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For years, Netflix Inc. boss Reed Hastings was emphatic that the streaming giant wouldn't show ads in its programming. Late last year, the company did a 180. Netflix didn't just want to enter the ad business -- it wanted to do so in a hurry.
The company assembled engineers to sound them out on the technical challenges. Executives quickly decided they would initially need an external partner to supply technology and sales power.
By spring, after announcing its plans publicly, Netflix had fostered a bidding war that included Alphabet Inc.'s Google, Comcast Corp.'s NBCUniversal and a dark horse, Microsoft Corp. One of Netflix's goals was to secure a big "minimum guarantee" -- a promise that it would get a large influx of ad revenue to limit its financial risk, say people familiar with the discussions. Netflix also hunted for a senior leader with advertising expertise, mindful that it knew little about the business of selling ads. The company approached at least two top Comcast executives while the partnership negotiations were continuing with their employer, angering the top brass at the cable giant, some of the people said.
Netflix's urgent move into the ad market, with a lower-cost tier that will be available early next ear, is its most dramatic pivot since shifting from DVD-by-mail to streaming. The U-turn reflects the company's desire for a course correction as it encounters its most difficult stretch in over a decade.
After years of looking invincible, Netflix has suffered two consecutive quarters of subscriber losses in the face of tougher competition, and its stock has lost roughly two-thirds of its value this year.
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Netflix's turn is a reminder of the challenges facing industry disrupters as competitors emerge in their wake. Now Mr. Hastings is in the uncomfortable position of playing catch-up with rivals that have already taken the lead in weaving advertising into their business models. "They have quality competition. Massive amounts of it," said Wenda Harris Millard, former vice chair of MediaLink, an ad and media consulting firm, referring to an increasingly crowded subscription-streaming arena that includes Disney+, Hulu, Paramount+, HBO Max, Amazon Prime Video and Apple TV+. While Netflix management was wise to focus on a subscriber business and doing so helped grow its customer base for years, she said, "these are different days now." Mr. Hastings has set lofty financial ambitions for the ad business. He and other company executives have told investors and ad industry executives privately in recent months that Netflix will eventually be able to charge advertisers about $80 for every 1,000 views of an ad by helping them target specific audience segments, people familiar with the discussions said.That would put Netflix among the most expensive destinations for ads, alongside top NFL television programming.The company hasn't spelled out what customers would pay for the ad-supported tier, but is expected to be less than the $9.99 cost to today's least-expensive option. Creating an advertising-supported tier isn't the only about-face the company is making in its quest to revive growth. After years of treating password-sharing by customers as a marginal problem -- Mr. Hastings said in 2016 he loved the practice -- Netflix plans to begin charging households a sharing fee sometime in 2023.While Netflix's subscriber base has grown, the ratio of paying members to password-borrowers has remained relatively consistent in recent years, a person familiar with the metric said. That suggests sharers are not necessarily converting to paying users after trying out the service, some analysts say. [...]
The challenge for Mr. Hastings and his co-chief executive, Ted Sarandos, is to find ways to drum up new revenue without losing what made Netflix appealing enough to attract an audience of about 220 million subscribers. Offering a less expensive, ad-supported tier and cracking down on password-sharing could turn off some existing customers.
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His [Reed Hastings's] change of heart [regarding an ad-supported tier] in recent months was spurred in part by the reality of the company's growth challenges, but also by market research on rival streaming services such as Hulu and HBO Max, people familiar with Netflix's advertising plans said. The research showed that customer satisfaction hadn't dipped for users of their advertising-supported plans, the people said.
In March, Netflix Chief Financial Officer Spencer Neumann said at a conference that the company would "never say never" to advertising, the first public signal that the company wasre considering its stance. On an earnings conference call the following month, Mr. Hastings said the company was exploring an ad-supported tier.
Top Netflix executives, including its co-CEOs and finance chief, and COO Greg Peters, blanketed the ad industry, talking to potential ad buyers and other executives as it plotted its approach, people familiar with the discussions said. Netflix officials got advice on things ranging from how many ads to show in programming to what ads should look like. Netflix hasn't said publicly what formats its ads will take. Internally, it has discussed ideas including running video ads from major brands before programming, plus some static ads within the app, according to people with knowledge of internal discussions.
Mr. Hastings' comments on the earnings call set off a competition over who could partner with Netflix and supply the advertising technology -- and, possibly, manpower -- needed to launch the service quickly. Among Netflix's asks was that the partner would guarantee a certain amount of ad revenue from markets around the world, people familiar with the company's requests said.
Netflix wasn't looking to outsource ad operations for the long term: The company sought a three-year deal to give it space to create its own ad infrastructure, some of the people said. Netflix's intention in the early going was to launch an ad product in the fourth quarter of this year, say people familiar with its plans -- a timeline that would slip. It said on its latest earnings call that it would launch an ad-backed tier in early 2023. [...]
Microsoft, meanwhile, came to the table early in Netflix's hunt for a partner with a much smaller ad business than Google and Comcast. Unlike those firms, however, it lacked a competing streaming business. Executives stressed the word "agnostic" in their pitches and their willingness to be a partner as Netflix eventually stood up its own ad-selling business. [...]
In the background, the Netflix talks with Microsoft had quietly advanced. Netflix and Microsoft announced their ad partnership on July 13, shortly after the annual gathering of tech and media moguls in Sun Valley, Idaho. Some Comcast NBCUniversal executives were upset when they discovered Netflix's attempts to poach its top talent during the partnership talks, which they viewed as unprofessional, people close to the company said. Netflix also made hiring inquiries at Google, according to a person familiar with the talks. Many advertisers are already plotting how to use Netflix as a marketing platform. One thing they will want to know: how many people they are reaching through Netflix ads. Netflix said for years that it didn't need to publish ratings for its content because it wasn't selling ads. More recently, the company has begun providing some viewership information, such as a look at the top 10 programs on the service. Netflix will have to be even more transparent after launching an ad-supported plan, since advertisers will be looking to pay based on the quality of that data, said Ms. Millard, the former MediaLink executive
Analyze the causes of Netflix's decision to develop an ad-supported tier for its streaming service. Why is the company pursuing this course of action?