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Hulu's Price Cuts Will Fuel Its Revenue Growth

Adam Levy, The Motley Fool

Hulu started charging new and existing subscribers just $5.99 per month for its ad-supported plan last month. That's down $2 per month from its previous standard pricing.

The company also recently revamped its partnership pricing with Spotify, so individual Spotify subscribers can also receive Hulu for the same $9.99 per month they normally pay for Spotify. That's down from $12.99 per month. Most of that discount is likely coming out of Hulu's end following the price drop for direct subscribers.

Disney (NYSE: DIS) will soon own a majority stake in Hulu.

But unlike competing streaming platform Netflix (NASDAQ: NFLX), Hulu has ads. And the additional scale provided by its lower pricing ought to push ad revenue growth a lot higher -- high enough to more than offset the lost subscription revenue.

Hulu's logo made out of plants on a wooden background

Image source: Hulu.

Getting subscribers to love ads

There's a loud minority of people that hate advertisements, but the majority of people don't mind seeing ads in the middle of their shows, especially if they're getting a deal. Fifty-six percent of respondents in a recent Interactive Advertising Bureau survey said they don't mind seeing ads if they're paying a reduced fee (e.g., $5.99 vs $11.99). That number climbs to 63% when viewers pay nothing (e.g., "free" with Spotify).

Hulu's pricing is taking advantage of this behavior in order to make ads more digestible. Consumers that may have objected to the ad-supported service before may happily sit through ads at its new pricing.

eMarketer expects the change to double its ad revenue growth rate over the next two years. The research firm now expects Hulu's ad revenue to grow an average of 24% per year over the next two years, compared to its 11.4% growth forecast before the price change.

That growth rate forecast is still well below the 45% increase in advertising revenue Hulu posted last year. And eMarketer doesn't give much reason for a slowdown. There's still a lot of room for Hulu to grow its subscriber count.

It has just 25 million subscribers compared to nearly 60 million U.S. subscribers at Netflix. It added around 8 million subscribers last year, and it would be surprising if its content and pricing investments didn't result in at least that many again this year.

eMarketer's forecast implies reduced average ad revenue per subscriber, which doesn't quite add up. Hulu is increasing the total number of advertisers on its platform, adding new ads during paused videos, and offering more valuable ad products to marketers. All of those should result in higher ad revenue per user. The change in eMarketer's forecast is driven by the expectation of increased account sign-ups, which can help inform one's own expectations for the company.

Three benefits of a larger on-demand streaming audience

There are a few big benefits Hulu gains from growing its subscriber base.

The first is the benefits of scale. Hulu spends billions of dollars on content every year. The more subscribers it has, the more it can spread those costs around. That's especially pertinent as Disney plans to expand into more original content, where it bears more expenses up-front.

Netflix's entire business model revolves around scale. Chief Content Officer Ted Sarandos said scale "definitely changes the economics in terms of licensing films in later windows versus producing films which is a more kind of front-loaded cash activity, but has a much better payback for us," during the company's fourth-quarter earnings call. Hulu could see similar benefits.

The second benefit of greater scale is that Hulu becomes more attractive to more advertisers. Hulu said that it grew active advertisers 50% last year. If Hulu can provide the same potential reach as some of the biggest cable networks, but with the ad-targeting capabilities supported by digital advertising, it should be able to drive increased interest in its ad products. With more marketers looking to advertise on Hulu, ad prices should climb.

Finally, Hulu's ability to get customers into its ecosystem via its partnership with Spotify or its cheaper ad-supported streaming option gives it a chance to upsell customers to its Live TV service. Hulu's live service has around 2 million subscribers already and it's on pace to become the most popular linear TV streaming service this year.

Hulu's price cuts ought to provide benefits in both the short term in the form of increased ad revenue, as well as the long term in the form of a stronger ecosystem of content, advertisers, and high-end subscribers.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool has a disclosure policy.