With Netflix (NFLX 1.74%) rolling out its ad-supported subscription tier for the first time last November, many investors were likely looking to the company's first-quarter report on Tuesday for an update on the new business. Fortunately, there's good news. The streaming-TV service company said it remains pleased with the unit economics of its ad-supported plans.
Here's exactly what Netflix said about its ad-supported plan -- and why investors should be happy with management's latest update on the nascent yet extremely important product.
How Netflix's ad business is faring
Netflix reported an acceleration in its top-line growth rate in Q1. Revenue increased 3.7% year over year to $8.2 billion. This is faster than the 1.9% growth the company reported in Q4. While most of this growth was due to subscriber growth, investors are hoping that the company's recently launched advertising tier will be a major driver of growth over time.
Fortunately, the new model is off to a good start. Netflix noted in the company's first-quarter shareholder letter that its advertising business is demonstrating "healthy performance" and is on a good trajectory. Indeed, it's doing so well that the company is increasing its investment in the product, upgrading its "ads experience with more streams and improved video quality to attract a broader range of consumers."
Even more, Netflix cited its advertising business as one of several catalysts behind management's guidance for revenue growth to accelerate in the second half of the year.
The company also revealed some surprising data about the economics of its ad-supported tiers on a per-member basis in the U.S. Management said its average revenue per member on these plans is now greater than the average revenue per member on its standard subscription-only plans. Equally important, user engagement across its ad-supported tier has exceeded management's expectations.
The opportunity
It would be difficult to overstate how big the opportunity for Netflix is when it comes to its advertising business. Management has said it expects ads to eventually account for at least 10% of its revenue. And even this forecast may be conservative. To this end, Netflix chief financial officer Spence Neumann said in the company's fourth-quarter 2022 earnings call that, longer term, he hopes the ad business can grow to be "much more" than 10% of revenue.
Putting some substance behind this bullish view, consider that major advertising agency GroupM projects that about $64 billion will be spent on traditional TV ads this year and more than $13 billion will be spent on streaming ads. The market is huge. Given Netflix's global reach of more than 232 million paying subscribers, the company is well-positioned to attract millions of subscribers for its ad-supported plans, tapping into the lucrative and big TV advertising market. In addition, the company's reach makes it well-positioned to generate substantial interest (and budget) from advertisers.
Importantly, Netflix spoke to its plans to better serve advertisers in its first-quarter update. It said it's pleased with the value it's providing them and that it's responding to demand with the launch of a programmatic private marketplace. This marketplace, Netflix said, will "enable more buying options for Netflix ad inventory using Microsoft's sales platform."
At this point, Netflix seems to have seen enough positive data on its ad-supported tiers to confirm management's commitment to making this a major part of its business as management attempts to capitalize on the opportunity to grab market share in an attractive global advertising market.
