Netflix Moves into Ad-Supported Streaming

In March of 2023, Netflix was the largest streaming subscription company in the world and had subscribers in more than 190 countries and territories. But the competitive landscape and a shift in viewing habits after the COVID-19 pandemic had forced Netflix to make two fundamental changes to its business practice. It had decided to offer a lower-tier subscription supported by advertising. It had also decided to aggressively cut down on password sharing and force subscribers to pay more if they wished to share passwords. Along with these two major changes, Netflix had also enacted company-wide cost cutting and began offering some mobile games. Would these moves be enough to cement Netflix’s position at the top of the streaming industry? Or were other changes, including a possible exit via a sale to a leading competitor, necessary?1

Netflix’s Initial Business Model

Based in Los Gatos, California, Netflix launched subscription services to customers in 1998. It invested in a library of DVD titles that it rented out to subscribers by mail, without charging any late or shipping fees. Subscribers could make their selections over the internet, and if a movie was not immediately available, they could create a personalized queue of DVD titles they wanted to watch. Netflix encouraged subscribers to list a DVD title even if it was not in the Netflix library. Before renting a DVD, subscribers could also review feedback from other subscribers, which Netflix encouraged. The Netflix site offered personalized recommendations, based on the customer’s previous rental behavior. These recommendations of films outside the mainstream allowed Netflix customers to expand their movie genre tastes simply and easily.

Netflix’s content strategy: Leverage its customer intimacy

Two things had remained constant about the content that Netflix offered its subscribers. First, Netflix preferred to own its content in perpetuity, or over a set period, allowing its subscribers unlimited access to it. Put another way, Netflix had never offered anything as pay-per-view. Second, Netflix was never about the latest cinematic content, which usually cost the most to acquire. Instead, it created a loyal coterie of subscribers by populating its DVD library with offbeat movies favored by movie aficionados. These titles were not easily available elsewhere but were inexpensive for Netflix to acquire.2 Furthermore, Netflix encouraged the creation of the community, which was its first step in acquiring the massive amount of customer data that it would use

1 Sarah Krouse, “Netflix Cuts Subscription Prices in Over 30 Countries,” Wall Street Journal, February 23, 2023, https://www.wsj.com/articles/netflix- cuts-subscription-prices-in-over-30-countries-ae6d047c (accessed Jul. 14, 2023).
2 Ken Auletta, “Outside the Box,” New Yorker, February 3, 2014, https://www.newyorker.com/magazine/2014/02/03/outside-the-box-2 (accessed Jul. 14, 2023).

This public-sourced case was prepared by Sayan Chatterjee, Batten Fellow and Visiting Professor. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2023 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an email to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to editorial@dardenbusinesspublishing.com.

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in customer analytics. From its inception, Netflix saw value in the information provided by movie aficionados and like-minded subscribers in chat rooms.3 The more information a subscriber provided to Netflix, the better their experience became. Over time, Netflix acquired a massive amount of data about user choices and purchasing trends that it could leverage to acquire inexpensive content it knew would be popular with its subscribers.

Customer loyalty and the ability to make content available at lower costs led to a virtuous cycle.4 Netflix invested heavily in its website technology, which captured massive amounts of empirical data, amalgamated data points into appropriate bins, and then applied germane analytics to postulate future customer desires. Using its state-of-the-art system, Netflix kept its customers engaged by offering a “one-of-a-kind” experience that included individualized recommendations, ratings, customer reviews, and unique genres. It utilized and refined this knowledge about customer preferences throughout its history to improve service, increase utilization of existing content (see social media strategy, later in this case), and, in the early 2020s, attract advertisers.

The initial move into streaming

Netflix planned to be a streaming-only service after September 29, 2023, and it notified its DVD subscribers that they could keep any DVDs they had not returned after that date.5 But it had started to build the background infrastructure for streaming as early as 2002, by partnering with media device companies offering set-top boxes to get them to include a Netflix button that their customers could use to project Netflix content to the TV.6

Once it had built the necessary online infrastructure, Netflix made the first move to offer streaming content to its existing subscribers—for free! Moreover, like all its existing DVD content, Netflix wanted to have the rights to stream the content without restrictions (as opposed to a pay-as-you-go model).

In 2007, Netflix introduced its “watch instantly” feature, which enabled its subscribers to stream any one of Netflix’s 12,000 movies and TV shows on their personal computers. This was available for free to all Netflix’s DVD-by-mail subscribers.

