Netflix reported Q4 earnings last week: the company outperformed expectations on subscriber growth, adding 7.66MM new subscribers compared to analyst expectations of 4.57MM. For reference, Netflix lost 203,000 subscribers in Q1, nearly 1MM subscribers in Q2, and added 2.4MM subscribers in Q3. Notably, Netflix launched its ads-supported product tier in November, which seems to have accelerated subscriber growth (and, per the company’s earnings call, likely pulled subscriber additions forward from Q1). Global subscriber ARPU decreased sequentially from $11.85 to $11.49, and US subscriber ARPU decreased sequentially from $16.37 to $16.23.
Revenue for the quarter was up nearly 2% on a year-over-year basis at $7.85BN, in-line with analyst expectations, but EPS of $0.12 registered lower than the company’s forecast of $0.36, which Netflix attributed to an “unrealized loss from the F/X remeasurement on our Euro denominated debt.” Netflix also announced in its earnings report that Reed Hastings, the company’s co-CEO with Ted Sarandos, would move into an executive chairman role, with Greg Peters being promoted from COO to co-CEO.
The advertising-supported product tier, which Netflix introduced in November and was designed to be ARPU-neutral, loomed large in both the company’s Q4 shareholder letter and its earnings call. A great deal of insight can be gleaned from both; I share excerpts that I found particularly penetrating below (all emphasis mine).
From Netflix’s Q4 shareholder letter; on the performance of the ads-supported product tier:
While it’s still early days for ads and we have lots to do (in particular better targeting and measurement), we are pleased with our progress to date across every dimension: member experience, value to advertisers, and incremental contribution to our business. Engagement, which is consistent with members on comparable ad-free plans, is better than what we had expected and we believe the lower price point is driving incremental membership growth. Also, as expected, we’ve seen very little switching from other plans. Overall the reaction to this launch from both consumers and advertisers has confirmed our belief that our ad-supported plan has strong unit economics (at minimum, in-line with or better than the comparable ad-free plan) and will generate incremental revenue and profit, though the impact on 2023 will be modest given that this will build slowly over time.
From the earnings call; on engagement in the ad-supported product tier:
We see that engagement from ads plans users is comparable to sort of similar users on our non-ads plan. So that’s really a promising indication. It means we are delivering a solid experience and it’s better than we modeled and that’s a great sort of fundamental starting point for us to work with.
On adding incremental subscriptions with the ad-supported product tier:
It’s great, because partly that take rate and that growth is due to incremental subscribers coming into the service, because we have a lower price point, that’s $6.99 in the U.S., €4.99 in Germany, just to give you two examples. And so that elasticity is a real – not only a benefit to sort of growing our ad scale and sustainability, but also to the general business…It means that we’ve got a complementary set of offerings that are working to sort of satisfy different needs for different consumers at the right mix of features and price points.
On cannibalization from the premium, non-advertising-supported tier:
We aren’t seeing as expected much switching from high ARM subscription plans like premium into our ads plan. So the unit economy remain very good as we modeled.
On improvements to the ad platform related to targeting and measurement:
So there is a bunch of technical improvements in terms of ad delivery validation, measurement. We’ve got progress already on that, more to do in the next quarter or two. Targeting improvements, which will be better for consumers. More relevant advertising, better for advertisers in terms of more value delivered, a better set of offerings on products for advertisers to buy. We’ve got a long list of experience improvements that we know we can deliver that will deliver more value to both subscribers and advertisers.
On revenue ambitions for the ad-supported product tier:
So we’re over $30 billion of revenue, almost $32 billion of revenue in 2022. And we wouldn’t get into a business like [ads] if we didn’t believe it could be bigger than at least 10% of our revenue and hopefully much more over time in that mix as we grow. So that’s kind of how I see it without putting a specific guide on it.
I parse two primary themes from Netflix’s Q4 earnings report.
First: that Netflix’s ads-supported tier is not ARPU neutral but rather is a drag on ARPU in support of subscriber growth. I propose in Ads in streaming, differential pricing, and the pursuit of ARPU that Netflix’s strategy in deploying an ads-supported product tier is to drive incremental subscription growth, with deteriorating ARPU not seen as a concern, given that the ad-supported tier is priced at a discount to the premium, non-advertising tier, the price of which has not changed. This stands in contrast to Disney’s decision to increase the price of its premium, non-advertising tier while introducing an ads-supported tier at the old price point, which seems intended to improve ARPU. From that piece:
Even assuming no cannibalization of premium subscribers by Netflix’s new ad-supported tier or loss of current Disney+ subcribers who would rather churn than pay more money or be exposed to ads, these two strategies represent different sides of a bet on the total addressable market of a subscription service. Disney, with its pricing strategy to chase ARPU, believes that it has more existing, price-inelastic users that will tolerate a higher subscription cost than there are new users to be acquired for the service. And Netflix believes the opposite.
Netflix points out in its earnings release that global ARPU (what it calls ARM, or Average Revenue per Membership) declined on a year-over-year basis by 2% but was actually up 3% on a constant-currency basis. Normalizing for currency effects: while ARPU in the US was up 9% on a year-over-year basis, the company introduced a price increase in January 2022 that was mostly perceptible in ARPU for Q2 and Q3 2022, and the ads-supported tier was only made available in Q4 2022. US ARPU was down sequentially by nearly 1% from Q3 to Q4 2022, which seems explained by the launch of the ads-supported tier.
And the second theme I parse from the results relates to the point I made last quarter in Does Netflix’s Q3 earnings beat undermine tech’s macro narrative? and, more pointedly, in The ATT Recession: that it is difficult to discern a macroeconomy-related slowdown in the advertising market outside of the social media space.
Note that, despite achieving greater subscriber growth through the ad-supported tier than was anticipated, as well as charging advertisers a premium $65 CPM while providing very little by way of measurement or targeting tools, Netflix returned money to advertisers because it could not fulfill total demand for its inventory. If a recession is afoot in the advertising market, the brands that paid a substantial premium for Netflix inventory aren’t aware of it: compare Netflix’s $65 CPM to the $50 CPM that Disney sought for Disney+ inventory, or to the $20-35 CPM range paid for cable and network television inventory. And then consider that, even at this price, with advertisers limited to utterly primitive targeting tools, Netflix couldn’t fulfill the entirety of advertiser demand for its inventory.