It’s been a month since Netflix rolled out its ad-supported subscription tier. From the initial online reviews of the service it’s been well received by consumers.  Some users have expressed how tolerable the ad load is and a fairly un-intrusive experience. But how does this fare for Netflix’s revenue and what is the outlook for advertisers? Let’s take a look.

 

Quick summary refresher. Netflx’s “Basic with Ads” subscription in Canada is $5.99 with its

Ad-free Basic counterpart priced at $9.99. “Basic with Ads” users should expect roughly 4 – 5 minutes of ads per hour of content consumed. Ads are being sold through an exclusive partnership with Microsoft with an initial CPM of $65 with spend caps to limit frequency.

 

While this model sprung as a result of reported decreases in subscribers in early 2022, the reality is that Netflix has been leaving money on the table for years. With a flat monthly rate as the only revenue stream, subscribers was the main metric that mattered. This is why Netflix has focused on a  content diversification strategy; each new trending series is an acquisition tool to bring users into the ecosystem. The problem comes with diminishing returns. Netflix can spend millions on a popular new series and see very few net new subscribers. In addition, as they continue to expand their content into new niches the likelihood of getting new subscribers decreases because their base audience already comprises a large population. This is also why Netflix has been dipping its toes into cheaply produced reality TV and documentaries: to manage production costs while hoping to attract niche audiences. However that mercenary approach to looking at programming success makes it difficult to justify content production and attributes the majority of conversions to the biggest shows. Time spent needs to be considered as a measure of success, and this is where the ad-supported model comes into play.

 

Let’s take a look at some math to see how lucrative this model is. Assuming roughly 4 minutes of ads (8 x :30 spot), with a generous 75/25 revenue split on a $65 CPM with Microsoft, a ‘Basic with Ads’ (BWA) subscriber only needs to watch 15.38 hours a month for Netflix to break even compared to the the non-ad-supported tier. But we can pump those numbers up; those are rookie numbers in this racket. According to Numeris, in Ontario, A18+ watches on average 5.2 hours per week; roughly 22.3 hours a month, earning at least $4.70 per user a month in ad revenue (after accounting for the base $4 discount). Those numbers are even higher against the valuable A18-34 audience, coming in at 5.9 hours weekly or 25.3 hours a month, bringing in a net $5.87 per user per month. If we assume a small 5% of their 7 million subscribers become BWA users, that’s roughly $1.64 million in additional monthly revenue in Canada just off the initial numbers, after accounting for the monthly savings for users. That’s roughly an additional $20 million a year.

 

	Base CPM	CPM%	Ad Tier Pricing	Ad-Supported Audience	Monthly Profit (after user savings)
Netflix	$65	75%	$6	350,000	$1,643,950
Microsoft	$65	25%	$6	350,000	$1,014,650

 

 

Again, these are rookie numbers. For this model to be sustainable, Netflix will need to gradually scale this subscriber base up so CPMs can be lowered to attract more advertisers. For reference, in the US, Hulu has grown their ad-supported audience to roughly 70% of their user base.  Imagine achieving that penetration rate for the ad-supported tier and what that could do for revenue. However, this is not an easy task.

 

For years, we’ve been conditioned to expect that we can turn on our Netflix, park ourselves on the couch and be degenerates for several hours without interruption.  So the approach to the new revenue model has to be done with a gentle touch. The transition from ad-free to ad-supported will be gradual, aided by the positive experience of early adopters.  This makes the launch experience so critical. Netflix needs to ensure that users avoid a negative ad experience during this vulnerable transition time. However, with a looming recession each dollar in price point becomes a greater consideration for consumers.

 

But what about advertisers? Agencies balked at the sky-high CPM when they considered a marketplace where premium OLV pricing is in the $30 – $40 CPM range. However, this all starts to make sense when you consider Netflix’s launch strategy. The $65 CPM is the initial costing, and that’s with the few early adopters who have signed up to this new ad-supported tier. This CPM is likely set high initially to offset operations and to make sure it’s a lucrative deal for Microsoft. However to get more advertisers on board, the costs will need to be lowered to more modest levels.

 

So what if we changed some parameters? What if after proving successful at generating revenue, Netflix decided it could lower the base CPM to something more digestible for advertisers? And what if Netflix lowered the ad tier pricing even further to nudge a mass of users over to the ad-supported platform. With a re-negotiated revenue split with Microsoft, this is what that could look like:

 

	Base CPM	CPM%	Ad Tier Pricing	Ad-Supported Audience	Monthly Profit (after user savings)
Netflix	$45	85%	$5	4,900,000	$8,936,620
Microsoft	$45	15%	$5	4,900,000	$5,900,580

 

 

This scenario does not account for any subscriber growth that will also occur as a result of a lowered price point and is one of many that could lead to a sustainable revenue model. However, with all these conservative estimates, this still represents roughly $100 million net revenue for Netflix a year. Assuming Netflix earns roughly $10 per subscription, that’s a 12% revenue growth! And Microsoft is certainly doing pretty well for itself along the way too.

 

There’s multiple dials that Netflix can turn to balance long-term audience growth, including advertiser CPMs, subscription pricing, revenue split, and hourly ad load. Over the coming months, it’s going to be interesting to see how Netflix and Microsoft negotiate and make adjustments to the offering to make this appealing to both consumers and advertisers