Netflix – ads or no ads?

James McGrath
By James McGrath | 4 June 2015
Netflix show: House of Cards

Recent revelations that Netflix may be playing around with pre-roll inventory has set tongues wagging, opening up the debate on whether SVOD services would adopt advertising as part of their model – and when.

Netflix got several observers in a tizzy over the last few days as users on Xbox and Roku started to notice that there was pre-roll inventory in their Netflix, with the inventory being used to highlight other Netflix shows

Quickly, Netflix CEO Reed Hastings got on the front foot and hosed down speculation that it was moving to introduce ads onto the platform.

"No advertising coming onto Netflix. Period. Just adding relevant cool trailers for other Netflix content you are likely to love," Reed Hastings said in a Facebook post.

But with it clear that Netflix has the capability to serve pre-roll ads, the question has become will it and when.

Sir Martin Sorrel has weighed into the topic by saying that Netflix would need to serve advertising to increase its profit as its profit margins are currently razor-thin.

In its latest result, Netflix revealed that it had made revenue of about $1.57 billion, but a final profit of just $23.5 million. But observers note that Netflix is heavily investing in content and international expansion, which makes reading future profitability on current numbers a foolish game.

In fact, its shares recent jumped above $600, up 5%, based solely on a Bloomberg report that Netflix is talking to companies in China

Clearly its investors are hedging on the long game.

But for advertisers, getting a clear read on what could become a seismic event in the world of advertising, particularly for linear TV networks, is becoming vital.

Supply-side video operator SpotXchange said news of Netflix trialling ads would have implications for local players.

“Subscription is a flat revenue model with a finite number of potential customers. For Stan, Presto and the other new players in the market, limiting revenue streams to a subscription model leaves money on the table,” SpotXchange's local director of supply, Daniel Rowlands, told AdNews.

“Adding ad-funded revenue streams into the mix, like Foxtel does, gives these businesses a more elastic and scalable business model.”

Locally, all SVOD players are saying that an ad-funded model is not in their forseeable future.

“Advertising isn't in our model, it's not in our business plan,” Presto interim CEO Sean James told AdNews recently.

“We look at it and say it's not in our roadmap. We've done our modelling based on what the market potential is, what share we can take in that market, and we've set the business up on that basis.”

Buyers who spoke to AdNews said that none of the players, including Netflix, probably have the scale needed to become a genuine challenger to the TV networks, but that may change after consolidation in the sector.

“Here in Australia, the play is to bed down the consumers first so I don't see that happening,” Amplifi managing director Paul Brooks told AdNews.

“It could be that Netflix comes in and swallows up one of the local players to build scale and then maybe, but it's hard to see.”

Other buyers who spoke to AdNews said they always welcome more choice in where to place their media dollars with some suggesting that TV networks “would be up a creek” if a consolidated SVOD player in Australia started to serve advertising.

However, they also said that in the US, it wouldn't make too much sense for Netflix to explore advertising in the shorter-term, where it already has scale and its model is working.

“You look at the US and they're in 50 million-odd households, so the subscription model holds up there,” Brooks said.

“There may be pressure from shareholders down the line, but everything for them is going really well, so I don't think they would get into it as a matter of priority.”

The numbers back up Brooks' sentiment.

According to Netflix's latest quarterly result, its US streaming service had a profit margin of 31%.

So if in the US it doesn't make sense, and internationally it doesn't have scale to serve advertising in the short-to-medium term, then why is Netflix mucking around with ads?

“I think the whole pre-roll thing is about retention of customers and getting people to come back,” Brooks said.

“I think when they're already watching Netflix, that's when they'd be really receptive to advertising about other Netflix content.”

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