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Netflix and Microsoft Team for Ads as Wider Consolidation Looms 

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Having signalled its intent to launch an ad-supported service earlier this year, Netflix’ announcement of Microsoft as its partner in the venture prompted immediate speculation about Redmond’s intent to buy the streamer wholesale.  

“Netflix is trying to get closer to Microsoft in hopes that, after Microsoft digests its [$68bn] Activision acquisition, it turns and buys Netflix next,” Laura Martin, Senior Analyst at investment firm Needham told Yahoo Finance

Several analysts are convinced that media and entertainment is due further consolidation. Many had pinned a move on Apple swooping for content libraries among smaller studios like Lionsgate or A&E Networks (or perhaps a FAST service like Roku). With Netflix, Microsoft would be compete directly with Apple on video content. 

The assumption is that Netflix needs deeper pockets to sustain content costs ($17bn this year) while competition intensifies and its subscription levels dip.  

The streamer is slated to report Q2 earnings on Tuesday and has warned it expects to lose 2 million subscribers. 

Microsoft and Apple could easily absorb Netflix’ $84 billion valuation. That market cap also represents almost a firesale given that the streamer was worth north of $300bn only last November. 

According to CNBC, Netflix has been interviewing potential ad-serve partners for several months, including Google and Comcast, as it prepares to launch the new tier before the end of 2022.  

Unlike Google, which owns YouTube, and Comcast, which owns NBCUniversal’s Peacock, Microsoft doesn’t operate a competing streaming service to Netflix. 

“Microsoft has the proven ability to support all our needs as we together build a new ad supported offering,” Netflix COO Greg Peters said in a statement. “More importantly, Microsoft offered the flexibility to innovate over time on both the technology and sales side, as well as strong privacy protections for our members.” 

Peters added that the ad-efforts are still in the “very early days,” with “much to work through.” 

Reading between the lines, investment analyst Tom Wilton thinks Netflix doesn't yet know how advertising will work on its platform - if at all.  

“By working with the seventh-most-popular global ad network, it will almost certainly have more say over the frequency and quality of the ads it offers,” Wilton (who blogs at financial advisor Motley Fool) told Nasdaq. “It's also possible Microsoft could give them more performance insight than they might get from bigger players. Plus, privacy protections are a bonus because Google and Meta both have muddy histories on that front.” 

Still, for both companies, the risks of failure can't be overstated. “Netflix has positioned a lower-cost ad-supported offering as a strategy to combat falling subscriber numbers,” Wilton says. “Meanwhile, Microsoft no longer operates a streaming platform on which to sell video ads. Fundamentally, this is an enormous opportunity for the two companies, but there's a chance they both might have bitten off more than they can chew.” 

Ad-supported Premium VOD Evolution 

The streamer is set to join the ranks of Peacock and HBO Max with its ad-supported offering. Disney also has plans to offer an ad-supported Disney+ subscription tier later this year. 

While a cheaper Netflix may lead to some of its existing customers paying less, an advertising-supported service could actually help with profitability.   

Comcast CEO Brian Roberts said earlier this year that the blended average revenue per user at Peacock, which already offers cheaper subscriptions with ads, is about $10 per month. That illustrates the value of advertising, given the vast majority of Peacock subscribers either pay nothing or $4.99 per month. HBO Max announced its $9.99 per month ad-supported service last year.   

Yet advertising is an inherently volatile business and the world’s markets are borderline recession. 

“The slowdown which started in the fall has accelerated in the last few months,” confirms Patrick Steel, former CEO of Politico. “We are now in a down cycle.” 

There is an inevitability about moving to cheaper ad-supported tiers but this represents a maturing of the OTT ecosystem, not one in terminal decline. After the pandemic-fueled boom, the OTT industry has reached a tipping point. Churn is endemic. 

Thirty seven per cent of U.S. consumers cancelled an SVOD service over the past six months, according to Deloitte’s 16th annual Digital Media Trends report. And as the number of services increases, so do opportunities for subscription-hopping: 33% of U.S. consumers said they had both added and cancelled a subscription over the same timeframe. 

