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Will Netflix Launch an Ad-Supported Tier?

By Daniel Sparks – Jun 20, 2019 at 8:41PM

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Some industry veterans think it's inevitable.

Netflix's (NFLX -0.27%) top-line momentum is impressive. Revenue surged in 2018, rising 35% year over year, to $16 billion. But the huge sums of money Netflix is spending on content to attract and keep its customer base is weighing on the company's financials.

Free cash flow, or cash flow from operations less capital expenditures, was negative $3 billion last year. And in 2019, free cash flow is expected to be negative $3.5 billion. 

Fortunately for Netflix, the company could unleash a key catalyst to boost its financials at any point in time. Doing so, however, will require a major shift in Netflix's monetization strategy: ads. Despite how farfetched this idea may seem for a service that's currently entirely ad free, some experts believe Netflix executives may eventually cave and do exactly this.

A couple watching TV and eating popcorn.

Image source: Getty Images.

Momentum in connected TV

You can bet Netflix is giving ads a second look. The momentum in the sector recently is mind-boggling.

Consider trends at The Trade Desk (TTD -6.86%), whose stock has soared 174% over the past 12 months as ad spend on its platform, which helps marketers, brands, and ad agencies optimize their ad spend programmatically, has soared. Growth in ads on connected TV, in particular, has been a boon for the company. Connected TV ad spend on its platform increased ninefold in 2018, compared to 2017. CTV "is the most exciting channel that we've ever seen [and] probably ever will see," said The Trade Desk CEO Jeff Green in the company's fourth-quarter earnings call.

Streaming-TV platform Roku (ROKU -4.02%) has similarly seen strong momentum, driven in large part by growth in ads on its platform. The company's platform revenue surged 79% year over year in Q1. A key driver of this growth was a more than doubling of its monetized video-ad impressions during the quarter -- a trend management expects to continue the rest of the year. 

Telaria (TLRA), which helps publishers like Hulu (owned by Walt Disney) optimize their ad inventory to be sold programmatically, saw its connected-TV-related revenue soar 169% year over year in Q1.

What industry experts are saying

The steep costs of original content and the undeniable momentum in connected TV ads have industry experts betting Netflix may soon change its tune about ads.

"[Netflix has] envied YouTube's international reach for a very long time," Green said in an interview with Recode Media late last year. He added, "I don't think there's any chance that they can catch up to YouTube, ... unless they go ad-funded in the same way that YouTube is."

Telaria's Mark Zagorski similarly expects Netflix to eventually debut ads. The company could do this by introducing an additional tier that is ad-supported, the CEO explained. In addition, Zagorski agrees with Green about there being a great opportunity for Netflix to do this internationally.

"Introducing advertising in global markets where Netflix's ad-free model isn't already the norm will result in little, if any, consumer backlash, while helping the service scale more quickly," Zagorski wrote in an article in AdExchanger. 

Now, Hulu's head of ad sales is chiming in (via CNBC), saying it's only logical for Netflix to eventually introduce an ad-supported option to help mitigate the costs of content.

Fortunately, an ad-supported Netflix won't have to look like linear TV at all, Naylor explained at the Cannes Lions advertising conference this week:

I think you're going to see a lot of innovation from all of these new OTT providers because we're allowed to. We're not married to the clock. Fifteen and 30-second ads were a product of linear TV. When everything's on demand and served through an IP address, the ad experience is going to dramatically improve.

Of course, Netflix will likely always offer an ad-free version of its service. But don't be surprised if the streaming giant begins experimenting with the idea of an ad-supported tier in some markets.

Daniel Sparks owns shares of Telaria, Inc. and The Trade Desk. The Motley Fool owns shares of and recommends Netflix, Roku, The Trade Desk, and Walt Disney. The Motley Fool has a disclosure policy.

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