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Will Netflix’s Ad Tier Be Undone by Poor Timing?

Netflix (NASDAQ: NFLX) is currently working on an ad-supported tier aimed at more cost-sensitive customers. The company has yet to disclose pricing details or to confirm an exact launch date, only saying it will arrive in early 2023. But there are signs that the advertising-based video on demand (AVOD) sector is running into economic headwinds, which could mean a difficult rollout for Netflix’s new ad plan.

Ads as a way to reignite subscriber growth

Historically speaking, Netflix founder and co-CEO Reed Hastings was against the idea of introducing an AVOD tier, suggesting such an offering would lead to unnecessary complexity. But following a drop in subscriber numbers earlier this year (and a sharp fall in its stock price), Netflix changed course, positing that an ad-based plan could sit alongside existing ad-free tiers.

Image source: Getty Images.

Netflix has since signed an exclusive partnership with Microsoft. The technology giant will handle the technical aspects of hosting ads on Netflix’s platform, including managing inventory and ad sales.

Market watchers have broadly approved of Netflix’s about-face. Mike Proulx of Forrester has suggested there is a substantial base of customers who will tolerate ad breaks, and Michael Nathanson of MoffetNathanson predicts the streamer could eventually generate $1.2 billion revenue from its ad tier. However, more recently there have been signs the marketing industry is not particularly buoyant.

Netflix’s AVOD tier could land at a tough time

Roku (NASDAQ: ROKU) recently delivered sobering Q2 results that triggered a significant tumble in its stock price: Despite adding 1.8 million active users over the quarter, the streaming platform posted a $112 million loss, citing “a significant slowdown in TV advertising spend due to the macro-economic environment.”

Roku told shareholders it saw consumers “moderate discretionary spend” in the quarter and that “advertisers significantly curtailed” their marketing efforts. But perhaps most concerning for Roku’s stakeholders (and its rivals) are the streamer’s beliefs that things may not improve quickly. “We expect these challenges to continue in the near term as economic concerns pressure markets worldwide,” the company said.

For Netflix, the news that consumers and marketers are tightening their belts surely can’t come at a worse time. The company has put its flag in the ground by announcing its ad tier for early next year, but if Roku’s predictions are correct, and “economic concerns” do continue, it’s possible Netflix’s AVOD offering may struggle to generate significant sums from subscribers and advertisers at launch.

Of course, it’s arguable that Netflix’s ad tier could be somewhat immune to the market pressures Roku describes. Netflix is the most popular streaming service on the planet, and it is home to popular shows and movies such as Stranger Things, Squid Game, and Red Notice. Yet despite its strong lineup, the streamer has still lost customers over multiple quarters.

Still, it is reasonable that, by the time Netflix is ready to roll out its AVOD plan, the market conditions Roku outlined may have improved. Or not. Professional services firm Deloitte posits that, if a recession is coming, it would likely land in late 2022 or early 2023 — which could put a wrinkle in Netflix’s plans.

Netflix could pause the launch of its ad tier

If things do get worse from an economic standpoint, Netflix could decide to delay the launch of its ad-based plan. Again, the company has been vague about when it will come to market, so the streamer could choose to bide its time until consumers and advertisers are feeling more confident. But will stakeholders be OK with that? After all, subscriber numbers matter, and Netflix has made AVOD an important part of its strategy to reignite growth.

Market watchers who want to gauge Netflix’s AVOD prospects would obviously do well to monitor the global economic environment over the coming months. However, they should pay attention to the progress of Netflix and Microsoft’s partnership. If there are whispers the ad system may not be ready for an early 2023 launch, it could be a clue about soft inventory demand, rather than any technical concerns.

Tom Wilton has business dealings with Netflix, but holds no financial position in any stocks mentioned.  The Motley Fool has positions in and recommends Microsoft, Netflix, and Roku. The Motley Fool has a disclosure policy.

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