While Netflix (NFLX 5.54%) was thriving for many years before 2020, the pandemic -- which forced people to stay inside and find ways to entertain themselves -- was a major boon for the business. But recently, as economies reopen and things return to normal, the company is struggling to achieve the impressive growth to which shareholders are so accustomed.
This top streaming stock needs to find a way to turn its prospects around, and advertising might be the answer.
Netflix is facing a new reality
It has been widely reported that because of shutting off its service in Russia, Netflix ended up losing 200,000 subscribers in the first three months of 2022 (compared to adding 500,000). And the management team, led by co-founder and co-CEO Reed Hastings, predicts the loss of another 2 million customers in the just-ended second quarter.
Investors had been used to seeing Netflix add 25 million to 30 million members annually, so it's no surprise that the unfortunate turn has pummeled the stock, with the shares down a whopping 70% so far this year.
A number of factors are to blame. The coronavirus pandemic caused a seismic shift in consumer behavior that drew forward demand, and Netflix is now facing a strange period where it's difficult to gauge quarter-to-quarter numbers. In the first quarter, revenue jumped 9.8% year over year, the slowest growth since the fourth quarter of 2012. And in Q2, sales are expected to rise just 9.7%. For what has traditionally been labeled a top growth stock to own, these figures aren't anything to write home about.
Then there's the cutthroat competitive nature of the battle for viewers' eyeballs. A number of direct rivals, like Walt Disney's Disney+, Warner Bros Discovery's HBO Max, and Amazon Prime Video, are gaining traction. And with the economic reopening, people are probably inclined to leave the house more often for leisure and entertainment activities.
Netflix's recent struggles have resulted in a major shift in tone from the management team, which must pull out all the cards to spur growth and please shareholders. After previously shunning the idea to sell advertisements on the service because they thought it would ruin the Netflix experience, leadership is now planning to introduce a cheaper, ad-supported tier by the end of this year.
And it's exactly the right move for the company to make right now.
Selling ads might be the answer
While Netflix should've introduced a low-cost, ad-supported option years ago, it's better late than never. Competitors have already been selling ads and have been successful doing so. "I think it's pretty clear that it's working for Hulu," said Hastings on the Q1 earnings call. "Disney is doing it. HBO did it. I don't think we have a lot of doubt that it works, that all those companies have figured it out."
It's an incredibly easy argument to make for why Netflix should pursue this strategy. For starters, the lucrative UCAN (U.S. and Canada) region seems to have plateaued, losing 640,000 subscribers in the first quarter. A cheaper option could help attract price-conscious consumers who have been on the fence. And in international markets, where Netflix has a huge expansion opportunity, developing countries with low per-capita incomes would welcome an ad-based version of the service if it meant they could watch a massive library of content.
Here's what could help as well. In its Q1 shareholder letter, Netflix highlighted 100 million households worldwide that are sharing other accounts' passwords. As the company clamps down on this discouraged behavior, instead of these viewers quitting Netflix completely, many could choose the lower-cost, ad-supported tier.
This move will undoubtedly help the company bring on more subscribers in an increasingly competitive industry, which leads to more revenue. And this ultimately keeps Netflix's flywheel of spending massive amounts on content going. Scale matters in streaming, and selling ads to continue growing ensures Netflix won't lose this advantage.
And instead of strictly operating a business model that invests tens of billions of dollars each and every year to create exclusive content to sell to viewers, Netflix is now monetizing its valuable base of 222 million subscribers to sell to advertisers. According to data from Nielsen Holdings, Netflix represented 6.8% of total TV viewing time in the U.S. during the month of May. This is prime "digital real estate" that can be sold to marketers, becoming a major revenue driver for the business going forward.
For a stock that has been absolutely crushed, this strategic pivot, which has the potential to improve the company's fortunes, is exactly what Netflix shareholders need right now.