Roku (ROKU -1.14%) introduced the free, ad-supported Roku Channel in late 2017. Over the last three years, it's seen a lot of changes, most of them behind the scenes. The company originally licensed much of the content available on The Roku Channel before it was able to secure revenue-sharing agreements with more media companies to put their content on the streaming service.

More recently, it's been able to secure rights to content for The Roku Channel as part of its distribution agreements for mainstream services from big media companies like Comcast (CMCSA 0.85%) and others, according to a report from The Wall Street Journal.

The Roku Channel home screen displayed on a wall-mounted flat-screen TV, with a side table and a potted plant nearby

Image source: Roku.

Growing viewership without growing content costs

Management said Roku Channel viewership more than doubled year over year in the third quarter, reaching households with an estimated 54 million viewers.

What's more, there are plenty of reasons to expect viewership to continue outpacing Roku's overall account growth. The company continues to add more content to the service, expand the presence both on and off Roku devices, and there's a secular trend favoring the growth of free streaming services over premium subscription offerings.

Usually, you'd expect a growing user base and expanding content library to come with additional content expenses. But by bundling them as part of its negotiations with media companies to distribute their premium streaming services, Roku may be getting quite a good deal on content. The Wall Street Journal suggests Roku asks for programming in exchange for distribution with no revenue-sharing or licensing costs.

And Roku will have lots of opportunities to ask for content going forward. Not only does it have a chance to renegotiate distribution every time a media company's contract for its TV Everywhere apps is set to expire, but also more and more media businesses are launching direct-to-consumer streaming services. 

For media companies, it's often not a huge imposition to offer some content in exchange for distribution on Roku's popular platform. In fact, it could be beneficial to give away some content, even if that same content is available on one of their own streaming services. It could prove a valuable form of advertising, especially if combined with Roku's ad tools.

Comcast is following the freemium model with Peacock. While popular shows like The Office and Parks and Recreation won't show up on The Roku Channel, users can watch select episodes on Peacock without a subscription. Comcast hopes offering a free sample will convince more users to subscribe.

There is a cost, but it's worth it

Even if Roku is getting a lot of content as part of its distribution agreements, it's likely giving up something in order to secure those rights. It may forego a greater share of subscription revenue or ad inventory. But that's a small price to pay for Roku.

Content for The Roku Channel is extremely valuable. More specifically, the viewing hours and ad impressions new content brings to The Roku Channel is extremely valuable. That's because Roku controls the entire environment in The Roku Channel, including content recommendations and ad impressions.

As a result, Roku's able to generate more revenue per hour streamed in The Roku Channel than in other apps, and it keeps a greater percentage of revenue as well. If it's licensing content as part of an agreement to distribute other streaming services, it's keeping 100% of revenue, in fact. 

With additional content, Roku's able to leverage its targeting capabilities to suggest content users are more likely to click on, creating a virtuous cycle of increasing engagement.

As Roku negotiates more deals for Roku Channel content with media companies seeking new distribution deals for their premium services, the business should see engagement on The Roku Channel continue to outpace user growth. 

Importantly for investors, the platform segment may start to see gross margin start to expand again as content costs as a percentage of revenue decrease. Platform gross margin has shrunk from 77.5% in the third quarter of 2017 when The Roku Channel launched to 61% in the most recent quarter. Look for the trend to start reversing even as The Roku Channel continues to grow.