What happened

Shares of Netflix (NFLX -0.95%) were moving backwards today on reports that the company's ad business is stumbling out of the blocks. In fact, advertisers are asking the company to return some of the money that they had paid it.

The news sparked a sell-off in the streaming stock because investors had seen the ad business as a key growth driver in 2023. As of 12:01 p.m. ET, the shares were down 8%.

So what

According to a report in Digiday, Netflix is missing the ad targets it had promised to advertisers because not enough members seem to have signed up for the new ad tier, which is priced at $6.99 per month in the U.S. 

Citing ad agency executives, Digiday said Netflix had only delivered 80% of the audience it had guaranteed, and it was allowing advertisers to take back money they had paid for ads that hadn't yet run.

Launching the ad business ahead of the holiday season, a peak time of year for many advertisers (as well as shoppers and retailers), may have seemed like a good idea. But Netflix now runs the risk of burning key relationships with advertisers, who demanded their money back so they can spend it elsewhere before Christmas.

The poor performance also means the company may have to lower its ad prices. It had been seeking a relatively high $55 CPM (cost per thousand impressions), above Disney+'s $50 CPM. Advertisers are also faulting Netflix for not giving the new ad tier a bigger push with its own marketing campaign. 

Now what

Too much advertiser demand isn't the worst problem to have, but it shows that co-CEO Reed Hastings' earlier misgivings about advertising may have been justified. He had long said that viewers prefer the ad-free experience. He also argued that the dual-tier structure is overly complicated.

Netflix, it seems, hasn't used its own platform to push the ad tier, and without converting existing viewers to the ad-based subscription, the streamer is unlikely to build a substantial advertising audience.

A rocky start for the ad product isn't a reason to change your thesis on the company, but it does deserve investor attention. If the ad tier fails to gain traction through 2023, the stock could have further to fall.