To expand its selection of movies, Netflix struck a four-year deal with Starz in 2008, for an estimated value between USD20 million and USD30 million.7 Starz, HBO, and other similar channels negotiated with studios for the rights to broadcast a bundle of older movies, including some recent releases, for a predetermined time— typically three years. Starz would try to recover its investments through cable or satellite customers who would pay an additional $10.00 to their cable provider to be able to watch the movies when Starz broadcast them (maybe twice a month). In contrast, Netflix’s subscribers had unconstrained access to movies during the four- year term. This deal effectively tripled the number of movies available to Netflix subscribers, including hits like Spiderman 3 and Ratatouille.

3 Brooke Besley, “How Netflix Uses Information Technology,” Brooke Besley’s Blog, November 16, 2013, https://blogs.ubc.ca/brookebesley/2013/11/16/how-netflix-uses-information-technology/ (accessed Jul. 14, 2023).
4 “The Multifaceted Strategy of Netflix,” Prophets of Profit (blog), Editorial Board of the Department of Economics, Indraprastha College for Women, University of Delhi, January 21, 2020, https://arthagyaipcw.wordpress.com/2020/01/21/the-multifaceted-strategy-of-netflix/ (accessed Jul. 14, 2023).
5 Weston Blasi, “DVD Giveaway: Netflix to Let People Keep the DVDs They Rented,” MarketWatch, August 23, 2023. https://www.marketwatch.com/story/dvd-giveaway-netflix-to-let-people-keep-the-dvds-they-rented-abfd9972?mod=weston-blasi (accessed Aug. 23, 2023).
6 Patrick Kariuki, “How and When Did Netflix Start? A Brief History of the Company,” Make Use Of (newsletter), February 14, 2023, https://www.makeuseof.com/how-when-netflix-start-brief-company-history/; Siddhant Jain, “The History of Netflix—Founding, Model, Timeline, Milestones (2023 Updated),” VdoCipher (blog), March 30, 2023, https://www.vdocipher.com/blog/2017/06/netflix-revolution-part-1-history/#4 (both accessed Jul. 14, 2023).
7 Keith Nelson Jr., “Big Red Mistake: Starz Calls 2008 Deal with Netflix ‘Terrible,’” DigitalTrends, December 10, 2014, https://www.digitaltrends.com/movies/starz-ceo-netflix-terrible/ (accessed Jul. 14, 2023). USD = US dollars.

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Rerun TV

To retain and attract new subscribers, Netflix next turned to a different type of content: older TV shows. The demand for older TV shows was well known, given the success of Nickelodeon, a TV channel. Much like the Starz deal, Netflix acquired the rights to stream these TV shows in an unlimited fashion for a specified period. What Netflix offered its streaming customers was the option to watch popular TV serials in a single sitting (which would come to be known as binge-watching8). Netflix leveraged its knowledge about customer preferences to acquire older TV shows such as Mad Men and Breaking Bad and created an unprecedented level of engagement with “rerun TV.”

Netflix’s own cinematic content

To offer more recent cinematic content, Netflix tried to renew its contract with Starz in 2011, reportedly for USD300 million, but Starz rebuffed the offer. While it sought out content from other studios, in 2012 Netflix decided to stake a claim for developing its own movies and TV series, despite the skepticism of many industry observers about Netflix’s ability to succeed in creating original content.9 The first Netflix Original movie, Lilyhammer, started streaming exclusively on February 6, 2012. Only partially funded by Netflix, Lilyhammer had premiered in Norway and was very popular there; it was also mainly in English. It illustrates the strategy, reinforced by algorithms, that Netflix used to acquire content inexpensively while having a pretty good idea that it was likely to be popular in the United States. Following Lilyhammer, Netflix started to produce its own shows and movies, many of which were critically acclaimed and became magnets for new subscribers.

Data analysis and algorithms in content creation

While Netflix positioned itself as an entertainment company, its proprietary technology and data-driven analysis was core to its decision-making. The proprietary technology enabled it to collect extensive data on user behavior, which it used to create algorithms that informed content recommendations to users and gave Netflix insights into which shows and movies to produce and renew, increasing its return on investment (ROI).

Processing all the subscriber data, the over-the-top (OTT) providers, such as Netflix, created the idea of classificatory imagination: viewing the world through a lens of genres, labels, and categories that helped shape customers’ own identities and sense of belonging in the digital world. Users were becoming hyperspecific, unlike in the past, when they had a handful of options to select from. Their preferences were saved in the form of metadata. Netflix’s algorithm began by identifying trending and popular programs in a local area (from Lilyhammer to Squid Game) and then promoted the content that matched the categories that a customer (in any country) was interested in.

