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10 Ways Roku Is Expanding Its Most Profitable Business

By Danny Vena – Updated Jul 8, 2019 at 9:08AM

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Most investors don't understand the many ways Roku makes money from advertising. Here's what you need to know.

Streaming pioneer Roku (ROKU -5.06%) no longer relies solely on the set-top boxes and dongles that bear the company's name in order to make money. In fact, beginning early last year, Roku's advertising business surpassed device sales as the company's biggest breadwinner.

The segment, which Roku has dubbed its "platform" business, now represents 65% of the company's total revenue. Even more importantly to shareholders, platform revenue is growing much more quickly, up 79% year over year, while boasting much juicier margins. In the first quarter, gross profit margins for the segment clocked in at 76%. 

The decision to pivot to advertising has been a veritable gold mine for Roku, and all indications are that the company's fastest-growing and most profitable segment is positioned to continue its stellar growth far into the future.

Here are 10 ways Roku is growing its advertising business. 

A list of premium subscriptions offered on The Roku Channel.

Image source: Roku.

1. Selling ads on hosted channels

With more than 29 million active accounts, publishers are eager to have their ad-supported channel appear on Roku's platform. While this entitles the publisher to the benefit from the majority of the advertising, Roku is also allowed up to 30% of the ads on these channels, a position it was able to leverage as the result of its massive viewer base.  

2. A cut of subscriptions

When a viewer subscribes to a streaming video service on Roku's platform, the company gets a piece of the action. For example, when a customer signs up for Netflix (NFLX 2.50%) or Hulu while on the Roku system, Roku gets a cut of the revenue. Many other premium paid subscription services are available, including HBO, Epix, Showtime, Starz, and many more.  

3. Roku Audience Marketplace

With all the data Roku collects on viewing patterns, it was inevitable that the company would eventually begin peddling data. Roku's Audience Marketplace, which debuted in mid-2018, allows publishers to more effectively target advertising to the viewers on Roku's platform. The company has extensive insight into its streaming audience, which helps match ads with their target market -- for a nominal fee. 

4. Homepage ads

Whenever a user first cranks up their Roku-supported device, the viewer sees display ads on the homepage. An advertiser can easily reach Roku's 29 million viewers by placing an ad on the start-up screen.

5. Recommending channels

When a user first sets up a Roku device, the company helps viewers decide which channels might be a good fit to download and add to their viewing choices. The suggestions the company makes are a combination of editorial recommendations and paid placements, giving it another opportunity for a little pocket change.

6. The Roku Channel

Roku signaled its intentions to grow the ad business with the introduction of The Roku Channel in late 2017, which offers a catalog of old movies and television series, while also streaming live network programming like television news broadcasts. By having its own ad-supported channel, the company has prime real estate to sell advertising. The Roku Channel can also be accessed via the web, so it isn't necessary to have a dedicated Roku device in order to access the service.

7. Brought to you by...

Another benefit of The Roku Channel is the ability to have big-name brands sponsor some of the shows. If the company has a special event or a fall preview of programs coming to the platform, Roku can entice a brand to sponsor the entire event.

8. Targeted emails

Like other over-the-top services, Roku users can opt to receive email messages that suggest programming choices. Similar to the channel recommendations made during platform setup, Roku sends a mix of editorial suggestions and targeted emails paid for by content publishers and providers.

9. The button on your remote

Most Roku devices come equipped with a branded remote, which can also be purchased as a replacement for an existing remote control. Publishers will pay a premium to include a dedicated button on the remote to send the viewer directly to their channel, rather than having to scroll through a list of choices -- particularly as something else seen along the way might be more appealing.

10. The connected-TV operating system

After getting into the streaming business, Roku quickly discovered that many of the operating systems (OS) on connected TVs were merely modified from an existing mobile OS -- not built specifically for that use case. Roku smelled an opportunity and designed a connected TV OS from scratch.

Roku has since partnered with a growing list of TV manufacturers that use the Roku OS for their connected TV. Manufacturers pay a modest upfront licensing payment, meaning they don't have to develop or maintain a system on their own. It's truly a win-win because it puts access to the Roku platform into the hands of more potential users. Roku said that in the first quarter, 1 in 3 smart TVs sold in the U.S. now run on the Roku OS.

Roku is poised for growth

The number of over-the-top viewers in the U.S. is projected to grow from 200 million in 2018 to 209 million by 2020. Roku's ad revenue is expected to far outpace its viewer growth, however, more than doubling to $633 million by 2020, up from $260 million in 2018, according to estimates by eMarketer. 

After gaining over 200% so far this year, Roku may still have plenty of gas in the tank.

Danny Vena owns shares of Netflix and Roku. The Motley Fool owns shares of and recommends Netflix and Roku. The Motley Fool has a disclosure policy.

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