After years of resisting the idea of advertising, Netflix (NFLX 1.29%) has done an about-face on the strategy. Its ad-based tier, priced at $6.99/month in the U.S., launched in November and is now live in 12 countries.

While it's too early to get any data on the performance of the ad-based tier, and the company has said it doesn't expect that offering to be material in the fourth quarter, Netflix co-CEO Reed Hastings made some comments at the New York Times DealBook conference that should stoke investor confidence in the ad business.

Several Netflix apps.

Image source: Netflix.

Mea culpa

Hastings admitted he was wrong to doubt the advertising business and said Netflix should have gotten into it years earlier.

He said the move into advertising ultimately comes down to customer satisfaction. "I have two religions: customer satisfaction and operating income," the Netflix chief told the Times' Andrew Ross Sorkin. He credited Hulu for showing that the dual tier could be successful, saying, "Hulu really proved that you could do that at scale and offer consumers lower prices, and that that was a better model."

Offering consumers lower prices is, naturally, one way to increase customer satisfaction.

Hastings, who once served on the board of Facebook (now Meta Platforms), also said he had believed Netflix wouldn't be able to compete with companies like Alphabet and Meta in digital advertising since they have so much data.

However, more recently, he recognized that his worry didn't apply to the TV market, saying:

What I failed to understand is that there's a lot of TV advertising that now couldn't find the viewers, because the 18 to 49 segment had moved online. They were not watching linear TV. And so the advertisers are desperate for connected TV or internet TV solutions. So that's the real thing that I missed. We didn't have to steal away the advertising revenue. In fact, it was pouring into connected TV if the inventory is there.

Hastings seems to be saying there is huge demand from advertisers for connected-TV inventory. While that isn't a specific comment on Netflix's own launch of its ad-supported service, it would seem to bode well for the new revenue stream.

A huge opportunity

The majority of Netflix's subscriber base will be on the ad-free tier for the foreseeable future, but the ad-based tier allows it to tap into a potentially massive market.

The linear TV ad market in the U.S. is estimated to be worth $68 billion in 2022. Connected-TV (CTV) ads typically fetch twice (or more) the price that a linear TV ad does, meaning the U.S. CTV market is worth tens of billions with linear TV ads gradually moving over to CTV. Raking in even a small percentage of that would move the needle for Netflix.

Adtech companies are also touting strong growth in CTV, even as the overall digital ad market has slowed due to fears of a recession.

Jeff Green, CEO of digital ad-buying platform The Trade Desk, said of CTV on the company's recent earnings call, "Right now, at The Trade Desk, we're living a secular tailwind that I don't know that we've ever seen before, and I don't know that we'll ever see again, and that is going to continue into 2023, largely because of the amount of inventory that is coming online." Green also said he thought CTV would soon be the most data-driven channel, meaning the premium for CTV ads could continue to rise.

What it means for Netflix

Though it could take several quarters or even years for Netflix's ad-supported subscriber base to scale, it's clear advertisers are eager to partner with the company. As the world's largest streaming service, Netflix can provide something no other platform can: a global reach with more than 200 million household members, targeting and tracking that comes with knowing who's watching, and the benefit of an engrossing large-screen experience.

Investors should learn more from the company's next earnings report in January, but the ad business is likely to delight them in the future. They shouldn't underestimate the opportunity.