This insight into classificatory imagination helped Netflix create new content that was budget friendly and had a high probability of connecting with its subscribers. Long-term Netflix viewers could relate to popular thrillers such as The Guilty, which were shot around one star and almost entirely in one location. Basically, this allowed Netflix to use its content budget much more effectively and efficiently than its competition. Because of this efficiency, Netflix could afford to run a scripted show (as opposed to reality TV) for as little as three seasons, compared to six seasons for a traditional broadcaster. Of course, the lure of new content attracted new subscribers and reduced churn. As of 2023, Netflix was increasingly using artificial intelligence (AI) to make informed decisions on building the right content with a limited budget.10

8 https://www.vdocipher.com/blog/2017/06/netflix-revolution-part-1-history/.
9 Nikki Finke, “Starz Won’t Renew Content Deal with Netflix,” Deadline, September 1, 2011, https://deadline.com/2011/09/starz-wont-renew- content-deal-with-netflix-166068/; Nathan Ingraham, “Netflix’s First Original Series ‘Lilyhammer’ Is Now Available for Streaming Users,” TheVerge, February 6, 2012, https://www.theverge.com/2012/2/6/2775007/netflix-first-original-series-lilyhammer-available (both accessed Jul. 14, 2023).
10 Christopher Mims, “How Netflix’s Algorithms and Tech Feed Its Success,” Wall Street Journal, July 28, 2023, https://www.wsj.com/articles/how- netflixs-algorithms-and-tech-feed-its-success-90632b92 (accessed Aug. 13, 2023).

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The algorithms that informed scripted content also helped Netflix negotiate with actors and writers better than other streaming services. In the early 2020s, Netflix started to privately share more of this data with actors and writers to determine fair compensation and residuals. This decision was also based on the expectation that the content creators would incorporate viewer tastes and classificatory imagination in the content while minimizing production costs.

Debt financing

To finance its content, Netflix took advantage of its high stock price and offered debt (see Exhibit 1); however, this increased its financial leverage significantly beyond that of other high-technology companies like Amazon. To maintain its high debt level, Netflix aggressively promoted its stock price by touting its future potential.11 So long as Netflix’s stock price remained elevated, it could secure debt financing at a reasonable interest rate. The main metric the stock market focused on was growth in subscriptions.

It secured a second source of financing by spinning off streaming as a separate service that was no longer available for free for the DVD-by-mail subscribers. This led to a large number of subscribers canceling the service and a steep decline in Netflix’s stock price in 2011. Yet although Netflix apologized to its subscribers, it never changed course. In retrospect, this de facto increase of the subscription by 100% was necessary to finance new content.

Increased utilization of existing content

Netflix adopted two broad strategies to increase utilization of its existing content. First, it created a social media team that would track conversations among its subscribers to gauge the kind of content they were most interested in watching at any given time and the types of devices they preferred to use to watch it. The second strategy was to influence the viewing habits of its subscribers. These strategies are described below.

Social media engagement to promote and acquire content

Algorithms were present in almost all streaming platforms. They organized content, guided subscribers’ attention in certain directions, and kept them active on a platform. Netflix adopted a different but complementary practice. Beyond responding to what its subscribers had watched previously, it began trying to shape and influence content selection through highly specific content and genre labels (also known as label culture). By interacting with participants on social media, Netflix directed even more attention to what it knew was already popular (e.g., Squid Game). It also used social media to find what was trending and popular in a local area and used this knowledge to acquire content.12 Further, using this process, Netflix would turn shows over much faster, much like retailers would clear store shelves to accommodate higher-demand products.13

Social media department directives included prescriptions such as “entertaining instead of promoting,” “encouraging risk-takers,” and “build a world rather than clipping a show.”14 The social media department worked with show producers and creative agencies to produce content with the motto “make being a fan more

11 Emily Bary, “Netflix Talks the Long Game but Analysts Are Split on Its Future,” MarketWatch, July 17, 2020, https://www.marketwatch.com/story/netflix-talks-the-long-game-but-analysts-are-split-on-its-future-2020-07-17 (accessed Jul. 14, 2023).
12 Jeff Beer, “Inside the Secretly Effective—and Underrated—Way Netflix Keeps Its Shows and Movies at the Forefront of Pop Culture,” Fast Company, February 28, 2019, https://www.fastcompany.com/90309308/by-any-memes-necessary-inside-netflixs-winning-social-media-strategy (accessed Jul. 14, 2023).
13 Josef Adalian, “Netflix Is Thinking of Ending Things,” October 8, 2020, https://www.vulture.com/2020/10/netflix-show- cancellations.html?utm_source=pocket-newtab (accessed Jul. 17, 2023).
14 https://www.fastcompany.com/90309308/by-any-memes-necessary-inside-netflixs-winning-social-media-strategy.