Research from subscription management and recurring billing platform Recurly suggests that as many as 90% of consumers are concerned by inflation, while 28% of respondents said they were planning on cancelling subscriptions. 

Streamers have to do something about it. Differential content/price options are now table stakes. 

“The move to a hybrid subscription model supported by an ad tier to lower monthly costs will be a welcome option for some subscribers,” says Oscar Wall, GM, EMEA for Recurly tells Streaming Media. “Streaming platforms need to look at ways to reduce churn and take steps to improve retention. Flexibility--in monetization models, scalable services, pricing, and payment methods--and an excellent user experience are key to supporting this, alongside access to exclusive content which 36% of UK consumers say is a main reason for signing up to a service.” 

In the medium term, shifts towards hybrid monetisation methods, connected TV, AVOD, FAST channels and ad-supported SVOD will cement video’s role as the main driver of revenue between 2021 and 2026, finds PwC in its latest report. It calculates the uptake of ad-supported subscriptions and FAST channels will expand advertising on connected TV by 16.8% a year to reach $17.5bn in 2026.  

In fact, streaming video continues to only go one way: up. A recent report from Omdia reckons online video subscriptions will top 2 billion by 2027--and with pay TV subscriptions still exceeding 1 billion, the combined global total for paid video services will exceed 3 billion.  

Analyst Rethink forecasts something similar. It suggests there will $1.8 billion subscriptions to SVOD worldwide by 2027 making the market worth $171 billion. What’s more it thinks the AVOD market will be worth $91 billion in ad revenue by 2027 based on 8.6 million monthly active users. 

“Netflix will not fade but will retain its top spot with Disney second and HBO Max in third but only because Netflix will have successfully launched an ad-supported tier,” says the analyst.  Indeed, Netflix’s move into advertising could see the lines between SVOD and AVOD “completely obliterated” the analyst suggests. 

Yet others warn that subscriber churn is systemic and won’t be beaten by tinkering at the edges of streamer business models. Streaming long form content itself may be facing an existential crisis in the evolving preferences of younger generations who have grown up with social and interactive media. 

Deloitte even has cause to question the very essence of the content streamers provide. “Like TV and movies before them, SVODs have relied on the innate emotional and intellectual value of their stories to engage audiences and monetize their attention. But will people always value this kind of passive, lean-back-and-watch experience? 

“A major shift is underway, one that could radically recompose internets and economies,” Deloitte underscores. “In the integrated marketplace of the future, streamers, social media, and gaming companies could see their business models further disrupted—not just by younger generations, but also by the emerging infrastructure of Web 3.0.” 

By the end of this year, top streaming providers might look more like digital platform companies, with premium SVOD and AVOD capabilities, user-generated content, gaming properties, and social integration. 

This evolving business model, Deloitte also says, “will likely test the willingness of shareholders to underwrite expansion, so pressures on profitability may become even more significant.” 

Perhaps part of the reason Netflix and Microsoft have looked to partner with one another is because of their respective gaming synergies. Netflix has a fledgling streaming games division while X Box developer Microsoft offers streaming game service Game Pass. 

Other intriguing results might develop from the union. TechRadar suggests it would make sense for Netflix to shift its streaming service from Amazon AWS to Azure. noting, “I'm sure they'll get a nice test drive through the ad-server system.” 

“If you’re Netflix you have a chance to really reinvent TV advertising and fix everything that currently ails it when you launch your product,” advises analyst Alan Wolk. “Focus on that, on hiring the right people, and once again be the revolutionaries you were born to be.” 

Netflix knows the days of "Netflix and Chill" are gone. Opening up new revenue streams from games to merchandise plus the ad-supported services should put the company in a much stronger position to win and retain customer loyalty. 

Here’s another positive take from Amagi’s EVP of Global Ads Sales & Programming, James Smith. He advises Netflix to stick to what they do best and create a conversation with their audience using ads. “Everything from Netflix’s UI to the way they personalize content for the consumer has a ‘texture’ and is on brand. I’d like to see them take this to the next level and apply it to advertising, offering engaging second-screen experiences, more interactive shows, and branded entertainment.” 

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