January 17, 2023

Growth of Ad-First Platforms Demonstrates Subscriptions Have Limits

Any operator will tell you that having consumers pay for content is the ideal relationship, especially with subscriptions turned on and auto-renewing. And investors have tended to agree, valuing subscription businesses higher than advertising-first ones.

However, we are increasingly seeing that there are limits to what can be monetized via subscriptions. And, whether subscription-only proponents like it or not, businesses will need to evolve with the times to continue growing.

Consider what David Zaslav, Warner Bros. Discovery CEO said on its third-quarter earnings call:

We have the largest TV and motion picture library. And so there’s content that belongs on HBO Max, when that product launches, whatever it’s called, as well as the AVOD service. But we could see now, what are people consuming on those platforms. There’s also a huge amount of content that’s not even on that platform that’s sitting with us that hasn’t been put to monetize in the marketplace. Some of that we will sell, which we’ve talked about, and we’ve started to sell. Some of it we’ll sell not exclusively, some of it, but we have the ability on the FAST side to build a service without buying content.

We can take content we already own, a lot of it where we have no participants, some of it where we have participants, but it’s at a fraction and get ourselves into an AVOD service, which I think makes us full service. And most of that has been fully amortized, or almost all of it has been fully amortized. And it gives us effectively a full service, which you’ll see as we come into the end of 2023, which is a premium service that we’re driving globally, with no ads, an ad-light service, which will have a robust and attractive advertising opportunity, where even in a difficult market we’re getting very good pricing.

The word fast is capitalized in that quote because it stands for Free, Ad-Supported Television. Many large content creators are reminiscing about a simpler time when free cable TV reigned supreme. In many respects, the idea of free content supported by advertising sounds like what we’ve spent the last ten years cutting from our lives. But I guess what’s old is new again.

And the money could be very good. According to a report by S&P Global Market Intelligence back in September:

Growth for free ad-supported TV, or FAST, services in the U.S. shows no signs of slowing as audiences, advertisers and content owners lean into the FAST model. We estimate that total FAST ad revenues in the U.S. could approach $4 billion in 2022, with that total projected to more than double to just under $9 billion by 2026.

For context, Netflix generated $7.9 billion in Q3 2022 revenue, so while the growth of FAST is incredible, it’s still early days. Nevertheless, if we look at Netflix’s revenue, its year-over-year growth is only 5.9%, which explains why even Netflix is considering advertising.

But it’s not just streaming where this is being considered. For example, Microsoft’s Xbox team might consider an ad-supported option for its Game Pass subscription. According to Eurogamer:

An unsourced screenshot, written in Spanish and shared on ResetEra (via VGC), alleges that Microsoft is surveying players and exploring a tier-like system – similar to that of Ubisoft+ and Sony’s PS Plus – by inviting them to “consider hypothetical subscriptions”.

The hypothetical family plan looks to be offering the full benefits of the current Xbox Game Pass service for five users across consoles and PC for €22 a month, whilst the €3 plan would essentially give a single individual an Xbox Live Gold-like plan that delays access to Microsoft’s first-party games for six months after release and would run adverts before you play a game from the XGP library.

Before you could play a game, you’d have to watch an ad. As someone who sucks at video games, I can imagine this becoming a slippery slope to more ads. Just as you’re about to do the final boss fight, an ad pops up, and you have to sit there for 30 seconds waiting. I digress…

YouTube is entering the FAST game, as well. According to WSJ:

The Alphabet Inc.-owned video platform is in talks with entertainment companies about featuring their shows and movies in the hub of cable-like channels and is testing the concept with a small number of media partners, according to people familiar with the discussions. It could launch the offering more broadly later this year, some of the people said.

YouTube has discussed taking a cut of ad revenue from the new hub that would be similar to its traditional arrangement with content creators, under which it gets 45% and allows the programmers to keep 55%, some of the people familiar with the discussions said.

We begin to see two strategies playing out with FAST platforms. First, there’s the aggregator, like what YouTube proposes, taking content from other content creators. Then there is a platform like what Warner Bros. Discovery is proposing: a free offering of its own content. I suspect whoever can provide the most content will win, but it’s still early days.

Why is everyone doing this?

People are becoming price-conscious. As I said above, Netflix’s Q3 revenue only grew 5.9% year-over-year. And it’s not only a streaming problem. According to The Wall Street Journal:

The Post is on pace to generate around $600 million in revenue in 2022 and has over 2.5 million subscribers, down from three million in January 2021, the people said. The company isn’t expecting to make a profit this year, they said.

It lost 500,000 subscribers in two years. There are many reasons for that, but people are looking at their credit card statements and deciding whether certain subscriptions make sense. And they’re making cuts.

So, what should publishers do?

To some extent, the answer is a return to a primary media tenet: diversification. It’s true; having a user pay for something is incredible. But having a robust advertising business complements the subscription revenue. And while consumers might cut their paid spend, they’re unlikely to cut their time spent with content; therefore, giving an ad-supported option makes sense. And so, even if subscription revenue drops, advertising shouldn’t drop as hard.

But how do you tactically execute? It’s highly dependent on the type of content you’re working with.

In the case of news, the shelf-life of the content is short. People want to know what happened today, not six months ago. So, it’s not as if the library has much value. And so it might simply be a tiering of content where the highest quality reporting is behind a paywall, and the rest is free.

For less time-sensitive content, the model might work for new-vs-old content. If you re-read Zaslav’s statement, he’s looking at his older content as the backbone for the FAST platform. If people want content immediately, they pay; if they want the re-runs, they’ll be able to get it by watching ads.

Ironically, this is how the movie business has always worked. If you want it at launch, buy movie tickets and go to the theater. Then, if you were willing to wait longer, you might buy it on DVD or rent it on Amazon Prime. And then, if you were willing to wait even longer, a cable channel would license it, and you’d watch with ads.

Monetizing content requires diversification. It’s not that advertising is better than subscriptions. On the contrary, getting users to pull out their credit cards is truly the peak of monetization. However, monetizing their attention is also lucrative. The best media companies do both. FAST is showing that what’s old is new again. We should lean into this as operators and maximize our revenue without getting trapped in business model dogma.

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