The last time I wrote about Netflix, I focused on Intellectual Property (IP) and Gaming. Valuable IP age like Scotch and Gaming is a very important medium to build exponential love for that IP. The lack of this IP has hurt Netflix. They lost 200k subscribers and are on the verge of losing more (approx 2M) according to recent reports. Netflix has also realized that subscription pruning is real and unless you bring in content that will keep people engaged every day (which is impossible) customers will continue to bleed. BTW this is not just a Netflix problem all OTT are suffering from subscription pruning.
Ben Thompson of Stratechary recently wrote that “despite having more original content than ever, Netflix has hit the wall in terms of subscriber growth, particularly in developed countries where it can charge the highest prices.” He goes on to say, “it does seem likely that Netflix is going to struggle to get significantly more leverage on its content costs than it has to date, as that is the only way to not just acquire but also keep its subscribers.”
Let me get down to the business and begin today’s blog. Today I am going to explain why advertisement is the only option for Netflix to turn green. I am going to explore Long Tail Effect and explain how it is helping YouTube make money. Finally, conclude with Strange Things season 4 and its impact on Netflix’s business. Alright then.
WSJ reported “Netflix said in April that it is exploring an ad-supported version of its platform and in recent weeks has explored a range of partnerships that could help it bring those plans to fruition. Comcast Corp.’s NBCUniversal and Alphabet Inc.’s Google have emerged as top contenders to work with Netflix, The Wall Street Journal reported Wednesday.”
Long Tail Theory
The advertisements make sense. Let me explain this with a theory – the long tail theory. The long-tail theory was theorized by Wired magazine editor-in-chief in 2006, Chris Anderson, who turned the term into a book called “The Long Tail: Why the Future of Business is Selling Less of More” in 2006.
The theory is about products that are less popular and less in demand. Anderson states that the profitability of these products could increase as consumers move away from conventional markets. Anderson found that products that are less in demand or that sell less in volume can outperform top sellers as long as the distribution channel is large enough. This happens because consumers divert their attention from the main market and focus on less popular products.
Long Tail and OTT
This theory is true for online marketplaces and OTT platforms. If you apply this theory to OTT, the argument is around the products with low demand may constitute a market share that will rival or surpass the bestselling movies and current blockbusters, but will only work if the move distribution is large (such as Netflix or YouTube or Disney etc). The Internet makes distribution easy and uses state-of-the-art recommendation models to allow customers to become aware of obscure products. This allows the demand to shift from popular products to the aggregate power of long-tail made-up demand of small or niche products.
Let me explain why. Consider YouTube and Hollywood for example. YouTube is the long tail, it has made it super easy to create and publish videos. On the other hand, Hollywood works on the short tail, releasing a handful of movies. YouTube’s model is to get as much content as possible in front of you, basically, build an unlimited supply of content. Then make money from that content. YouTube wants to promote creators with huge followers (short tail) and make money out of them. At the same time, creators with small or limited followings (long-tail) are still posting content and YouTube puts ads on their content too. Contrary to this Hollywood’s goal is to make as much money as possible with the limited movies (the short tail) it releases every year.
This has worked very well for YouTube because to build an advertising business you need a massive scale. This is where a long tail comes in handy. Examine Spotify under the same lens. Spotify has creators (podcasts and music labels) publishing music. Spotify works as an aggregator/distributor of content. Spotify sells access to the content. Also, it makes money via advertisement and shares a piece of that revenue with its top creators. While continuing to monetize other creators who do not have a big following.
The logic here is to control the demand, and then sell access to this demand (this is true in most cases, except the model of Amazon and Apple, Amazon and Apple have extensive ML algorithms which enable them to monetize outside of advertisements. Let us keep this topic to another time). Once the user has access the distributor can control the content that the user watches. Even suggesting less viewed or followed content.
Long Tail and Netflix
Applying this logic to Netflix and you get the answer, sell ads. Netflix is an aggregator. It sells access to content. It has long-tail content (as Netflix keeps adding to its inventory and specific niche items in regional languages, or for specific geographies). Netflix has reached a stage where it has sufficient content to scale on advertisements. This is the opportunity for Netflix to do what its competitors are doing, sell ads.
I believe streaming is now no different than YouTube or TikTok. I have previously stated that the biggest problem of all apps that require user attention is time. How are you going to get maximum user attention within 24 hours? Viewers are overwhelmed and exhausted by the plethora of services available. YouTube and TikTok have emerged as great competitors for streaming. In order to compete with social media services and accept the fact that subscriber growth will stagnate or even fall (irrespective of adding new and engaging content) it is the right opportunity for Netflix to start looking at ad tiered options.
Stanger Things Effect
The supernatural series is now Netflix’s most popular English language TV series and is No. 2 globally after Squid Games. The part I or Vol 1 of Stanger things season 4 was watched for ~287 Million hours, dethroning Bridgerton. Though there is no exact data for volume 2 (or part II) of season 4, but it was so heavily watched that after the last episode was released, over 14000 Netflix outages were reported across the globe as of midnight of release (Pacific time). While all of this was happening, the results of a survey from WHIP Media, which captures customer satisfaction, reported a 10-point drop in Netflix ratings. This puts Netflix behind HBO, Disney+, and Hulu. HBO and Hulu are less expensive and offer ad-supported viewing.
Data supports the notion that Stranger Things 4 was a massive success and provided a much-needed promotion for the platform. It will be interesting to see if the count of subscribers increased due to the Stranger Things Effect. Squid games resulted in a net gain of 4.4M subscribers for Netflix. Stranger Thing is a great IP for Netflix which can be monetized on multiple fronts.
With Stranger Things, Netflix split the release. To avoid binge-watching and subscription pruning. The show was released in two parts to keep the subscribers engaged (old and new). The problem now that it’s done, Netflix will again struggle to keep the subscription volumes higher. That again goes back to the point that they do not have an IP.
Apart from great competition, macroeconomic headwinds are needed to be factored in. Inflation and rising prices for every essential are causing customers to cut back on subscription services. According to Antenna, a research service that tracks consumer spending on subscriptions, stated by the end of April, 23% of Americans who signed up for Netflix had dropped the service within a month of joining. According to a survey conducted by Momentive for CNBC and Acorns around 36% of Americans are considering cutting a monthly subscription like Netflix or Amazon Prime Video to rein in their spending.
Outside of macroeconomic trends, this could also mean that Subscribers are feeling they are not getting their worth. This was before the Stranger Things release hence I would like to review the latest data before jumping to conclusions.
Ads provide a steady revenue stream option to Netflix. There is no end to production costs, they keep on increasing. With almost 2M subscribers expected to quit by the end of this year, Netflix needs to find them a revenue stream that shows them green on the balance sheet. It will certainly impact Netflix’s motto of viewing experience without distractions but people want this. Competitors have proven that ad-based models work in OTT.
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