Subtracting Ads at Netflix

They're tearing down parking lots and planting trees over at Netflix (Nasdaq: NFLX  ) . That's what the flick renter's move to eliminate banner ads on its website boils down to.

If you hate ads, you may be applauding the move. I'm sure most of the company's 6.3 million subscribers will prefer a user interface free from graphical ads pitching the latest theatrical releases or new television shows.

However, I'm not sure whether shareholders will feel the same way. There was a golden opportunity to create a lucrative revenue stream here, and Netflix gave up too early and failed to test it out the right way.

This is not my beautiful Monster House
The move to tack on banner ads started back in June, when Netflix gave Sony (NYSE: SNE  ) three days to advertise its computer-rendered Monster House movie. Netflix has working relationships with all of the major production studios -- of course -- so I was never shocked to see ads pitching things like the Heroes television show or the upcoming Academy Awards telecast.

But why didn't Netflix ever think outside of the backlot? The company has the perfect ingredients to be an ad-serving darling. It runs a high-traffic website. It attracts a well-to-do audience that is clearly open to e-commerce. It also knows each member of its audience intimately, thanks to its deep database of rental histories and viewer ratings.

Marketers, control your drooling!

"By this time next year, don't be surprised if you see a Harley-Davidson (NYSE: HOG  ) ad show up the moment Easy Rider gets clicked into your DVD rental queue," I wrote last summer. "Even better, you decide to rent Supersize Me or Fast Food Nation in a few years, and you get an ad from McDonald's (NYSE: MCD  ) to present its side of the story."

Clearly I was wrong, but only because the company behind the red mailers failed to push the envelope.

Netflix blew it. Really. There are 1.3 million people who have rated Walk the Line. How many of those do you think were tempted with ads to buy country music CDs, Johnny Cash collectibles, or book a trip to Tennessee to check out the Country Music Hall of Fame and the Grand Old Opry? None.

Sideways has had a whopping 1.4 million subscribers chime in with an opinion. How many of them were offered opportunities to explore wine clubs, buy Pinot Noir appreciation guides, or ponder wine country vacation packages?

You know the answer, because Netflix never asked the right questions. The company posted an amazing quarter this week, yet if we go by the Netflix's year-end subscriber targets, this will be the first year in the company's history that it lands fewer net members than it did the year before. Axing banner ads isn't going to make those users trickle in any faster -- it's only going to make sure that Netflix isn't making the most it can off each willing subscriber.

I see red
I know the drill. Someone in the Netflix Investor Relations department is going to get steamed, turn as red as one the company's signature mailers, and tell me how the move is no big deal, because site ads were contributing an inconsequential amount to the overall revenue pie.

The company willcontinue advertising on its mailers; supposedly, that's where the real ad bucks lie.

I don't buy it. According to Alexa.com, there are only 306 websites in all of cyberspace receiving more traffic than Netflix. The average visit finds a subscriber going through six to seven pages on the site. Alexa.com has its flaws as a site rating guide, but it's usually within the ballpark of reason.

So if you're drawing more visitors than sites like IBM.com, WashingtonPost.com, and even Overstock.com (Nasdaq: OSTK  ) , why take up that billable ad space and fill it -- symbolically enough -- with red space?

Two years ago, Netflix made a great hire, bringing in Peggy Fry to launch an ad-sales program for the company. She had previously been with Time Warner's (NYSE: TWX  ) AOL for six years as an interactive marketing executive.

AOL has come to worship Google (Nasdaq: GOOG  ) as a paid-search savior. The company is able to serve up well-paying ads, targeted perfectly to the content on the page. The success of Google's ads has been one of the few bright spots over at Time Warner in recent years.

My examples of what Walk the Line and Sideways pages can be? I wasn't reaching at cumbersome solutions. They would be served up dynamically through Google's AdSense program. All Netflix would have to do is to painlessly filter out competitors' ads, and the passive revenue stream would start gushing in.

Am I being overly simplistic in my reasoning? Probably. Am I condoning graffiti for profit? Perhaps. All I know is that if subscriber count growth has in fact peaked at Netflix, it's more important to be creative and expansive than stick to its red-sweater knitting.

Netflix and Time Warner have been recommended to Stock Advisor subscribers. Get your cold-weather season started right by cuddling up to a free 30-day trial subscription today.

Overstock.com is a former Rule Breakers and Hidden Gems selection.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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