Offering Netflix as Ad-Backed 'Option' is No ‘Short-Term Fix,’ Says CEO

Netflix has begun studying the possible rollout of lower-priced, ad-supported tiers as one way of restoring subscriber growth, said CEO Reed Hastings in a Q1 investor interview Tuesday. Netflix blamed its dismal Q1 results on the lack of an account-sharing monetization strategy, plus “pretty high market penetration” and intensified competition, all driving lower subscriber acquisitions.

Netflix reported paid net subscriber losses of 200,000 compared with the Jan. 20 outlook for 2.5 million global streaming paid net additions, and is projecting 2 million additional losses in Q2 (see 2204190066). Even factoring out the 700,000 subscribers lost when Netflix suspended the service in Russia, global paid net adds would have fallen 2 million short of projections, said the company. But for Asia Pacific, all global regions where Netflix does business had subscriber losses in the quarter. The disclosures sent the stock plunging nearly 35.1% Wednesday to close at $226.19.

Increasing the “price spread” through ad-supported tiers is possibly a formula for reinvigorating subscriber acquisitions and retentions, said Hastings. “Those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription,” he said. As much as “I'm a fan of that, I'm a bigger fan of consumer choice,” he said. “Allowing consumers who would like to have a lower price and are advertising-tolerant” now “makes a lot of sense, so that's something we're looking at now,” he said.

Offering Netflix as an ad-supported "option" is “not a short-term fix,” cautioned Hastings. “Once you start offering a lower-priced plan with ads as an option, some consumers take it,” but Netflix has “a big installed base" of subscribers who "probably are quite happy where they are,” he said. Hastings advised market watchers to think of an ad-supported Netflix as something the company “would phase in over a couple of years” before it reaches “material volume.”

Asked if Netflix would test an ad-supported service in a few small markets before deploying it widely, Hastings said: “We're probably not that advanced.” He thinks “it's pretty clear” that an ad-supported strategy is “working for Hulu,” he said. “Disney is doing it. HBO did it. I don't think we have a lot of doubt that it works, that all those companies have figured it out. I'm sure we'll just get in and figure it out as opposed to test it and maybe do it or not do it.”

Netflix is “working on how to monetize sharing,” said Hastings. “We've been thinking about that for a couple of years, but when we were growing fast, it wasn't the high priority to work on.” Netflix estimates the service is “being shared” with 100 million homes globally -- including 30 million in the U.S. and Canada -- that are not paying for it, said the company’s shareholder letter. Those 100 million homes “love the service,” said Hastings in the interview. “We just got to get paid at some degree for them.”

If a paying Netflix subscriber shares the service with a sister living in a different city, said Chief Operating Officer Greg Peters, “we're not trying to shut down that sharing, but we're going to ask you to pay a bit more to be able to share with her.” The goal is that the sister “gets the benefit and the value of the service, but we also get the revenue associated with that viewing,” he said.

In its tests of account-sharing pricing schemes in three Latin America markets, “we're trying to find a balanced approach here, and we're trying to basically come up with a model that supports a customer-centric approach,” said Peters. Peters admits “it will take a while to work this out and to get that balance right” before Netflix is ready to deploy a “solution” globally.

A “shocking Q1 subscriber miss” and weak subscriber and financial guidance spurred a “sell” rating by Pivotal Research Group analyst Jeffrey Wlodarczak Wednesday. Lower than expected subscriber growth is due to the “sizeable pull-forward” in demand due to COVID-19, slow connected TV growth, pirating and competitive effects, Wlodarczak wrote investors.

The 100 million households currently receiving Netflix but not paying for it gives the company a chance to boost average revenue per user in the medium term, offset by the potential for pushback from existing subscribers, Wlodarczak said. He was chilly toward the idea of a Netflix ad-supported tier, saying it “cheapens the brand and the product” and introduces “ad volatility.” The Netflix flywheel “has slowed substantially,” said the analyst, and it will take time to get it going again, creating uncertainty for the rest of 2022, he said.

Wedbush analyst Michael Pachter said market saturation in the U.S. and Canada will make Netflix’ future subscriber growth “challenging,” in a Wednesday investor note. He said headwinds include competition for content and wallet share with other streaming services, inflation, Netflix’ “ill-timed” subscription increase and effects of the pull-forward of subscribers during COVID. The Russia situation “will continue to be a drain on revenues, and in a more modest way, on subscribers,” Pachter said, saying the stock is “‘dead money’ for at least another quarter.”