Roku (ROKU -0.55%) doesn't really make any money selling its streaming sticks and set-top boxes. All of its profits come from the platform business, which earns money from advertising and sales commissions on premium subscription video services. Last year, the average Roku account generated $23.14 in revenue for the streaming company -- that was up 29% from 2018.
But there's still a lot more room for Roku to grow, and there are three reasons that number will keep climbing in 2020 and beyond.
Opening the door to new advertising opportunities
Roku is already well positioned to benefit from the secular growth of connected-TV advertising, but the acquisition of DataXu last year ought to give it even broader appeal with marketers. There are two key things DataXu brings to the table for Roku.
First, it makes Roku advertising more accessible to small businesses. "We had historically been focused on talking to large advertisers and the agency holding companies," CFO Steve Louden said at an investor conference earlier this month. "DataXu's focus was on the small- to mid-sized advertiser, which we had not looked at at all." He also points out a lot of the big digital advertising companies get a large percentage of their revenue from small businesses, so it's a significant opportunity in aggregate.
The other opportunity for Roku with DataXu is offering broader reach for advertisers. Instead of just showing ads on Roku devices, DataXu can also place ads across the web with other advertising partners. Marketers can easily retarget consumers that saw an ad on Roku when they might be more ready to buy on a desktop computer.
That could make Roku advertising even more appealing to more brands and puts Roku on better footing against competitors like Amazon. One of Amazon's advantages in advertising is that it can show an ad on its Fire TV platform and then show that viewer an ad for the same brand or product when she's browsing Amazon's marketplace. That can result in better overall conversion rates for marketers. While Roku can't emulate that exactly (no one can), DataXu helps it become far more competitive with retargeting advertisements.
Shifting engagement to The Roku Channel
Roku's own ad-supported channel on its devices presents far superior economics for the company than convincing consumers to download individual apps. The Roku Channel aggregates content from dozens of ad-supported streaming services alongside select content Roku has licensed itself.
Over the last year or so, however, Roku has mostly focused on drawing in new partners to its revenue-sharing program instead of licensing additional content. The partners cede control of their entire ad inventory for content they offer in the Roku Channel, and Roku splits the ad revenue 50-50 with the partners. That compares to the standard ad inventory split in individual apps, where Roku takes just 30% of the inventory.
The partnership is valuable for both sides. Roku's able to generate more revenue per hour streamed while partners get additional exposure and don't have to worry about ad sales. And as Roku improves its targeting capabilities through increased data and demand, the 50% revenue share could result in greater payouts than selling 70% of ad inventory itself for some partners.
With more content coming to The Roku Channel through revenue-sharing partners, it's attracting more and more engagement. A highly engaged user base in The Roku Channel may be more likely to subscribe to premium services through the channel instead of through the main platform. The economics for subscriptions in The Roku Channel are far more favorable for the company, because it operates under a wholesale agreement. It also gives Roku more direct access to viewer data, which could be valuable for content recommendations and increasing overall engagement.
Increased negotiating power
Roku's audience is growing quickly. It added nearly 10 million new accounts in 2019, about the same amount as Amazon gained. That said, Roku grew considerably faster than Amazon in the fourth quarter of the year. Roku is also more widely used in the United States than Fire TV.
That scale gives Roku a lot of negotiating power. Louden explained, "We tend to sign shorter deals, because as our scale has been growing significantly, in general, we're getting better economics." It's the same strategy Spotify has taken with record labels in order to get better music-licensing terms. Spotify is practically always negotiating its next deal with the record labels in order to improve the gross margin on its service. And as it has become more and more essential to the growth of the music industry, it gains negotiating power.
Roku has the same opportunity. "We've become a more essential partner over time for the ecosystem. And now, in the U.S., if you want to have a legitimate OTT offering, you need to be on Roku," Louden said.
Roku exercised its negotiating power earlier this year when it faced a dispute with Fox right before the Super Bowl. The two sides managed to come to an agreement before the game, but Roku showed considerable strength. Investors may see more blackouts or potential blackouts as Roku stands up to bigger media companies and asks for a greater percentage of ad inventory or subscription revenue.
With all of these factors working in Roku's favor, investors should see the streaming specialist's revenue per user continue climbing as it scales its audience.