A couple of days it go it was reported that Netflix has started trialling house ads to promote the content it produces on its service in the US. Perhaps unsurprisingly, the reaction from the (ad-funded) mainstream media has bordered on the hysterical. ‘People are freaking out about ads coming to Netflix,’ reported Quartz. ‘Netflix are testing something that you won’t like one bit,’ said the Daily Star. While ‘Oh Goddamn It, Netflix is Testing Ads’ was Gawker’s headline.
Netflix, however, came out to insist that they have no plans to introduce advertising. “We do not and will not be adding third-party ads,” a spokesperson told the Vice-owned Motherboard. However, in spite of the public denials, advertising on Netflix seems inevitable.
The first and most obvious motivation for Netflix to run ads is growth. Netflix still isn’t profitable and is ploughing its cash into scaling globally, all of which requires heavy marketing, along with content production and licensing*. The company currently operates in 50 countries and intends to add an additional 150 markets in the coming years. While investors have been willing to forgo profitability in favour of international expansion and new subscriptions, investor patience won’t last forever. Eventually there will come a point when subscriber growth plateaus and the markets will want to see a higher average revenue per user (ARPU).
The Path to Profitability
Hiking up prices is one route, although Netflix have been badly burned by meddling with pricing in the past. In 2011 the company lost 800,000 US subscribers when it split the billing for its DVD rental and online services in two. Last year’s $1 dollar increase didn’t stir up too much controversy, but these days Netflix has to fend off ever-increasing competition from the likes of Amazon, HBO and other broadcasters. At some point, advertising will become essential for Netflix to expand and evolve.
But what direction is Netflix likely to take as the company grows? While Netflix executives insist they’re committed to an app-based future, there’s no reason the app won’t evolve into a fully-fledged pay TV offering similar to those offered by multi-service players like Comcast, Liberty Global and Sky. That would be an obvious ambition, as making do with TV’s hand-me downs won’t drive major growth in the long run. Things like live sports and linear channels must be on the road-map, and advertising revenue will be absolutely essential if Netflix is going to compete for first-run and sports rights.
Exploiting the Netflix Data Hoard
Another major motivation for Netflix to move into advertising is the mountain of data it’s currently sitting on. Even without advertising, Netflix’s business model has always been highly data-driven. As Todd Yellin, VP of Product Innovation at Netflix, told The Guardian, “We own the Netflix customer experience from the moment they sign up, for the whole time they are with us, across TV, phone and laptop. We climb under the hood and get all greasy with algorithms, numbers and vast amounts of data. Getting to know a user, millions of them, and what they play. If they play one title, what did they play after, before, what did they abandon after five minutes?”
Netflix currently uses that data to inform decisions on everything from content personalisation right through to which shows the company should license and produce. House of Cards was perhaps the most famous example. Netflix’s analysts found that people who loved the original 1990s BBC version also liked films starring Kevin Spacey and films directed by David Fincher, so they decided to make a new version starring Kevin Spacey with a pilot directed by David Fincher. Netflix then marketed the show using multiple trailers. Fans of Kevin Spacey saw trailers featuring him, while women watching Thelma and Louise saw trailers featuring the show’s female characters, and hardcore film fans saw trailers that reflected David Fincher’s style.
Taking all of the above together, becoming a fully-fledged pay TV platform is an obvious progression for Netflix. In time it will be an international and IP-delivered TV powerhouse, unburdened by the costs of running a set-top box business and one that is driven by data. However, Netflix will still have to overcome numerous obstacles to ensure its future growth. It still doesn’t have any control over the pipes required to deliver its content and the debate over neutrality is far from over. It’ll also face major competition from both international and national players internationally as both the tech giants and the broadcasters play catch-up with rival services. Maybe not today, maybe not tomorrow, but soon…
*Interestingly, Netflix say their originals cost them less money, relative to their viewing metrics, that most of their licensed content, much of which is already established and produced by leading studios.