Madison Avenue Loves the Idea of a Netflix With Ads

The announcement came after Netflix posted its first quarterly subscriber loss in more than a decade and said it expected to lose an additional 2 million subscribers in the spring quarter, sending the company’s stock plummeting. Netflix shares fell 35% on Wednesday.

“I think there’s a lot of pent-up demand from advertisers to be able to reach Netflix viewers, especially younger, more affluent households that historically have been hard to reach with television advertising,” said Andre Swanston, a senior vice president for the media and entertainment vertical at TransUnion, a credit-ratings firm.

In the U.S. alone, traditional pay-TV providers have lost nearly 30 million customers since 2013—a decline of about 30%—as more and more consumers cut the cord, according to MoffettNathanson, a research firm. A growing number of Americans now get their entertainment solely from streaming services, which have signed up tens of millions of new subscribers in recent years.

“From an advertising standpoint, this is an opportunity to really reach those hard-to-find consumers,” said Brad Stockton, a senior vice president for U.S. national video innovation at dentsu, an advertising company, of a potential ad-supported version of Netflix.

Many streaming services are already offering lower-priced, ad-supported versions of their platforms, including

Walt Disney Co.

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-controlled Hulu,

Warner Bros. Discovery Inc.’s

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HBO Max and

Comcast Corp.’s

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Peacock. Disney is also planning to do so with its flagship service Disney+ by late 2022. But with nearly 222 million subscribers world-wide, Netflix has a far greater reach than any of its rivals.

Of all the digital-marketing options available to advertisers, not many allow marketers to deliver a specific message to a specific group of people within such a large audience, said Nick Drabicky, a senior vice president and general manager of client services at January Digital, a strategic consulting and digital media firm. “So to say advertisers would be thrilled for this option is likely an understatement,” he said in an email.

Mr. Drabicky said Netflix would be particularly attractive to advertisers who don’t want to pay for traditional TV ad campaigns or are looking to reach a more targeted subset of viewers. “Netflix also has an extremely sophisticated recommendation algorithm, making the possibilities extremely appealing to advertisers,” he said.

Morgan Stanley analysts expect Netflix to generate billions of dollars in ad revenue over the long term, they wrote in a note Wednesday. They estimate that Hulu generates more than $3 billion in ad revenue, despite having just over half of Netflix’s customer base. Hulu didn’t immediately respond to a request for comment.

Advertisers have been shifting ad dollars away from traditional TV and toward streaming for some time, and a potential ad-supported version of Netflix is expected to further hasten that shift, said Dallas Lawrence, the head of communications and brand for Samba TV, a TV ad-measurement firm.

Denise Ocasio, executive director and U.S. investment lead at Mindshare, an agency owned by WPP PLC’s GroupM that buys advertising among other services, said she expects Netflix could tread carefully as it explores offering an ad-supported tier.

“Netflix subscribers are used to an ad-free experience,” Ms. Ocasio said in an email. “I can’t see an ad-supported option that has the same number of ads anywhere close to what we’re used to seeing [on traditional television],” she said.

One risk for Netflix and other streamers is that users will downgrade from premium, ad-free plans to lower-cost plans with ads, cannibalizing revenue. The bet that Netflix and others are making is that they will add enough new subscribers with the discounted offerings to result in an expansion of their customer base.

“Once you start offering a lower-priced plan with ads as an option, some consumers take it,” Mr. Hastings said during Tuesday’s post-earnings interview. “And we’ve got a big installed base that probably are quite happy where they are.”

Mr. Hastings also said Netflix is likely to outsource the ad-technology functions, rather than build its own software for the purpose. “We can be a straight publisher and have other people do all of the fancy ad-matching and integrate all the data about people. So we can stay out of that.”

Mr. Stockton of dentsu said ad buyers are asking plenty of questions about what the advertising experience is likely to be on Netflix, including whether ads would be shown before a show starts or be spread throughout programming, at which frequency, and whether advertising would appear on all content or just some of it.

Mr. Hastings had few specifics to offer on Tuesday.

“I think it’s pretty clear that it’s working for Hulu,” Mr. Hastings said of advertising. “I don’t think we have a lot of doubt that it works.”

Write to Megan Graham at [email protected] and Patience Haggin at [email protected]