Why the Future of Streaming Is in Advertising

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As the world continues to ponder what streaming’s path forward looks like, the first half of 2022 offered more evidence that its journey will be lined with advertising.

After streaming services’ overall household penetration in the U.S. stalled out in the year’s first quarter, growth resumed in Q2, according to data from analytics firm Kantar. That growth came from all streaming tiers, with SVOD (paid streaming without ads), AVOD (paid streaming with ads) and FAST (free ad-supported streaming TV) all seeing increases in household reach.

While the three tiers grew by similar proportions — 1.5 percentage points for SVOD, 1.6 points for AVOD, 2.1 points for FAST — looking at these figures in the context of historical trends is illuminating. SVOD penetration has fluctuated within two points of 81 percent over the past year, while FAST and AVOD have seen continuous growth, with the former doubling its household penetration in that time.

FAST apps Tubi, Pluto and the Roku Channel also increased their share of viewing time in the last year, while several of the major SVOD services, including Netflix and HBO Max, saw their shares decline, according to data from TVision.

And though ad-supported streaming continues to lag far behind SVOD’s household reach, this gives AVOD and FAST substantial growth potential that SVOD no longer has. Indeed, the AVOD market will soon see a major expansion as Netflix and Disney+ prepare to launch ad-supported subscription plans. The former makes an apt case study for streaming’s potential future with advertising, which offers a path toward a more sustainable, long-term business model for Netflix and for the streaming business.

Netflix’s initial announcement of this move seemed rushed and undercooked, but its strategy is beginning to come into focus. The streamer recently chose Microsoft as a partner to build out its ad-supported tier, suggesting Netflix may be planning to leverage new, high-tech forms of advertising such as virtual product placement.

The company’s Q2 letter to shareholders essentially said as much, stating, “Over time, our hope is to create a better-than-linear-TV advertisement model that’s more seamless and relevant for consumers, and more effective for our advertising partners.” It’s a logical maneuver: Audiences unsurprisingly prefer ads that are less disruptive to the viewing experience, meaning techniques like product placement are preferred to standard commercial breaks.

It's still unclear, though, just how well an AVOD tier would perform for Netflix. Some data suggests the plan would attract more current subscribers than non-subscribers, cannibalizing the core SVOD service. According to Cowen’s Consumer Tracking Survey, more than 53 percent of non-members said they were unlikely to sign up for an ad-supported account, and just 19 percent were likely to do so. (This data begs the question of whether the respondents would be more inclined to sign up if they knew the ads would not interrupt streaming content.) Among current Netflix members, 41 percent said they would switch to an ad-supported subscription, and in another survey, by CivicScience, 42 percent of Netflix users said they were likely to switch.

Still, with Netflix continuing to bleed subscribers in the U.S. and Canada (it lost 1.3 million in Q2), any new members that can be lured with an AVOD plan would likely be welcome. And given the choice of losing subscribers or having them downgrade their subscription, Netflix leadership would undoubtedly prefer the latter. If Netflix has indeed peaked in the U.S. as an SVOD-only service, much of its future potential for growth and subscriber retention will come from an ad-supported tier.

Furthermore, even as these subscribers pay less, advertising could help Netflix extract more revenue from them. Analysts expect ads to boost Netflix’s average revenue per user (ARPU) by a significant margin over several years. The streamer’s ARPU in the U.S./Canada market was $15.95 in Q2 2022; Wells Fargo estimates ARPU from an AVOD tier to reach more than $16.50 in 2023 and surpass $20 by 2025. Cowen is even more optimistic, projecting ARPU of $17.07 for an ad-supported plan as soon as it is introduced.

Implementing this plan successfully will of course take time (Netflix has already pushed back its launch date from the end of the year into 2023), and there’s plenty of turbulence ahead, including a slowdown in digital ad spending as economic conditions worsen. In the long term, however, advertising presents the best opportunity to keep expanding the domestic streaming market.