It's a difficult time to be in the digital advertising business.
Big-name companies like Amazon (AMZN 2.98%) and Alphabet's (GOOG 1.46%) (GOOGL 1.41%) Google are showing signs of slowing ad sales, while video ad specialists like Roku (ROKU 1.18%) gave a dismal outlook for this year's fourth quarter. And the drop is coming right in time for the launch of Netflix's (NFLX 2.10%) and Disney's (DIS 1.85%) ad-supported streaming tiers.
Netflix launched its new Basic with Ads tier earlier this month, and Disney will launch its ad-supported Disney+ tier at the start of December. The timing couldn't be worse.
Ad sales are falling off
Recent earnings reports and news items from major advertising businesses show a bleak outlook for digital advertising -- specifically, video and brand advertising.
Alphabet reported a year-over-year decline in YouTube ad revenue in Q3. During the earnings call, management said it saw a pullback in ad spend that started in the second quarter continue into Q3. The fourth quarter will feature more of the same, management said.
That trend was echoed by Roku, the leading platform in connected TV. Management's outlook called for a decline in platform revenue in the fourth quarter due to the weakening advertising market. "We expect the macro environment to further pressure consumer discretionary spend and degrade advertising budgets," executives wrote in their letter to shareholders. In fact, management said platform revenue could decline sequentially in the fourth quarter, despite the usual strength of the holiday season at the end of the year.
Meanwhile, Amazon, which has grown a massive advertising business over the last few years, is starting to take its foot off the gas pedal. It's freezing hiring for its advertising business, despite posting 30% year-over-year foreign currency-neutral revenue growth. The move is a surprise for the third-largest digital advertiser, especially considering its efforts to expand its video advertising inventory with sports rights, including Thursday Night Football.
The entire industry is facing significant headwinds just as Netflix and Disney are trying to ramp up ad sales.
What it means for the streamers
The ad-supported tier on streaming services like Netflix and Disney+ might not generate as much revenue as expected to start.
When Netflix announced the launch of the Basic with Ads tier, management said it anticipates the total revenue generated from the subscription and ad sales to equal or even exceed revenue from the subscription-only Basic tier. In other words, it expected to generate $3 per account per month in ad revenue.
While early ad sales have gone relatively well for Netflix, there are reports it's not able to command the high asking price it was originally looking for. The company was originally asking for $65 per 1,000 viewers, but it's settled for prices between $45 and $55, according to The Wall Street Journal.
Meanwhile, Disney has long been in the digital advertising market with its breadth of online properties and its operational control of Hulu. But as the biggest and most-experienced advertising companies struggle to grow sales, there's no reason to think Disney will be able to fare much better. In fact, Roku suggests the entire TV scatter market (all the ad inventory that's not bought up front) is seeing a decline in spending, which suggests Disney's TV networks could see reduced profitability in the near term.
Both streaming services plan to keep the total ad load low to start. And they face the challenge of generating enough revenue from ad sales to show strong revenue per user numbers relative to their subscription-only products. That's the opposite of what's historically been the case for ad-supported streaming services. Hulu, for example, consistently generates average revenue greater than its subscription-only price.
Investors shouldn't be surprised if Netflix or Disney's new ad-supported tiers create a drag on revenue per user for the first few quarters. But as the ad market recovers, they should show strong growth potential without the need to raise prices as quickly as the ad-free service. That could ultimately become a strength for both companies in the long run.
