Netflix's (NFLX -9.09%) new ad-supported tier is off to a slower start than expected.
The streaming leader is offering advertisers some of their money back after it determined that it will only deliver 80% of its guaranteed ad impressions, according to a report from Digiday. That suggests that either Netflix has seen fewer sign-ups for the ad-supported tier or that those users aren't watching as much as management expected.
While the slow start is unfortunate, the ad-supported tier only debuted on Nov. 3. Investors should take a longer view on this strategy than just one month.
Netflix oversold to advertisers, undersold to consumers
Netflix made some big promises to advertisers, and it asked a lot in return. Its ad prices were some of the highest in the industry. Its asking price for a standard ad -- a $65 CPM (cost-per-thousand impressions) -- was higher than the equivalent price for last year's Super Bowl.
While it didn't always get that asking price, Netflix managed to sell a lot of untested inventory at very high price points. It brought on well-regarded ad chiefs Jeremi Gorman and Peter Naylor, to manage the business as well, which gave more confidence to ad buyers.
But Netflix didn't do as good of a job selling the ad-supported tier to consumers. Its marketing to them was extremely limited, and it didn't announce the details about it until a few weeks before its launch. As a result, consumer awareness was likely relatively limited, which meant fewer sign-ups.
The good news is that Netflix can fix this issue, and many advertisers are willing to stick around as it tries. Most of the advertisers that took their money back from Netflix are more seasonal businesses, and they're looking to redeploy their money on other platforms before the end of the year. Others, however, simply rolled over their budgets into 2023, when Netflix will be able to make good on its guarantees.
Importantly, Netflix is still commanding premium ad pricing.
2023 holds a lot of promise for Netflix
Netflix said it expects to reach 40 million ad-tier viewers by the end of 2023. Here's how it can get there.
Growing consumer awareness should help. That can come from a more concerted ad campaign to introduce the lower-priced tier to more people, or awareness could grow organically through word of mouth. With the amount of switching and service-hopping taking place across the streaming service industry, better product awareness can drive a lot of subscribers, especially the more cost-conscious types.
Second, Netflix has yet to crack down on password sharing in the U.S. market. Management said it plans to ramp up that effort in 2023, which will lead to millions of subscribers either paying more to share their subscriptions or pushing out-of-household viewers off their plans. Some of those displaced viewers may end up signing up for the ad-supported tier.
Netflix will also use the ad-supported tier as a standard retention tool. It can show the option to subscribers when they're about to cancel. Price is one of the biggest reasons consumers cancel streaming services, so offering a lower-priced option may sway a material share of those would-be cancelers to stay.
Finally, Netflix has work to do to improve the content library on its ad-supported tier. Due to licensing contracts, Netflix is unable to offer everything in its standard library to subscribers in the ad-supported tier. Including the ad-supported tier in future contracts as well as renegotiating for the rights in existing contracts will help.
Netflix expects those efforts will help it grow the subscriber base for the ad-supported tier by 200% in the first quarter. If it can meet that target, it'll have enough viewership to make good on its deals with the advertisers that stuck around, and further grow its ad business.
