Netflix introduced its ad-supported subscription tier in November of last year. Consumer response was tepid: Bloomberg reports, per leaked data, that Netflix had accrued roughly 1MM ad-tier subscribers two months after launch; Netflix had informed prospective advertisers that it forecasted 4.4MM subscribers by the end of 2023. This shortfall in ad-tier subscriptions actually led Netflix to return money to some advertisers, given the lower number of ad impressions available relative to expectations.
Disney launched an ad-supported tier roughly one month after Netflix did (Netflix: November 3rd; Disney+: December 8th). The two companies pursued different pricing strategies for their ad-supported subscription tiers: Netflix kept the price of its cheapest premium tier fixed and introduced the ad-supported tier at a lower price point, while Disney+ increased the price of its cheapest premium tier and introduced its ad-supported tier at the old reference price point. The above diagram depicts the pricing changes.
I contrast the ostensible motivations behind these pricing choices in Ads in streaming, differential pricing, and the pursuit of ARPU. From that piece:
Disney is pursuing increased revenue with a deliberate attempt to grow ARPU that very likely won’t result in net new subscribers; Netflix is pursuing increased revenue with a deliberate attempt to grow its subscriber base that will decrease ARPU. Even assuming no cannibalization of premium subscribers by Netflix’s new ad-supported tier or loss of current Disney+ subcribers who would rather churn than pay more money or be exposed to ads, these two strategies represent different sides of a bet on the total addressable market of a subscription service.
According to subscription analytics company Antenna, 19% of all new US-based Netflix subscribers purchased the ad-supported tier in January 2023, three months after its launch. This compares to 36% of all new subscribers to Disney+ on the three-month timeline from the launch of the ad-supported tier.
Disney’s fiscal year ends at the end of September; the company revealed in its Q1 2023 results for the quarter ending December 31, 2022, that ARPU for Disney+ decreased by 3% globally and by 2% in the US relative to Q4 2022 (which ran through October 1st, 2022), although the price increase was live for less than one month in the quarter. Disney attributed the decrease in ARPU to currency headwinds and an increased share shift for multi-product streaming packages in its earnings call:
Disney+ core ARPU decreased by $0.19 versus the prior quarter, driven by an unfavorable foreign exchange impact and a higher mix of subscribers to our multiproduct offerings, partially offset by a benefit from the recent domestic price increase, which occurred toward the end of the first fiscal quarter…Disney+ core ARPU will continue to benefit in the second quarter from the domestic price increase. And while it’s only been two months since the launch of the Disney+ ad tier, we are pleased with the initial response, which includes continued demand from top-tier advertisers. As I mentioned last quarter, we do not expect the launch of the Disney+ ad tier to provide a meaningful financial impact until later this fiscal year.
Netflix similarly saw ARPU decline in Q4 2022, by 3% globally and by nearly 1% in the US. Netflix’s ad-supported tier was introduced in November and would naturally cause ARPU to decrease on the basis of the company’s subscription mix shifting to include lower price points. When Netflix first announced its ad-supported tier, the company claimed that the ARPU impact of users switching from its cheapest premium tier ($9.99/month) to its ad-supported tier ($6.99/month) would be “neutral to positive,” accounting for the revenue contribution of ads. I questioned that assumption at the time, and it’s hard at this point to determine if this will ultimately be the case:
- Netflix’s ad-supported tier was live for less than two months in Q4, meaning the data is immature;
- Netflix couldn’t fully deploy the ad budgets that were committed to it by advertisers, although it now claims that it can, per Bloomberg reporting. Increased ad spend will presumably lead to an improvement in ARPU values.
Ultimately, a decrease in ARPU isn’t a negative outcome if overall revenue increases. Netflix’s global ARPU was up 3% year-over-year in Q4 2022 on a constant-currency (real) basis but down 2% on a nominal basis. And while Netflix’s revenue grew by 4% year-over-year in nominal terms in Q4 2022, it declined sequentially by 1% even as subscriptions grew sequentially by 7.66MM. Netflix’s historical high-water mark for revenue came in Q2 2022, when it delivered nearly $8BN in revenue against 221MM subscriptions, its lowest count for any quarter in 2022. This increase in revenue coincides with a price increase.
Clearly, the impact of subscriber growth on Netflix’s revenue is heavily influenced by Netflix’s subscription and revenue mix, in terms of both geography and subscription tier. US subscribers account for roughly 1/3rd of Netflix’s global subscriber base, and currency headwinds in 2022 are explanatory for some portion of declining revenues despite subscriber growth. But US ARPU decreased sequentially in Q4 against subscriber growth of nearly 1MM.
The ad-tier calculus for both Netflix and Disney+ considers whether an ad-supported tier should undercut existing price points or nudge existing prices higher. Notably, Disney operates a proprietary advertising infrastructure, Disney Unified Advertising Platform (UAP). This platform is built atop the Disney Ad Server, which was built specifically for Hulu and accommodates video ad formats that are optimized for streaming. The Disney Audience Graph comprises first-party data from over 190MM device identifiers and 100MM households. Disney+ utilizes the Disney Ad Server but featured limited targeting at launch, with Hulu’s full suite of ad targeting tools being rolled out to Disney+ starting this month.
Netflix partnered with Microsoft’s Xandr for ad serving and implemented fairly primitive targeting and measurement capabilities at launch, ostensibly in service of delivering its ad-supported tier quickly (impressively, within four months of being announced). And while Netflix has announced partnerships with Nielsen for audience insights and DoubleVerify and IAS for viewability measurement, Netflix’s advertising platform still lags behind many other CTV and video display competitors in terms of functionality. And its inventory is priced at a considerable premium to other CTV channels at a $65 fixed CPM.
Shifting pricing upmarket with the addition of an ad-supported tier, as Disney has done with Disney+, makes sense in light of the existence of robust advertising technology. Shifting pricing downmarket creates adverse selection issues: subscribers to this tier will either have downgraded from the cheapest premium option or represent consumers who couldn’t previously justify the expense of a premium tier. Advertisers have less economic incentive to target this group, broadly, so the product experience will be worth less.
So Netflix may have introduced its ad-supported tier at a lower price simply to generate sufficient supply (having struggled to do), knowing that it could recruit advertisers even at a price premium through novelty alone. But Netflix is reportedly exploring the option of building its own advertising technology or acquiring an existing platform ahead of the expiration of its contract with Microsoft in 2024. When Netflix is able to provide advertisers with better audience segmentation, targeting, and measurement tools, it may unlock the ability to not only retain its premium CPM given improved functionality but also to shift its entire price structure higher as a result of the improved consumer advertising experience through native, bespoke placements and better targeting.