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fun.” Watching and listening at the right places and at the right times yielded positive results as social media users interacted with Netflix subscribers.15

Internationalization of content

Streaming companies were shifting to creating localized content. In contrast to other streaming platforms, Netflix intended to distribute its localized content (produced in the United States or other countries) internationally, beyond the local markets (in a process called “globalization of entertainment”). This meant that Netflix, which operated globally, tried to adapt its content to meet the expectations of subscribers in each country. This dramatically increased the ROI of new content.

Netflix’s first regional show, Lilyhammer, was Norwegian, but much of the dialogue was in English. Throughout its history, Netflix has repurposed and created “international buzz” for content it acquired from different countries. Examples include Lupin, from France, and Squid Game, from South Korea. Internally the message was “build out the world.”16 For example, Italian children’s positive reaction to the American TV series Happy Days prompted Netflix to open an Italian office to massively fund original local content based on why Happy Days had resonated with the Italian audience. Netflix would then take the new Italian content and distribute it worldwide to reach global audiences. This strategy was unique to Netflix.

Video games

Netflix had always considered Fortnite (the mobile game maker) to be a serious competitor as it hogged screen time for younger viewers. Netflix entered the video game market in November 2021.17 In contrast, Apple Arcade and Google’s Play Pass were already established on their platforms and offered a large variety of games. Netflix subscribers could download Netflix games from the Play Store and App Store for free, without in-app purchases or ads. The idea was that the games would keep existing subscribers engaged and thus less likely to unsubscribe. The games could also, in theory, help drive new subscriptions.18 Netflix had only 26 games as of August 2022. But it offered several popular games such as Exploding Kittens and Into the Breach. It had also managed to modify popular games like League of Legends into video content. Netflix executives thought if its subscribers watched Stranger Things, then they would be more engaged if they had the option to play Stranger Things, the game.19 The games did not seem to have a material influence on subscriber defection, as only
23.3 million downloads were observed as of August 2022. In contrast, it was estimated that Fortnite had 500 million downloads in the first six months of 2023 alone.20 It is important to note the Netflix games were not set up for the in-app purchases (microtransactions) that drove profitability for most video games. In August 2023, Netflix started beta testing video games over a broad range of devices in Canada and the United Kingdom.21

15 Netflix (@netflix), “.@YouNetflix is kinda awkward when you remove Joe’s voiceover,” Twitter, February 4, 2019, 3:01 p.m., https://twitter.com/netflix/status/1092513594317520896; David Beer, “How Netflix Affects What We Watch and Who We Are—And It’s Not Just the Algorithm,” The Conversation, October 14, 2021, https://theconversation.com/how-netflix-affects-what-we-watch-and-who-we-are-and-its-not- just-the-algorithm-169897 (both accessed Jul. 17, 2023).
16 Paolo Sigismondi, “Netflix’s Big Bet on Foreign Content and International Viewers Could Upend the Global Mediascape—And Change How People See the World,” The Conversation, April 7, 2021, https://theconversation.com/netflixs-big-bet-on-foreign-content-and-international-viewers- could-upend-the-global-mediascape-and-change-how-people-see-the-world-156629 (accessed Jul. 17, 2023).
17 Jon Gilbert, “Netflix Games: Will Its Mobile Gaming Strategy Work Out?,” Android Police, August 10, 2022, https://www.androidpolice.com/netflix-games-will-its-mobile-gaming-strategy-work-out/ (accessed Jul. 17, 2023).
18 Peter Kafka, “Why Netflix Is Getting into Games,” Vox, July 20, 2021, https://www.vox.com/recode/2021/7/20/22586084/netflix-gaming- strategy-earnings-explained (accessed Aug. 11, 2023).
19 https://www.vox.com/recode/2021/7/20/22586084/netflix-gaming-strategy-earnings-explained.
20 “Inside the Numbers: Fortnite Download Statistics,” Active Player (blog), https://activeplayer.io/inside-the-numbers-fortnite-download- statistics/#:~:text=Fortnite%20Total%20Download%20Count%20in%202023&text=No%20official%20record%20shows%20the,than%20400%20m illion%20registered%20users (accessed Aug. 11, 2023).
21 Bill Peters, “Netflix Starts Testing Videogames on TVs and Computers,” MarketWatch, August 15, 2023, https://www.marketwatch.com/story/netflix-is-testing-videogames-on-tvs-and-computers-209c3b92?mod=mw_latestnews (accessed Aug. 14, 2023).

