Netflix (NFLX -0.63%) told investors in an earnings call this week that its ad-supported tier, which now boasts more than 23 million monthly active users, is still a very small part of its business. That might seem like a massive size in absolute terms, but it's only a small subset of the company's 260 million members. Further, the streaming service is still scaling its ad products to access this audience.
But the days of Netflix's ad business being immaterial to overall results won't last much longer. Management expects the nascent business to contribute to its financials substantially by next year.
Here's a closer look at this important catalyst for the business and the stock.
Rapid growth
There's a huge appetite for cheaper, ad-supported tiers. Netflix said in its fourth-quarter shareholder letter this week that members in this ad-supported tier rose 70%, compared to the sign-ups the tier had attracted by the end of its third quarter of 2023. That's on top of 70% quarter-over-quarter growth in the prior three-month period, too.
This growth has been driven by product enhancements, like the ability to download content. In addition, the phasing out of its cheaper, ad-free "Basic" plan was a catalyst for further growth.
Forty percent of new membership sign-ups in the markets where Netflix has ad-supported tiers are signing up for plans with advertising. This highlights the segment's potential to be a significant contributor to Netflix's business over time.
Here comes the tidal wave
While Netflix's advertising business is still too small to have a meaningful impact on the company's overall business, management believes this will change next year. "Our aim is to make ads a more substantial revenue stream that contributes to sustained, healthy revenue growth in 2025 and beyond," management said in its fourth-quarter update.
To achieve its goal of making advertising revenue meaningful by next year, Netflix plans to continue scaling its reach by attracting new members to its advertising tier, enhancing the product, and improving its go-to-market strategy for its advertising business.
The size of the opportunity isn't lost on Netflix management. "[W]e're focused on the long-term revenue potential here," said Netflix co-CEO Gregory Peters during the company's fourth-quarter earnings call. "We're very optimistic about it. It's a huge opportunity: $180 billion of ad spend [excluding China] and Russia -- $25 billion alone on connected TV."
During the company's fourth-quarter 2022 earnings call, Netflix Chief Financial Officer Spencer Neumann provided some commentary on just how big he thinks the company's advertising can be long term. He noted that the company wouldn't dabble in advertising if it didn't believe the revenue stream from ads could grow to 10% or more of its total revenue.
With trailing-12-month revenue of nearly $34 billion today, Netflix likely anticipates its advertising revenue will grow to around $4 billion to $5 billion or even more someday. Further, since this revenue will likely be highly accretive to earnings, advertising could have an outsized impact on profitability over time.
No wonder Netflix isn't wasting any time scaling its advertising business.
