Ads are where the real money is made

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4 min
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As the team's Capital Markets Analyst, Jacob conducts market and investment research and assists in the development of business strategy to serve our clients more effectively.
June 30, 2023

In an era of free money it didn’t matter if the streaming companies, or any other company, had actual earnings to show for their efforts. All that mattered was that the subscriber count was growing and the revenue was growing. This was the growth at all costs mentality.

Earnings and stock prices of giant media companies.

Now in the era of no more free money these companies are being forced to find profitability in their services. But the catch is the à la carte streaming business model is fantastic for the consumer and rather terrible for the business.

Traditionally your favorite movies and TV shows are funded by the advertisers. The more successful a show becomes the more expensive the ad space is because of the demand to be placed on that show. The production of the show will continue until the viewer numbers drop or the advertisers drop because of the drop in viewership. It’s a platform for viewers and advertisers to coexist, similar to the internet, newspapers, and magazines.

If you can’t see the problem, this is it. At a $11/month for Disney Plus, $15.50/month for Netflix, and $10/month for Peacock these streaming businesses can’t push out the quality and quantity of content without sacrificing their earnings. So either they have to figure out how they can charge more for the subscriptions or they have to figure out how to introduce advertisers to their platforms.

But here’s a major problem.

Ad-free to ad-supported tv streaming subscribers.

People obviously don’t want ads if the cost of the ad-free subscription is only modestly higher than ad-supported subscription.

In most cases, 50% or more are paying for the premium ad free versions of these platforms, which is largely unsustainable from a future business standpoint.

So how do you get them to switch, and boost your profitability?

I think everyone thought that these companies were introducing ad-supported tiers to help them grow subscribers.

But here’s my thought, if people truly wanted your service they would already be buying it.

I believe they are introducing these tiers to try and convert their premium subscribers into ad-supported subscribers, which is the more profitable version. It is almost poetic that Netflix is starting to kill the basic-no ads option.

If they can charge you $8/month and the advertiser an equivalent of $40/month to be placed in front of you that is obviously better than $15/month for ad-free subscriptions.

Disney is trying to fold Hulu into Disney Plus. Hulu has a ton of ad-supported subscribers.

It would not be surprising to me if these companies start to bid up the price on their ad free options to the breakeven with ad supported revenue. Which, I assume would be much higher.

This report from 2019 says that Hulu’s $2/month ad tier is it’s most profitable tier.

The investing case for this is that earnings, revenue, and profit margins should improve, if everything goes to plan, in these companies and subsequently the stock prices should also improve. However, this is a comeback story not a innovation story.

All of these companies had to learn the hard way that their way didn’t work. They burnt billions of dollars trying to make it work and have this new challenge.

The risks are that nobody switches, which causes advertisers not to show up, which means that those who do switch are no longer bringing in as much revenue leading to lower profits, lower revenues, and worsening margins. That of course means a damaged stock price.

These companies have a lot riding on this working, and if you are an investor you need to understand that this is not a riskless bet, and actually has a deeper set of risks that many can comprehend.

I think it is very important to recognize that this may take years to play out and work.

Maybe if you are a investor and a customer you should consider switching to the ad-tier.

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