Hulu is coming off its best year of subscription growth ever, ending the year with over 25 million subscribers. That's nearly half the number of Netflix (NFLX 2.18%) subscribers in the U.S., and Hulu is growing about twice as quickly.
Hulu hopes to keep accelerating subscriber growth in 2019, and pricing might play a key role. While Netflix just raised prices for its U.S. subscribers, Hulu is taking the opposite approach. The streaming service co-owned by Disney (DIS 2.66%), Fox (FOXA), Comcast's (CMCSA 1.33%) NBCUniversal, and AT&T's (T 0.86%) WarnerMedia is cutting the price on its ad-supported video-on-demand service by $2 per month to just $5.99.
Hulu offered that same price as a 12-month promotional price for new subscribers last year, and now it's making it permanent. But with a growing content budget already producing significant net losses for its parent companies, should investors worry about Hulu's new pricing?
The power of ad-supported streaming
It's important to note that Hulu is keeping the price of its ad-free option the same, at $11.99 per month. Only ad-supported subscribers will get a discount.
That shows Hulu's confidence in its ability to grow ad revenue per user. Last year, the company managed to increase ad revenue 45% to nearly $1.5 billion. But that trailed the 48% increase in subscribers the company reported. The amount of ad revenue per user didn't increase much if at all.
That said, Hulu also reported a 50% increase in its advertiser base. In other words, it's building up the demand side of its advertising business, which could result in higher average ad prices.
Hulu's growing slate of original series provides another opportunity to grow advertising. The company has worked with marketers to integrate its original content into commercials. For example, SunTrust Banks worked with Hulu to create an ad that runs before every episode of The First. Engagement with originals and the effectiveness of more-integrated ads ought to both be higher than average, making them particularly valuable to Hulu.
Finally, there's still room for Hulu to grow its ad load. The company says ad load on Hulu is less than half that of traditional TV broadcasts. Even increasing the ad load 50% would keep its commercial time below that of traditional TV while generating more than enough additional ad revenue to offset the price decrease. Granted, Hulu's management likely sees increasing ad load as a last resort to boost profitability.
Hulu's ability to manage and grow ad revenue gives it a lot more flexibility with its pricing than Netflix.
Finding the best way to scale
Hulu spends billions of dollars on content. It spent an estimated $2.5 billion in 2017, and that number likely climbed significantly higher in 2018, as indicated by the reported details around net losses by its owners. Higher Hulu programming costs are mentioned by Disney in its recent SEC filing outlining its new corporate structure.
In order to make the most of that growing content budget, Hulu needs to scale. While more and better programming will continue to attract new subscribers, a permanent price cut will work as well.
If Hulu can offer a better price to consumers while keeping its overall revenue per consumer relatively stable through an increase in ad revenue, it will scale profitably. Even if revenue per user falls somewhat, the expected increase in its subscriber base from the price cut ought to offset climbing content expenses.
That stands in contrast to Netflix's strategy. But Netflix is a much more mature company. Its U.S. subscriber base grew just 11% last year. And it's unlikely a price cut would boost its subscriber growth, as customers have shown a strong willingness to pay. Netflix, therefore, is investing in making the service more appealing to consumers who, for whatever reason, haven't yet signed up.
That's not to say Hulu isn't working to make its service as appealing as possible, but it has a lot of potential subscriber growth to milk and an additional lever it can pull in ad revenue. So, while Netflix is increasing its prices, Hulu can offer consumers a relative steal.
Check out the latest Disney earnings call transcript.