If Netflix Introduces an Ad-Supported Tier, Revenue Could Soar 20%

It hasn’t been a good year for Netflix (NASDAQ: NFLX) investors. In the first quarter, the streaming pioneer reported its first subscriber loss in more than a decade, sending its stock into free fall, losing more than a third of its value overnight, resulting in an overall loss of 75% since its high reached late last year.

In the wake of this uncharacteristic member decline, Netflix management announced a change to its long-standing business model. In addition to its flagship subscription service, it now plans to offer an ad-supported tier, something the company has long resisted. The recent decision to offer a lower-priced level that includes advertising could mark a fundamental turning point for Netflix and estimates suggest that its revenue could surge, fueling a rebound for its flagging stock price.

It all “ads” up

Much like offerings from Walt Disney‘s Hulu and Warner Bros. Discovery‘s HBO Max, Netflix plans to offer a lower-priced tier that uses occasional advertising to defray the typical subscription cost. The company has yet to decide on specifics, such as the number of hourly ads and the price point of its ad-based video on demand (AVOD) service, which will ultimately impact its subscriber and revenue gains. Investors can, however, use estimates to get close.

HBO Max offers plans that start at $9.99 per month, which also include about four minutes of advertising per hour. If Netflix were to take a page from its rival’s playbook, the company could increase its U.S. subscriber count from its current level — estimated at 66 million — to 76 million, according to estimates provided by The Information. 

This assumes that 30 million customers choose the lower-priced, ad-supported tier, while 46 million opt to continue to pay the full subscription price, and that Netflix is able to realize ad revenue of roughly $7 per month per subscriber (similar to HBO Max). Using those variables would generate $2.5 billion in incremental revenue from advertising. In all, this would drive Netflix’s U.S. revenue to roughly $14.4 billion, an increase of 21%. 

The goal is obviously to maximize its revenue and subscriber numbers, so the actual combination of subscription price and advertising will likely differ — but it’s easy to see how Netflix will benefit by offering an ad-supported tier.

Rumor has it

While Netflix has been mum as to the exact nature of its plans, the rumor mill has been more than willing to fill in the blanks. Roku stock recently surged on reports of a potential acquisition by Netflix, as the company would directly benefit from Roku’s advertising experience, but the talks may have been to discuss marketing services. The company has also reportedly met with Alphabet‘s Google, Comcast, and its subsidiary NBCUniversal to discuss potential advertising partnerships. 

Netflix closed out 2021 in fine fashion, generating revenue of nearly $30 billion, up an impressive 19% year over year. In fact, since the start of the pandemic, revenue surged 47%, fueled by the addition of 55 million new subscribers. However, as the pandemic-related tailwinds subsided, Netflix’s long track record of growth promptly reversed course, resulting in the loss of roughly 200,000 accounts in the first quarter — and the company is forecasting it will lose 2 million more in the second quarter. 

Now would be a great time for Netflix to engineer a turnaround and the addition of a lower-priced tier might be just the catalyst the streaming giant needs.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Danny Vena has positions in Alphabet (A shares), Netflix, Roku, and Walt Disney. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Netflix, Roku, and Walt Disney. The Motley Fool recommends Comcast and Warner Bros. Discovery, Inc. and recommends the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool has a disclosure policy.

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