Can Netflix’s ad tier be ARPU-neutral?

Netflix revealed the eagerly-awaited details of its forthcoming advertising-supported subscription tier yesterday. The new product tier, which Netflix calls Basic with Ads, will debut on November 3rd in the United States at a price point of $6.99 per month. Netflix’s ad-supported tier falls in the middle of the price range for comparable ad-supported tiers from other streaming services: Hulu’s ad-supported tier is priced at $7.99, as will be Disney+’s when it debuts in December, and HBO’s ad-supported tier is priced at $9.99 per month, but Peacock and Paramount+ both price their ad-supported tiers at just $4.99 per month.

Note that the Basic with Ads tier will support a maximum resolution of 720p, each account can only be watched on one device at a time, and not all Netflix content will be available to stream. A few other details about Netflix’s ad-supported tier were leaked in September, when Netflix began shopping its ad product to agencies:

  • $65 CPM;
  • $20MM annual spend cap per brand / advertiser;
  • 15- and 30-second unskippable preroll and midroll placements;
  • Year-long upfront commitments;
  • Audience targeting that is limited to: Top 10 programming in the US, genre-level content (eg. Comedy), and geography.

Netflix announced yesterday that it is targeting an ad load of between four and five minutes per hour, and it has told advertising agencies that it expects to have roughly 4.4MM worldwide viewers on its ad-supported tier by the end of 2022, expanding to 40MM by Q3 of 2023.

Notably, Netflix believes that the revenue impact from any user switching from the current ad-free Basic tier (priced at $9.99) to the Basic with Ads tier will be “neutral to positive.” This means that Netflix has determined that it will generate at least $3 in ads revenue per user per month with the Basic with Ads tier. At a $65 CPM, this means that Netflix expects to expose users in this tier to at least 46 ads per month.

Is this feasible? Netflix shared in 2019 that, on average, its users each streamed approximately two hours of content daily. If that level of engagement applies to the Basic with Ads tier, then each user would be exposed to eight to ten ads per day, or 240 to 300 ads per month. But is it reasonable to apply the engagement metrics from the current subscription tiers to the new ad-supported tier?

It’s important to consider here that Netflix only commented on the ARPU impact of users switching from the Basic tier (and not the Standard or Premium tiers), and the Basic with Ads tiers exists roughly at product and feature parity with the existing Basic tier (the new ad-supported tier will feature 5-10% less content). While the revenue impact of incremental new subscriptions will obviously be positive, Netflix is saying that it will suffer no negative consequences if existing Basic subscribers transition to Basic with Ads at the lower price point, given the ads opportunity.

Applying the two-hour daily view time metric to the ad-supported model, given the lofty $65 CPM, no stretch of the imagination is needed to project astronomical advertising ARPU values. This is because Netflix plans to expose between four and five minutes of advertising each hour, which is captured by between eight and sixteen ads per hour across the 15- and 30-second video formats.

It doesn’t seem unreasonable to consider that net new users to the ad-supported tier — that is, users that were not previously subscribers — will engage less than current subscribers, given the calculus around the personal value proposition. But are emigrants from the Basic tier already at the lower end of the engagement spectrum? It stands to reason that, for current subscribers, engagement time might be inversely correlated with likelihood of switching to the ad-supported tier. So when the Basic with Ads tier is launched, not only will it onboard net new users that engage at a lower rate, but it will invite the transition of current Basic subscribers that had existed on the lower end of the engagement range. This could create two segments of users with very different retention profiles: the ad-supported (net new and ex-Basic subscribers) and the paid (remaining Basic, Standard, and Premium subscribers).

Why does this matter? Because the $65 CPM that Netflix currently commands likely benefits from a novelty premium, and it was informed, at least in part, by Netflix’s engagement metrics. Lower average engagement within the Basic with Ads tier, relative to the users that remained behind in the no-ads Basic and other paid tiers, could weigh on Netflix’s CPM as its ads business matures, especially if its targeting and measurement tools remain primitive.