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Pricing strategy

During the COVID-19 pandemic, Netflix increased prices in the United States and Canada for the second time,22 while lowering the price in India.23 The US increases led to decreased subscription growth but increased revenue. The basic plan in India would now cost just USD2.61 (INR199) per month, a sharp decrease of 60%. The premium tier would cost USD8.51 (INR649) per month. Several factors prompted the price drop in India. In India, the conversion rate for USD1 was about INR74, which was on an uptrend (meaning Indians had to spend more rupees to buy USD1.00 over time).24 This made Netflix increasingly expensive for Indians. Netflix also faced serious competition in India from Amazon Prime Video and Disney+ Hotstar, since both had lower prices. Amazon had 19 million subscribers and cost the lowest, at USD0.78 less than Netflix’s newly reduced monthly rate. Disney+ Hotstar had 45 million subscribers and a subscription cost of USD0.55 per month less than Netflix, and it also streamed popular sports programming such as Indian Premier League cricket and English Premier League soccer. Netflix had only 4.4 million to 5 million subscribers. India was an untapped market, so companies were trying to find the right incentives to grab market share. Netflix’s strategy in India was content-focused: it created localized content for Indian audiences in Hindi and South Indian languages such as Tamil, Telugu, and Malayalam. Despite this effort, Netflix still significantly lagged behind Amazon and Disney due to higher pricing.

Advertising Model

On January 20, 2022, Netflix admitted that increased local and international competition from Disney, Apple, Amazon, and others was affecting its marginal growth. Investors were beginning to realize that Netflix should be valued as a mature stock with a potential dividend.25 Netflix reinforced this view by stating that streaming was an established business, and Netflix was self-funding its content creation. Netflix’s stock fell 20%.

Netflix had taken some actions concurrent with this price drop. The minor action was a change in its subscriber pricing, described above. The major action was to decide to offer an ad-supported subscription tier starting at $6.99 a month that included a service it called “Basic with Ads.” This was $1.00 less than a similar service offered by Disney and was scheduled to be released one month before Disney offered its version. Existing Netflix subscribers could transition to the ad-supported plan or choose to remain in their current plan at the same price. Netflix expected no drop in revenue with ad-supported plans, but it was unwilling to say what percentage of existing subscribers it expected to switch.26 Competing streaming services (Hulu and HBO Max) had not experienced a drop-off of subscribers for ad-based plans.

The streaming industry advertising market

With the pay TV market declining by nearly 30% since 2013 (a decline of 30 million customers), advertisers had to find the subscribers who had cut the cord. The US-based TV ad market for streaming services was expected to reach USD18.9 billion, which was 27% of the USD70 billion spent on traditional TV ads, and it

22 It also changed corporate governance by removing supermajority voting provisions from its bylaws, so that shareholders would have the right to call special meetings with a standard large-cap governance structure.
23 Toni Fitzgerald, “Why Did Netflix Suddenly Drop Subscription Prices in India?,” Forbes, December 16, 2021,
https://www.forbes.com/sites/tonifitzgerald/2021/12/16/why-did-netflix-suddenly-drop-subscription-prices-in-india/ (accessed Jul. 17, 2023).
24 INR = Indian rupees.
25 Therese Poletti, “Opinion: Netflix Admits That It Is Time to Grow Up, but Wall Street Isn’t Happy about It,” MarketWatch, January 20, 2022, https://www.marketwatch.com/story/netflix-admits-that-it-is-time-to-grow-up-but-wall-street-isnt-happy-about-it-11642729667 (accessed Jul. 17, 2023).
26 Sarah Krouse, Suzanne Vranica, and Jessica Toonkel, “Netflix Is Scrambling to Learn the Ad Business It Long Disdained,” Wall Street Journal, August 3, 2022, https://www.wsj.com/articles/netflix-ads-plan-streaming-business-11659538834 (accessed Jul. 17, 2023).

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was expected to grow to USD33.5 billion by 2025.27 Some TV subscribers had migrated to the streaming market, which made an ad-supported streaming market very attractive to advertisers. In a proof of concept, Hulu had expertly exploited this trend (see Exhibit 2). Netflix was particularly attractive, as it had a subscriber base that was young and affluent but had previously been unavailable, given Netflix’s no-advertising policy.28

How the ads might benefit advertisers

Advertisers on Netflix would have a lot of flexibility in choosing ads that would target customers based on content genre, such as action or comedy, as well as country of residence. Advertisers could also choose not to participate in a genre that they found offensive. Further, advertisers could reach audiences that spent hours binge-watching. Subscribers could expect to view 15- or 30-second ads, totaling 4 or 5 minutes per hour. This was much less than the 18 to 23 minutes of advertising per hour that was common in broadcast TV.29 In order to improve the efficacy of targeted ads, Netflix would collect additional demographic information, such as gender or birth date, from ad-tier subscribers. But licensing restrictions would reduce the content that would be available to the ad-tier subscribers, as well as their ability to download content.30

