Netflix's Ad Plans Could Hit the Competition Where It Hurts

Netflix (NFLX -0.63%) plans to introduce an ad-supported tier to its streaming service in 2023. The shift comes after a slew of competitors entered the market, most of which are priced well below Netflix's standard plan pricing of $15.49 per month.

While an ad-supported tier will help Netflix compete on price, it has a lot of potential to hit its competition where it really hurts: by cutting into television ad spending. With much of Netflix's new competition still generating most of their revenue from linear TV, it could put more pressure on their streaming businesses to generate profits by raising prices.

How big could Netflix advertising be?

There's a lot of enthusiasm about the potential for Netflix's advertising sales. "We've seen a lot of excitement in our early discussions with brands," COO Greg Peters said during the company's second-quarter earnings call. Ultimately, Netflix wants to build "a better-than-linear-TV advertisement model," management wrote in its letter to shareholders.

The combination of Netflix's high-demand premium content and the potential for it to build technology has had some analysts estimating the media company could generate as much as $5.6 billion in annual revenue. Even estimates on the low end put the number at $1.2 billion in domestic ad sales. Most analysts believe Netflix will generate between $2 billion and $4 billion in ad sales per year.

Creating a massive new source of premium ad inventory in just a couple years means ad budgets will have to shift. Someone needs to lose sales in order for Netflix to win them, and the most likely source is linear TV.

Despite the prevalence of cord-cutting, linear TV ad spending in the U.S. remains robust. Advertisers are expected to spend $68.4 billion on TV commercials this year, according to eMarketer. And while that number will decline a bit over the next few years, analysts still think linear TV will bring in $65.9 billion in 2025.

The introduction of Netflix's ad tier could accelerate the decline in linear TV ad spending. And that's bad news for competitors like Warner Bros. Discovery (WBD -2.17%), Paramount Global (PARA -2.22%), and (to a lesser extent) Walt Disney (DIS -0.04%).

How important is TV advertising to Netflix's competitors?

Warner Bros. Discovery, Paramount, and Disney all generate significant amounts of revenue from linear TV advertising around the world. The three companies combined attracted $28.7 billion in marketing spending in 2021.

*Combined results of WarnerMedia and Discovery.
Data sources: AT&T, Warner Bros. Discovery, Paramount Global, and Walt Disney. Calculations by author.

As you can see, linear TV advertising is an extremely important source of revenue for all three companies. Even though it accounts for a smaller percentage of revenue for Disney, it's still a major contributor to the profitability of its linear networks business, which spends heavily on expensive content rights like sports.

If Netflix's ad business eats into the competition's TV commercial sales, it could put pressure on other streaming services to improve profitability on a faster time frame. Paramount saw its streaming losses triple in the first quarter as it invested heavily in content and marketing for the service. Disney's direct-to-consumer operating loss more than doubled in the first nine months of the year, but it's shown a willingness to raise prices to keep losses in check. Meanwhile, Warner Bros. Discovery is already focused on more profitable growth.

If the competition is forced to raise prices, it could swing the pendulum back in favor of Netflix. Many subscribers defected after Netflix's latest price hike, but they could come back as the prices from the competition move higher and streaming pioneer starts to look like a great value again.