Walt Disney (DIS -0.04%) and Netflix (NFLX -0.63%) rank as arguably the top two U.S.-based streaming companies. Both have rolled out ad-supported tiers. The Netflix version costs $6.99 per month while Disney+ costs $7.99. Disney+ and Hulu with ads cost $9.99 per month and Disney+, Hulu, and ESPN+ (all with ads) clock in at $14.99.
Both media companies hope that an ad-supported tier will help grow subscribers and provide a lower-cost option that prevents customers from unsubscribing altogether during price hikes.
While Netflix deserves a lot of credit for pioneering the streaming model, Disney has a much deeper history with content creation and with advertising across its media outlets. Here's why an ad-supported tier is particularly important for Disney, and why it could be the catalyst that drives Disney+ toward becoming the profitable growth engine the company always hoped it could be.
Image source: Getty Images.
Choosing the right streaming strategy
Streaming companies can make money in a variety of ways. The Netflix model is the simplest.
Netflix avoids the box office and hosts a variety of original and exclusively licensed content on its platform, which adds value to its offering. The goal is to produce or license enough content to retain existing subscribers, attract new ones, and justify price increases, while also making more money from subscriptions than it spends.
The Disney model is far more complicated but also more powerful. Its roots stem from the box office. And Disney relies more on the power of franchises like Toy Story, Star Wars, and Marvel comics to support productions, inspire rides at its theme parks, sell merchandise, and more. Disney's 100 years of intellectual property (IP) and beloved characters are very valuable and reduce the need to make more content.
Netflix doesn't have that. There's little value that can be derived from a popular series like Stranger Things or The Crown once it ends, whereas Disney taps into nostalgia. This puts pressure on Netflix to follow up big hits with more big hits. Disney has that pressure, too -- both at the box office and with it shows. But when Disney lands a big hit, it has more room to run.
Winning big
One of the best examples of a successful Disney franchise is Frozen, which came out 10 years ago. Frozen and Frozen 2 (released in 2019) were box office blowouts, combining for over $2.7 billion in global box office revenue, and both rank in the top 10 of Disney's all-time box office winners.
The franchise inspired the Frozen Ever After Ride at EPCOT, an incredibly successful merchandise campaign, a hit Broadway musical, and so much more.
This is all to say that although Disney and Netflix are the two top streaming companies, their business models are different. At first, Disney tried to emulate Netflix's model by spending a ton of money on content to grow subscribers. But now, it's pulling back and expects to spend $27 billion on content this year compared to initial guidance in excess of $30 billion.
A major strategic shift
In many ways, the launch of Disney+ cannibalized Disney's traditional media business. The company used to make hundreds of millions of dollars in licensing fees from Netflix for hosting Pixar, Marvel, Star Wars, and other content on its platform.
At its core, the strategic shift meant Disney would now be directly distributing its content to consumers instead of through other companies. In the short to medium term, Disney is taking a significant profit hit in exchange for long-term content control and will continue to.
By ending licensing deals and buying back the rights to some of its content, Disney can leverage its vast history of IP. If you factor in its top franchises, as well as the movies made by Twenty-First Century Fox, Searchlight Pictures, and other production studios, you quickly realize that the value of this existing content library is light-years ahead of Netflix or any other streaming platform.
Having so much content is Disney's ace in the hole, especially during this period of pulling back on spending, because it takes the pressure off the need to make new content. Paying $7.99 per month opens the door to Disney's content library and new content as well. It's a far better option for the consumer than the old days of buying a copy of a movie or TV show and essentially having to build out your own content library.
In sum, there's an inherent value to Disney's existing content library that makes a relatively inexpensive ad tier easy to justify.
Purposeful productions
Disney CEO Bob Iger's comments on recent earnings calls suggest a heightened focus on profitability. Investors should keep a close eye on subscriber numbers once its price hike takes effect on Oct. 12, which increases the cost of many ad-free streaming options but keeps the ad-supported prices the same.
The ideal outcome is that Disney doesn't spend nearly as much on new content as Netflix due to the strength of its existing content. It can then focus on purposeful production and quality over quantity.
With the stock near an eight-year low and Disney+ on track to be profitable by the end of fiscal 2024, now seems like a good time to take a look at Disney stock. Especially if you believe the value of its existing content library is worth eight bucks a month with ads.