To assure advertisers of the validity of its viewing statistics, Netflix was going beyond the typical Nielsen measurements. It used DoubleVerify Holdings and Integral Ad Science Holding Corp. to verify its actual viewership.31

Netflix planned to limit to USD20 million the annual expenditure by any brand advertising on its ad- supported tier, to ensure its subscribers saw a variety of advertisements.32 It claimed to have sold out all its ad inventory during its initial launch.33

Advertising financial model

Netflix extended its practice of acquiring content for unlimited distribution for a given time (as opposed to a pay-as-you-go model) when negotiating with advertiser buyers. Netflix was renegotiating deals with major studios such that most content could be run with ads.34 Netflix wanted ad buyers to commit to a given period (a minimum of one year) with a minimum amount of ad purchases during that time.35 Beyond the minimum purchase, Netflix expected to charge USD80.00 per 1,000 views of an advertisement. Netflix expected to make the case that it could help advertisers target very specific audiences, given its knowledge about customer preferences. Netflix financial statements are available in Exhibits 3 and 4.

27 Suzanne Vranica, “Netflix and Other Streaming Platforms Are Embracing Ads—but Will the Advertisers Love Them Back?,” Wall Street Journal, October 18, 2022, https://www.wsj.com/articles/netflix-streaming-ads-advertisers-money-11666035099 (accessed Jun. 3, 2023).
28 Megan Graham and Patience Haggin, “Madison Avenue Loves the Idea of a Netflix with Ads,” Wall Street Journal, April 20, 2022, https://www.wsj.com/articles/madison-avenue-loves-the-idea-of-a-netflix-with-ads-11650489712?mod=article_inline (accessed Jul. 17, 2023).
29 Suzanne Vranica, “Netflix Seeking Top Dollar for Brands to Advertise on Its Service,” Wall Street Journal, August 31, 2022, https://www.wsj.com/articles/netflix-seeking-top-dollar-for-brands-to-advertise-on-its-service-11661980078 (accessed Jul. 17, 2023).
30 Sarah Krouse, “Netflix’s Ad-Supported Plan Will Launch in November at $6.99 a Month,” Wall Street Journal, October 13, 2022, https://www.wsj.com/articles/netflix-ads-to-launch-in-november-11665680110 (accessed Jul. 17, 2023).
31 https://www.wsj.com/articles/netflix-ads-to-launch-in-november-11665680110.
32 https://www.wsj.com/articles/netflix-seeking-top-dollar-for-brands-to-advertise-on-its-service-11661980078.
33 https://www.wsj.com/articles/netflix-ads-to-launch-in-november-11665680110.
34 Suzanne Vranica and Sarah Krouse, “Netflix Locked Out Advertisers for Years, but Now Brands Have Big Plans,” Wall Street Journal, July 19, 2022, https://www.wsj.com/articles/advertisers-were-locked-out-of-netflix-for-years-now-they-have-big-plans-11658223002 (accessed Aug. 12, 2023).
35 https://www.wsj.com/articles/netflix-seeking-top-dollar-for-brands-to-advertise-on-its-service-11661980078.

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Advertising capabilities needed

Having ignored advertising-based plans for its entire history, Netflix suddenly found itself following streaming competitors that had already incorporated advertising in their businesses. And these were serious competitors such as HBO Max, Amazon Prime Video, Disney+, Hulu, Paramount+, and Apple TV+.36

Netflix needed advertising expertise in its senior leadership, and it sought partnerships with several organizations to help start the advertising business. One of the earliest partners was Microsoft. Although it had very limited exposure to the ad business compared to Google and Comcast, Microsoft did not have a streaming business (unlike Google or Comcast) that might compete with Netflix; however, Microsoft promised a guaranteed ad revenue to Netflix that may have sealed the deal.37 While Comcast had a competing streaming service, it stressed its willingness to partner with Netflix and even developed a pitch for Netflix’s ad business under the code name “Calamari,” which alluded to the highly popular “Squid Game.”38 Comcast was willing to leverage its ad-serving technology from its FreeWheel video ad unit and even offered the services of NBCUniversal’s sales team. While these negotiations were going on, Netflix targeted two senior leaders from Comcast to head its senior leadership for advertising.39 Ultimately, however, Netflix hired Jeremi Gorman and Peter Naylor from Snap.40

