Netflix’s ad-supported tier is ARPU dilutive. Enter proprietary ad tech.

Netflix made three substantive announcements at its upfront event yesterday:

• The company’s ad-supported tier, Standard with Ads, has reached 40MM subscribers, representing roughly 15% of its total subscriber base. This compares to 23MM as disclosed in January 2024, 15MM as disclosed in November 2023, and 5MM as disclosed in May 2023;
• The company has signed a three-season deal with the NFL to air two Christmas day games, at a cost equivalent to “one of [its] medium-sized original films.” This deal expands Netflix’s existing live sports content strategy, with Netflix having acquired the streaming rights to WWE events in January for $5BN;
• Netflix will develop its own proprietary advertising technology, ending its exclusive reliance on Microsoft’s Xandr. Netflix revealed at the event that it had secured partnerships with The Trade Desk, Google’s DV360, and Magnite in buttressing its advertising business.

Netflix reaffirmed at the event that 40% of new users in the 12 countries that support the ad-supported tier choose it, although this isn’t a new metric: Netflix revealed the same in its Q1 2024 and Q4 2023 earnings.

This 40% number is touted as a sign of success, but my view is different: MoffettNathanson estimates that Netflix has the lowest proportion of ad-supported subscribers at roughly 22%, compared to 85% for Prime Video and 41% for Disney+. Netflix repeatedly stated that its Standard with Ads tier generates more aggregate ARPU than the ad-free tier. Merely achieving a minority of subscriptions for the ad-supported tier — despite its significantly lower cost — is, in my view, a disappointment. The gap in adoption across the services is certainly a function of their implementation tactics. Per the diagram above, Amazon imposed ads to Prime Video by default, requiring users to pay an additional $2.99 monthly fee to remove them, whereas Netflix introduced the ad-supported tier as a new, lower-cost (and lower-functionality) tier.

I make the case in Netflix, price discrimination, and the Goldilocks zone that Netflix was only able to increase its ARPU above the pre-advertising threshold in the United States and Canada (UCAN) region by strategically eliminating the Basic tier and instituting a password-sharing crackdown and price increases. Netflix’s UCAN ARPU stood at $16.37 in Q3 2022, the quarter before the introduction of ads; its UCAN ARPU only eclipsed that level in Q4 2023 at $16.64, the same quarter that price increases were introduced.

Ahead of Netflix’s introduction of ads, in Can Netflix’s ad tier be ARPU-neutral?, I argued that it would be challenging for Netflix’s ad-supported tier to achieve ARPU neutrality, as it claimed, because ads would 1) diminish engagement and 2) see CPM compression over time from the launch rate.

This seems to have happened. Regarding engagement: in 2019, Netflix revealed that subscribers streamed content, on average, for two hours per day. But in January, the company disclosed that 85% of its ad-supported accounts streamed for more than two hours per day. This is a peculiar approach to relaying engagement and is clearly anchored to the two-hour, pre-advertising benchmark. To my mind, the most sensible interpretation of these numbers is that ad-supported engagement is relatively lower than the pre-advertising standard.

And Netflix’s announcement that it will develop its own proprietary advertising technology is likely a remedy for the dilutive effect that its current ads product has on ARPU. I note in Netflix, Disney+, and the ad-supported streaming calculus that Disney’s proprietary advertising technology (the Disney Unified Advertising Platform, or UAP) unlocks customized formats, better audience segmentation and targeting, and more granular measurement.

Netflix offered very little in terms of ad targeting or measurement at launch, although it has slowly improved functionality in both of those areas, announcing a number of measurement partnerships at its upfront event this week. Nonetheless, in order to maximize the ARPU opportunity inherent in its advertising business, Netflix was always faced with the proposition of developing proprietary advertising technology. From that piece:

So Netflix may have introduced its ad-supported tier at a lower price simply to generate sufficient supply (which it struggled to accomplish), knowing that it could recruit advertisers even at a price premium through novelty alone. But Netflix is reportedly exploring the option of building its own advertising technology or acquiring an existing platform ahead of the expiration of its contract with Microsoft in 2024. When Netflix is able to provide advertisers with better audience segmentation, targeting, and measurement tools, it may unlock the ability to not only retain its premium CPM given improved functionality but also to shift its entire price structure higher as a result of the improved consumer advertising experience through native, bespoke placements and better targeting.

I’d argue that all of this is done in service of improving the ARPU profile of its ads-supported tier.