There has been a lot of talk recently about Netflix (NASDAQ:NFLX) potentially running ads on its platform to promote awareness regarding its plethora of original content. The way they strike the balance on ads will have a significant impact on Netflix stock.
The streaming giant experimented with original content ads in the United Kingdom earlier this year. Social media response wasn’t great. Users weren’t happy. And, to corroborate the angered sentiment, a recent survey found that a quarter of Netflix subs would leave the platform if the traditionally ad-free service adopted advertisements.
In other words, the consensus is that Netflix shouldn’t run ads. It would be disastrous for business, and would cause a huge drop in Netflix.
But, that oversimplifies the issue.
In reality, Netflix shouldn’t run ads in the way everyone is speculating they should run ads. That is to say that Netflix shouldn’t run ads on its paid platform. If users are paying for something, it should be ad-free. Plus, those paying customers are already used to an ad-free experience, and disrupting that experience could cause huge churn.
Instead, Netflix should create a free, ad-supported tier. Importantly, that tier should be limited from a content standpoint. The goal of that tier shouldn’t be to sustain ad-supported users. Instead, it should be to create greater awareness for the Netflix original content portfolio outside of the current consumer base, and turn potential customers into paying subs.
From this perspective, Netflix should run ads. If they do launch a free, ad-supported tier with limited content, I reasonably see that being a big driver for sub growth and Netflix stock over the next several years.
The Free Netflix
When it comes to Netflix and advertisements, there seem to be two popular theories out there:
- Netflix should run ads on its paid platform that help promote greater awareness of original content.
- Netflix should create a free, ad-supported version of Netflix, like YouTube.
I don’t think either of those popular theories are right. Instead, I think the best path forward for Netflix is a blend of the two theories: launch a free, ad-supported and limited content version of Netflix with the intention of using that as a teaser to turn potential customers into paying subs.
Why do this? Netflix doesn’t want to get into the advertising game. The company already makes nearly $10 per month per user. Netflix would never be able to get that sort of rate in the advertising world, so opening up an unabridged, free, ad-supported tier of Netflix would likely dilute profits.
Also, Netflix doesn’t want to scare away its loyal customer base, which has fallen in love with the ad-free experience.
In the meantime, though, Netflix is spending an arm and a leg on original content. And, the company does need to advertise that content. But, not to subscribers.
After all, those subscribers are already paying for Netflix’s services. They already like what they are seeing, and are paying up for it. They don’t need to be educated about the value of Netflix.
That education needs to happen outside of the Netflix subscriber base. It needs to happen everywhere else, where consumers are considering Netflix but haven’t yet pulled the trigger.
The solution? A free, ad-supported tier with limited content. You make it free so anyone can have access to it. You run original content ads so that interested customers are educated about Netflix’s wealth of content. And, you limit content to promote interested customers to pay up for the real deal.
What does this look like? Just like Netflix. But, you can only watch the first show of any series, and the first 20 minutes of any movie. You are also forced to watch previews before each viewing.
What It Could Mean for Netflix Stock
The aforementioned free and abridged Netflix could move the needle for Netflix stock.
Anyone who follows Netflix knows that this stock trades off of subscriber numbers. If the subscriber numbers are good, NFLX roars higher. If the subscriber numbers are bad, NFLX drops like a rock.
A free and abridged Netflix would undoubtedly cause a huge boost in Netflix subscriber growth.
Why am I confident in this? Because I’m confident in Netflix’s original content and value prop. Despite hiking prices, the Netflix churn rate has remained relatively low.
The reason for that is because once people get hooked on a Netflix series, they can’t stop watching it. And, importantly, they will pay up to keep watching it.
The same dynamic will happen with a free, ad-supported and abridged version Netflix. The most likely outcome from the launch of such a product will be a bunch of potential customers use it, most of them find a show or multiple shows they love, they realize they can’t get watch that show anywhere else, and so they sign up for the paid version of Netflix.
The result? A huge influx of Netflix subs, the likes of which could power Netflix stock substantially higher.
Bottom Line on NFLX Stock
Netflix stock is a winner. But, that winning streak could get an extra boost if this company does launch a free, ad-supported tier that has limited content. In so doing, Netflix will turn interest into action, and see its subscriber numbers soar. Soaring sub numbers usually lead to a soaring Netflix stock, and as such, this free tier could be a major catalyst for the stock.
As of this writing, Luke Lango was long NFLX.
