Microsoft (MSFT 0.73%) has signed a deal with Netflix (NFLX 2.44%) to provide the technology and sales expertise that will underpin the streamer's upcoming ad-supported tier. For Netflix, working with one of the biggest tech firms in the world on one of its most important projects in recent years is somewhat of a boon. And for Microsoft, overseeing the nascent ad product for the most popular streaming service on the planet only serves to boost its suite of marketing services.
Still, for both companies, the risks of failure can't be overstated. Netflix has positioned a lower-cost ad-supported offering as a strategy to combat falling subscriber numbers. Meanwhile, Microsoft no longer operates a streaming platform upon which to sell video ads (R.I.P. Mixer). Fundamentally, this is an enormous opportunity for the two companies, but there's a chance they both might have bitten off more than they can chew.
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Why not Google or Meta?
When talking about advertising in the internet age, Alphabet's Google and Meta are always part of the conversation. Google generated almost $210 billion from ads last year, while Meta pulled in close to $115 billion. By contrast, Microsoft drew just $10 billion in ad revenue in 2021.
Of course, Microsoft has never presented itself as an advertising-driven operation -- it's always been a software and services business. Conversely, Google and Meta built their fortunes by creating successful ad platforms, and their successes have been borne out by the fact that marketers want to use their tools.
Needless to say, as video has become a major part of the modern web experience, Google and Meta have been there to exploit the advertising opportunities: Google's YouTube serves 1 billion hours of content each day, while Meta's Instagram Reels can reach as many as 675.3 million users each month. With those achievements in mind, why didn't Netflix choose to partner with Google or Meta?
The need for control
Neither Microsoft nor Netflix have provided specifics about the tie-up, so it's unwise to speculate whether there were any financial incentives or other favorable terms that helped seal the deal. However, in Netflix's press release discussing the arrangement, there may be a clue: Netflix wants control.
"Microsoft has the proven ability to support all our advertising needs as we work together to build a new ad-supported offering," Netflix stated. "More importantly, Microsoft offered the flexibility to innovate over time on both the technology and sales side, as well as strong privacy protections for our members."
Reading between the lines, Netflix seems to suggest it doesn't yet know how advertising will work on its platform -- if at all. By working with the seventh-most-popular global ad network, it will almost certainly have more say over the frequency and quality of the ads it offers. It's also possible Microsoft could give them more performance insight than they might get from bigger players. Plus, privacy protections are a bonus because Google and Meta both have muddy histories on that front.
Are the trade-offs worth it?
Despite all the reasons for Netflix opting to work with Microsoft, there are a host of reasons it could ultimately prove to be a misstep. Notably, it's not just the money Microsoft has (or has not) previously generated in the ad-network space that matters, it's also the relationships associated with that revenue. It's almost inevitable that the larger the ad network, the more connections it has with marketers.
For Netflix -- a company that's literally creating a whole new pricing tier subsidized by advertisers -- access to the biggest available pool of marketers will be important. That need will be even greater when you consider the user experience -- subscribers will quickly become irritated if they're shown the same carousel of ads over and again while binging Stranger Things. Does Microsoft have a deep-enough pool of connections to really satisfy Netflix's needs?
As things stand, many details of Netflix's ad-supported plan are still vague, so it's possible a lot of these concerns may be addressed in the company's upcoming Q2 earnings call. Investors should see what Netflix says about how its ad-based tier will operate, as well as any details about how long they're tied to Microsoft. After all, if the streamer wants "flexibility," part of that idea might be eventually moving to an ad network that has more stature in the advertising industry.
