Walt Disney (DIS 1.54%) has quickly grown to become one of Netflix's (NFLX 4.17%) biggest threats in streaming. So investors in the streaming leader were happy to see a decline in Disney+ subscribers alongside plans to pull back on content spending for the service when the House of Mouse reported its second-quarter earnings recently.
Disney's 300,000 subscriber decline in the U.S. and Canada stands in contrast to the 100,000 net subscriber addition Netflix posted for the quarter. And Disney's plans to focus on its most efficient content to lower spending is in contrast to Netflix's efforts to maintain its massive content budget this year and next year.
But the great news for Netflix investors doesn't have anything to do with Disney's struggles last quarter. In fact, Disney's successes in the quarter are even better news for the streaming leader.
The ad-supported tier is a success
Disney launched an ad-supported tier of Disney+ in the U.S. in December, about a month after Netflix, and it's going really well so far.
Management said the ad-supported tier has the potential to generate more revenue per subscriber than the ad-free tier. As such, it plans to increase the price of the ad-free tier later this year to drive more consumers to the ad-supported tier. It'll also expand the ad-supported tier to Europe later this year.
Netflix also saw early success with its ad-supported tier. Management said revenue per user in the U.S. exceeds that of its standard plan, despite roughly half the subscription price. And while those strong results may have been fueled by early enthusiasm and experimental ad budgets, Disney CEO Bob Iger's enthusiasm for the digital ad market indicates it may have staying power.
"There's going to be a substantial growth in digital advertising in this upfront, I mean, quite substantial," he said during Disney's second-quarter earnings call. Considering Disney has substantial stakes in linear TV advertising, that's a strong admission from the exec that the future of television advertising is in streaming.
Disney's bullishness on the ad-supported tier should give Netflix investors more confidence in its ad-supported efforts.
The long-term importance of ad-supported streaming on Netflix
Advertising currently represents a minimal portion of Netflix's overall revenue, but it plays an extremely important role in the future of the company.
Netflix introduced the ad tier just ahead of its rollout of paid sharing, which will require subscribers to pay to share their accounts with viewers outside of their household. It expects a significant number of subscribers to cancel as a result, but ultimately it expects to win back many of those customers. One way it's going to win those customers back is with the low-price ad-supported tier.
Indeed, the relatively low price of the ad-supported tier should support reenergized subscriber growth across the markets where it launched. Netflix has long been saturated in the U.S. and Canada, but it's starting to show progress. Management said Canadian subscribers grew since the implementation of paid sharing, indicating the strategy is working.
Over the long term, however, the ad-supported plan will support substantial increases in revenue per account. As Netflix gets better at monetizing viewers through ads, it'll be able to push its ad-free subscription price higher in order to maintain parity. That's exactly what Bob Iger is trying to do, pushing another Disney+ price hike later this year. Alternatively, Netflix can lower the price of the ad-supported tier in order to draw in more subscribers. Hulu did that in 2019 before Disney acquired a majority stake in the company.
Disney's results and management commentary suggest there's a lot of pricing power at Netflix -- not just from its ad-free tier, but from its ad-supported tier. And raising ad prices is the best kind of price hike, one that has no impact on consumers.
As Netflix looks to reaccelerate its revenue growth, the ad-supported tier will play a major role in doing so, both directly and as support for Netflix's other revenue generators. Ultimately, that should drive strong operating margin expansion and produce even more free cash flow. So while Netflix investors were cheering after Disney's results, they'll probably be cheering even louder as the streaming veteran's own ad business takes off.