Monetizing existing subscribers

Apart from ad revenues, Netflix had to consider how much revenue it could get from its existing subscribers, and what future growth of such revenue might look like. One problem with both existing and future subscribers was that part of the subscriber pool was not contributing new revenues to Netflix because of password sharing. Also, according to new research from Antenna, the percentage of new subscribers who continued their subscription was dropping (78% in May 2022, down from 83% in 2021). It was possible that a recent price increase for the US market contributed to this change. Instead, Netflix had reduced prices across many of its international markets. This might have resulted in a larger-than-expected growth in subscribers, but its global average revenue per user declined to USD11.49 in the final quarter of 2022, from USD11.74 a year earlier.41

Content and existing practice

In the past, Netflix had always released all episodes of a given series at once; however, it seemed to be considering staggering the releases of the more popular programs, like other traditional networks and streaming providers did. This might be geared toward reducing subscriber churn.42

Cost-cutting measure43

To cut costs, Netflix was reducing the number of copies of the content it made available across its global footprint. After establishing a norm of hiring senior people, the company was hiring more fresh and junior engineers. Employees were now restricted to ordering USD300 or less in company-branded perks such as mugs

36 https://www.wsj.com/articles/netflix-ads-plan-streaming-business-11659538834.
37 “Netflix Reworks Microsoft Pact, Lower Ad Prices,” Reuters, July 27, 2023, https://www.reuters.com/technology/netflix-reworks-microsoft-pact- lowers-ad-prices-wsj-2023-07-27/#:~:text=July%2027%20(Reuters)%20%2D%20Netflix,Street%20Journal%20reported%20on%20Thursday. (accessed Aug. 15, 2023).
38 https://www.wsj.com/articles/netflix-ads-plan-streaming-business-11659538834.
39 https://www.wsj.com/articles/netflix-ads-plan-streaming-business-11659538834.
40 https://www.wsj.com/articles/netflix-seeking-top-dollar-for-brands-to-advertise-on-its-service-11661980078.
41 https://www.wsj.com/articles/netflix-cuts-subscription-prices-in-over-30-countries-ae6d047c.
42 https://www.wsj.com/articles/netflix-ads-plan-streaming-business-11659538834.
43 Sarah Krouse and Jessica Toonkel, “Netflix Hunts for Cost Cuts, from Cloud Computing to Corporate Swag,” Wall Street Journal, September 7, 2022, https://www.wsj.com/articles/netflix-hunts-for-cost-cuts-from-cloud-computing-to-corporate-swag-11662565220 (accessed Jul. 17, 2023).

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or sweatshirts. The company was also getting rid of real estate assets such as its building in Salt Lake City. And it became more careful about the software it used for everything from content creation to scheduling meetings. Employees had also been told to limit the number of licenses for any software they used.

Netflix was also removing some features like the “surprise me” button (like Google’s “I am feeling lucky” option), whereby Netflix simply started playing a movie or show based on the user’s past viewing habits. While this might save some costs, it might fall more broadly under focusing on user experience and what users were or were not using; however, Netflix still offered the highly popular option of skipping credits before or after a show.44

Latest developments

In June 2023, Nielsen reported that Netflix had captured 8.2% of TV viewing, which was second only to YouTube among streamers. In July 2023, Netflix reduced the price for ads from $39 to $45 per 1,000 views, compared to $45 to $55 earlier. These new rates were more in line with what other streaming services charged. Simultaneously, Netflix was also renegotiating its contract with Microsoft. Published reports suggested that while Microsoft abided by its commitment, Netflix thought Microsoft had not made much effort to ramp up ad sales.45 Instead, Netflix claimed that ad revenue was not that critical and did not expect it to be a significant portion of its revenue. Despite this, Netflix stock fell when the second-quarter revenue missed expectations. This was surprising because Netflix had added six million subscribers—the previous metric by which the stock market had priced the stock.

Netflix requested patience from advertisers and actively interacted with them at the Cannes Lions International Festival of Creativity (a prestigious advertising event) in June 2023—a far cry from the days when Netflix and ads were not mentioned in the same breath. Netflix was also making it easier for advertisers to buy ad space, and it was in talks with advertising technology (ad-tech) companies, such as Comcast’s FreeWheel and Trade Desk, to sell Netflix ad space to attract more advertisers that did not directly deal with Netflix or its partner Microsoft. Would the ad business make a difference or remain a footnote for Netflix?

