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If Netflix Ran Advertising, the Results Could Be Catastrophic

Danny Vena, The Motley Fool

As consumers increasingly abandon linear TV for internet programming, the changing media landscape has given birth to a number of different streaming models. While Netflix (NASDAQ: NFLX) has always fervently adhered to an ad-free strategy, some services like Hulu have adopted a multitiered offering. Hulu offers a limited commercials plan at $7.99 per month, and a no commercials plan for $11.99. This combination provides the platform with multiple revenue streams and greater optionality for subscribers. 

Over the years, there have been suggestions that Netflix should at least consider adding advertising to its model. That would be a huge mistake, with a recent survey suggesting that the resulting subscriber losses could be catastrophic.

Woman sitting wearing headphones smiling and looking at tablet.

Image source: Getty Images.

Survey says...

A recent study conducted by Hub Entertainment Research found that if Netflix began running advertising, roughly 23% of customers said they would "definitely" or "probably" cancel their subscription. That compares to 41% who would "definitely" or "probably" keep the service, even if Netflix ran advertising. A significant number -- 37% -- said they were "undecided" as to how they would proceed if Netflix began running commercials. For reference, Netflix currently counts 130 million subscribers worldwide, with about 57 million of those in the U.S. 

There's still clear demand for a service like Hulu. Of those surveyed, 51% said they preferred the free, ad-supported model, though that dropped to 43% if the ability to fast-forward through advertising was disabled, and nearly half, or 46% of respondents, would rather pay for a subscription than endure advertising.

While Netflix has shown a significant amount of price elasticity, even that has its limits. While only 8% of customers said they would cancel the service in the event of a $2 per month price increase, nearly a quarter of viewers, or 23%, said they would defect if the cost of a subscription increased by $5 per month. A $10 per month increase would cause 28% of Netflix subscribers to cancel.

Viewers expressed outrage

Some subscribers recently noticed video promos for other Netflix programming that played between episodes -- and it set off a firestorm of complaints. Users took to social media to vent their frustration about the change.

Netflix attempted to quell the outrage, saying:

We conduct hundreds of tests every year so we can better understand what helps members more easily find something great to watch ... In this particular case, we are testing whether surfacing recommendations between episodes helps members discover stories they will enjoy faster. It is important to note that a member is able to skip a video preview at any time if they are not interested. 

This reaction is likely a good barometer to subscribers' feelings about advertising on the service.

Would ads result in higher revenue?

Not everyone believes that advertising on Netflix would be a bad thing. Ampere analyst Richard Broughton even suggested that if Netflix adopted a full broadcast ad load, the company would generate $2 billion per quarter in revenue from advertisers. Assuming the 23% cancelation rate referenced in the survey, Netflix would sacrifice $900 million in quarterly revenue, but gain $2 billion from ads. 

It's important to note that this is all conjecture and fun with numbers. Netflix has repeatedly stated that it will never run traditional advertising, and it even addresses the issue in its Long Term View (emphasis mine): "We don't offer pay-per-view or free ad-supported content. Those are fine business models that other firms do well. We are about flat-fee unlimited viewing commercial-free."

As a longtime Netflix subscriber, I would personally rather pay a few extras dollars per month than suffer through commercials. As a Netflix shareholder, I don't think the company should mess with success. To quote the old saying, "If it ain't broke, don't fix it."

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Danny Vena owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.