Netflix’s Business Model: Subscriptions

Netflix is, incredibly enough, 24 years old, and a subscription model has served the company well. Not that Netflix had much choice when it started: the company briefly sold DVDs online, before focusing exclusively on renting them; neither approach offered much surface area for advertising, and besides, the subscription model was revolutionary in its own right.

DVDs-by-mail was, from a certain perspective, inconvenient: you couldn’t simply drive to your local Blockbuster and peruse the selection; on the other hand, Netflix’s model gave you access to nearly every movie ever released, not just those in stock at your local store. The real innovation, though, was that business model: instead of paying to rent a DVD and being gouged with late fees, you could pay a set amount each month and keep the DVDs Netflix mailed to you as long as you wanted; send one back to get the next one in your queue.

Consumers loved it, and Netflix has stuck with the model even as the shift to streaming flipped their value proposition on its head: streaming is even more convenient than hopping in your car, but only a subset of content (ever-expanding, to be sure) is on Netflix. That has been more than enough to fuel Netflix’s growth; the service had 222 million subscribers at the end of 2021.

Still, as The Information noted, that number isn’t increasing as quickly as it used to. Netflix sported over 20% year-over-year subscriber growth for years (usually more than that), but hasn’t broken the 20% mark since Q4 2020; growth for the last three quarters was in the single digits. Some of that is likely due to growth that was pulled forward by the pandemic:

The bigger problem, though, is saturation: Netflix has 75 million subscribers in the US and Canada, where there are around 132 million households. That is nearly as many subscribers as linear TV (84 million), and once you consider shared passwords, penetration may be higher. Other markets like India have more room to grow, but much lower household incomes, and Netflix’s relatively high prices have been an obstacle.

Netflix has ways to grow other than subscribers, most obviously by raising prices. The company has done just that on a mostly annual basis for eight years: in the U.S. the price of a Standard subscription (HD, 2 screens) has increased from $7.99 to $15.49. Netflix executives argue that customers don’t mind because Netflix keeps increasing the amount of content they find compelling; it’s an argument that is easier to accept when subscriber growth is up-and-to-the-right. Now the task is to keep raising prices while ensuring subscriber numbers don’t start going in the opposite direction.

Netflix’s New Initiative: Gaming

To accomplish this Netflix is not only continuing to invest in original programming, but also branching out into new kinds of content, including games. This may seem an odd idea at first: sure, Netflix is generating some new IP, but it would generally be much easier to license that IP than to become proficient at gaming. Netflix, though, believes it has a unique advantage when it comes to gaming: its business model. Chief Product Officer Greg Peters said in the company’s Q2 2021 earnings interview:

Our subscription model yields some opportunities to focus on a set of game experiences that are currently underserved by the sort of dominant monetization models and games. We don’t have to think about ads. We don’t have to think about in-game purchases or other monetization. We don’t have to think about per-title purchases. Really, we can do what we’ve been doing on the movie and series side, which is just hyper laser-focused on delivering the most entertaining game experiences that we can. So we’re finding that many game developers really like that concept and that focus and this idea of being able to put all of their creative energy into just great gameplay and not having to worry about those other considerations that they have typically had to trade off with just making compelling games.

Netflix’s gaming efforts to date have been fairly limited; the company launched with five titles in November, but the fact the company has bought three gaming studios suggests a strong appetite for more — at least amongst Netflix executives.

But what about consumers?

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