44 Katie Deighton, “Netflix Sunsets ‘Surprise Me’ Shuffle-Play Button,” Wall Street Journal, February 14, 2023, https://www.wsj.com/articles/netflix- sunsets-surprise-me-shuffle-play-button-6d29cf2a (accessed Jul. 17, 2023).
45 Suzanne Vranica, Jessica Toonkel, and Patience Haggin, “Netflix Reworks Microsoft Pact, Lowers Ad Prices in Bid for Growth,” Wall Street Journal, July 27, 2023, https://www.wsj.com/articles/netflix-reworks-microsoft-pact-lowers-ad-prices-in-bid-for-growth-159b359a (accessed Aug. 15, 2023)

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Exhibit 1
Netflix Moves into Ad-Supported Streaming: Cause for Concern or a Normal Transition?
Netflix Debt and Equity

Source: Created by author based on “Netflix Debt to Equity Ratio 2010–2023 NFLX,” Macrotrends, https://www.macrotrends.net/stocks/charts/NFLX/netflix/debt-equity-ratio (accessed July 20, 2021)). Note: the reader can replace the Netflix ticker by AMZN to compare the debt financing.

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Exhibit 2
Netflix Moves into Ad-Supported Streaming: Cause for Concern or a Normal Transition?
Streaming-Service Pricing, Monthly

WITH ADS    WITHOUT ADS

Apple TV+ Not Offered $ 4.99
Discovery+ $ 4.99 $ 6.99
Disney+ $ 7.99
Prime Video $ 8.99
Starz $ 8.99
Paramount+ $ 4.99 $ 9.99
Peacock $ 4.99 $ 9.99
Netflix $ 6.99 $ 9.99
Showtime $10.99
Hulu $ 7.99 $14.99
HBO Max $ 9.99 $14.99
ESPN+ $ 9.99

Note: Prices were for each individual service and as of October 13, 2022. Ad-free price for Netflix shows the lowest available option, with launch expected in November 2022. In December 2022, Disney+ was expected to launch an ad- supported tier for $7.99 a month and to raise the price of its ad-free tier to $10.99.

Source: Created by author based on Sarah Krouse, “Netflix’s Ad-Supported Plan Will Launch in November at $6.99 a Month,” Wall Street Journal, October 13, 2022, https://www.wsj.com/articles/netflix-ads-to-launch-in-november-11665680110 (accessed Aug. 28, 2023).

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Exhibit 3
Netflix Moves into Ad-Supported Streaming: Cause for Concern or a Normal Transition?
Netflix Income Statement (unaudited), 2022 (in thousands of US dollars, except per-share data)

Twelve Months

Ended December 31,
2022
Revenues 31,615,550
Cost of revenues 19,168,285
Marketing 2,530,502
Technology and development 2,711,041
General and administrative 1,572,891
Operating income 5,632,831
Other income (expense):
Interest expense (706,212)
Interest and other income (expense) 337,310
Income before income taxes 5,263,929
Benefit from (provision for) income taxes (772,005)
Net income 4,491,924
Earnings per share:
Basic 10.10
Diluted 9.95
Weighted-average shares of common stock outstanding:
Basic 444,698
Diluted 451,290

Source: Netflix annual report, 2022.

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Exhibit 4
Netflix Moves into Ad-Supported Streaming: Cause for Concern or a Normal Transition?
Netflix Balance Sheet (unaudited), 2021 and 2022 (in thousands of US dollars)

December 31,    December 31,
2022    2021

Assets
Current assets:
Cash and cash equivalents 5,147,176 6,027,804
Short-term investments 911,276 –
Other current assets 3,208,021 2,042,021
Total current assets 9,266,473 8,069,825
Content assets, net 32,736,713 30,919,539
Property and equipment, net 1,398,257 1,323,453
Other non-current assets 5,193,325 4,271,846
Total assets 48,594,768 44,584,663
Liabilities and Stockholders’ Equity
Current liabilities:
Current content liabilities 4,480,150 4,292,967
Accounts payable 671,513 837,483
Accrued expenses and other liabilities 1,514,650 1,449,351
Deferred revenue 1,264,661 1,209,342
Short-term debt – 699,823
Total current liabilities 7,930,974 8,488,966
Non-current content
liabilities 3,081,277 3,094,213
Long-term debt 14,353,076 14,693,072
Other non-current liabilities 2,452,040 2,459,164
Total liabilities 27,817,367 28,735,415
Stockholders’ equity:
Common stock 4,637,601 4,024,561
Treasury stock at cost (824,190) (824,190)
Accumulated other comprehensive income (loss) (217,306) (40,495)
Retained earnings 17,181,296 12,689,372
Total stockholders’ equity 20,777,401 15,849,248
Total liabilities and stockholders’
equity 48,594,768 44,584,663
Source: Netflix annual report, 2022.