Spurred by the loss of 200,000 subscribers, as well as the possibility of two million more in the current quarter, Netflix (NFLX -1.13%) has seen its shares take a beating in 2022 -- down nearly 70% as of this writing. The market's reaction should come as no surprise, given that the company's success depends on adding more customers over time.
In order to find ways to keep growing, the management team, led by co-founder and co-CEO Reed Hastings, has announced it is exploring the introduction of a cheaper, ad-supported tier. What's noteworthy is leadership's sudden change of tone after they have long opposed the idea.
Advertising would be a major strategic pivot for this top streaming stock. Let's look at why it makes sense and why it doesn't.
Why it makes sense: Ads would help with customer growth
The argument for Netflix to start offering an ad-based membership is straightforward. The business has hit a rough patch in terms of growth, so this move could boost the subscriber count, which now sits at 222 million.
The U.S. and Canadian markets are increasingly looking saturated. Netflix lost 640,000 customers there in Q1, and there are now 75 million households with a Netflix account. For comparison's sake, there are approximately 80 million cable TV households total in these two countries. If we include the more than 30 million households that share Netflix passwords in this region, it's clear that the market there might have reached a plateau.
An ad-based tier could help to convert some of these password sharers to paying customers. And in lower-income countries, like India, a cheaper option might allow Netflix to better compete with the dominance of Amazon Prime Video and Walt Disney's Hotstar services.
What's really the most important consideration is that this strategy can help to drive revenue higher over time by bringing on new customers. And this will keep Netflix's flywheel going of investing tens of billions of dollars each year into content.
Netflix has been in the streaming game for over a decade, and it has the most subscribers of any other service out there. This first-mover advantage and scale means that the business has amassed a treasure trove of data that I'm sure advertisers would love to be able to utilize to target customers.
The company has made strategic pivots before, moving from a DVD-by-mail service to streaming licensed content to producing original shows and movies. Advertising is the next logical step in Netflix's evolution.
Why it doesn't: Ads are not a core competency
Offering a lower-cost ad-supported option to gain new subscribers makes for a strong argument. However, it completely clashes with Netflix's historical focus of providing an exceptional viewing experience. Ads would obviously affect this for certain customers. Additionally, members in the higher-priced tiers would now essentially be paying for no ads as opposed to paying for quality content. It's a subtle mental shift that could weaken Netflix's brand.
Again, the company's core competency is in creating wonderful content. Advertising would distract from this. It would also mean that leadership now has another very large, important stakeholder. This could cause some internal strife with employees, as the company would now have two separate strategies: developing content and selling targeted ads.
Instead of trying to build an ad platform in-house, Netflix could just start licensing its older series and movies to other services. This would not only help to drive higher incremental revenue, but it could serve as a customer acquisition tool for people who are still on the fence about signing up for a Netflix membership. It's also something that the business could incorporate quickly.
For what it's worth, I think introducing a cheaper, ad-based tier is the correct move for management. Netflix shareholders might have to deal with some more pain in the near term, but this is the right course of action to propel the business toward its next stage of growth. Plus, it's never been a good idea to bet against Hastings and his team.