Netflix (NFLX -0.75%) didn't exactly impress investors with its first-quarter results on Tuesday afternoon. Revenue fell short of its earlier forecast. Subscriber additions came in a bit weak. Netflix's top- and bottom-line guidance for the current quarter was shy of where Wall Street pros were perched.
There was good news, too. It now expects to generate $3.5 billion in free cash flow for all of 2023, up from a goal of $3 billion three months ago. Engagement remains strong. Its polarizing move to crack down on password sharing by offering a paid-sharing plan has fared well in four test markets overseas. It's aiming for a broader rollout for paid sharing, including the U.S. later this quarter.
Then there's the initial success that Netflix is seeing with its ad-supported streaming plan. It's still early when it comes to that initiative, but buried in its shareholder letter came one of the more stunning -- in a good way -- remarks that Netflix has made in a long time.
Putting the ad in addition
Rolling out an ad-supported tier seemed like a dicey proposition for Netflix. Would customers trade down for the cheaper plan, upending the value proposition of the service? Would the commercial-free image of the aspirational brand that founder Reed Hastings cultivated lose status by handing the keys of the streaming experience to marketing missives?
It's too early to call the new tier a success, but it's off to an encouraging start. Check out the following remark that is deep into Tuesday afternoon's letter to shareholders: "In the US for instance, our ads plan already has a total ARM (subscription + ads) greater than our standard plan."
Let's break down all of the moving parts here. Netflix charges $15.49 a month for the standard plan mentioned here. It's the most popular offering. Subscribers can watch ad-free streams in full HD on at least two different screens at the same time. Netflix also offers what it calls the basic plan, charging $9.99 a month for stateside users. The ad-free tier -- at $6.99 a month -- is essentially the basic plan with limited commercial interruptions and the inability to download content to play later.
Netflix is saying that ARM -- or average revenue per month -- is greater on the basic ad-backed plan than it is for the standard offering that costs viewers $8.50 a month more to watch. In other words, it's generating more than $8.50 in monthly ad revenue from the average user paying $6.99 for the subscription itself.
Image source: Getty Images.
This is pretty wild. Roku is generating an average of roughly $3.50 a month in ad revenue over the past 12 months, and its accounts are spending an average of nearly four hours a day on hub. How is Netflix scoring so much ad revenue, especially as it initially holds back on the number of ads it's presenting? How is this happening at a time when the advertising market itself is struggling as marketers hold back in the current climate?
Will this revenue channel get even stronger as Netflix ramps up the ads it wedges into its content and the connected TV ad market improves? Is this just an initial spike, as advertisers overpay to be among the first to reach the previously unreachable Netflix audience?
You have to like Netflix's chances. Things are going so well with the economics of streaming that Netflix points out enhancements coming to the plan. It will let ad-supported viewers stream in full HD on at least two devices. In short, this will essentially be the standard plan's features at the discounted price of the ad-backed basic plan. It's going to resonate with cost-conscious consumers.
It will be the ultimate win-win relationship for the leading streaming services stock. Customers pay less. Netflix shareholders make more. Everyone lives happily ever after. Suddenly the rough first quarter doesn't seem so rough after all.
