Friday Mailing #49: After Q3 2021, Does Netflix Have the AVOD Model In Its Sights?
The shift to an “hours viewed” metric from total households may be an implicit acknowledgement of the inevitable: growth must come from an AVOD model
In its Q3 2021 letter to shareholders, Netflix announced a new standard for reporting engagement, moving away from the number of accounts which viewed at least two minutes of title in its first 28 days on Netflix (emphasis in bold added):
Later in the year, we will shift to reporting on hours viewed for our titles rather than the number of accounts that choose to watch them. There is some difference in rankings, as you see below, but we think engagement as measured by hours viewed is a slightly better indicator of the overall success of our titles and member satisfaction. It also matches how outside services measure TV viewing and gives proper credit to rewatching. In addition, we will start to release title metrics more regularly outside of our earnings report so our members and the industry can better measure success in the streaming world.
I have no reference point for if hours viewed is a “better” standard than the two-minute standard.
But, I can say that the argument for the two-minute standard from the Q1 2020 letter offered a notably different argument:
Our new methodology is similar to the BBC iPlayer in their rankings based on “requests” for the title, “most popular” articles on the New York Times which include those who opened the articles, and YouTube view counts. This way, short and long titles are treated equally, leveling the playing field for all types of our content including interactive content, which has no fixed length.
These are two fundamentally different rationales: in Q1 2020 Netflix compared itself to other digital media, and in Q3 2021, Netflix compares itself to TV viewing.
The Objectives Have Changed
The most obvious answer is that the objective of “leveling the playing field for all types of our content including interactive content” has changed. We hear less about the promise of interactive video than we did before and more about the future of gaming.
COO Greg Peters hinted at this in his answer to a question on the Q3 2020 earnings call about how Netflix could improve the consumer experience in games:
And I think it's important to note that, first of all, we're going to learn our way through that just as we have in the other content categories that we've served. And we'll learn by basically putting stuff out there and then having our members tell us what's working and what's not.
Games seems to be a more robust value proposition than interactive video for Members:
We're creating all these amazing universes and worlds and characters and storylines, and we can attach to the passion and fandom that our members have on viewing those on the video side with game experiences and allow them to go deeper and explore spaces that they wouldn't have otherwise seen on the video side. And so we really think there's a good connection and synergy there. And over time, we'll try and bring those closer together and sort of let those 2 worlds more influence each other and have a more direct connection.
Members going “deeper” into “amazing universes and worlds and characters” is better reflected in hours of engagement than a two-minute standard. But. since 100% of engagement on Netflix outside of Poland, Italy and Spain is going to be with videos, it does not explain why the change occurred now.
The Competition Has Changed
The “Competition” section of the Letter to Shareholders has evolved noticeably since the first mention of Fortnite in the Q4 2018 Letter to Shareholders:
In the US, we earn around 10% of television screen time and less than that of mobile screen time. In other countries, we earn a lower percentage of screen time due to lower penetration of our service. We earn consumer screen time, both mobile and television, away from a very broad set of competitors. We compete with (and lose to) Fortnite more than HBO. When YouTube went down globally for a few minutes in October, our viewing and signups spiked for that time. Hulu is small compared to YouTube for viewing time, and they are successful in the US, but non-existent in Canada, which creates a comparison point: our penetration in the two countries is pretty similar. There are thousands of competitors in this highly-fragmented market vying to entertain consumers and low barriers to entry for those with great experiences. Our growth is based on how good our experience is, compared to all the other screen time experiences from which consumers choose. Our focus is not on Disney+, Amazon or others, but on how we can improve our experience for our members.
This year, the Competition section was shorter, and other than Fortnite the examples had changed:
We compete with a staggeringly large set of activities for consumers’ time and attention like watching linear TV, reading a book, browsing TikTok, or playing Fortnite, to name just a few. As one example of this dynamic, on October 4, when Facebook experienced a global outage for several hours, our engagement saw a 14% increase during this time period.
We are still quite small, with a lot of opportunity for growth; in our largest and most penetrated market, according to Nielsen, we are still less than 10% of US television screen time. Our approach as always is to improve our service as quickly as we can so that we can earn a greater share of people’s time.
The most interesting change between both letters is how Netflix discusses television: Netflix was “less than 10% of US television screen time” both in 2018 and in Q3 2021.
Additionally, the Q4 2018 Letter to Shareholders it offered this interesting footnote:
We serve on average about 100 million hours a day to television screens in the US, and we estimate television screens in the US are on about a billion hours daily (120m homes x 2 TVs x 4 hours, plus hotels, bars, etc).
The number of households has not changed substantially, according to Nielsen (the total as of August 2020 is 121MM homes).
But, that 120MM is significant because it’s the number YouTube has been marketing since it revealed over 120MM people in the U.S. streamed YouTube or YouTube TV on their TV screens in a March 2021 blog post.
Does Netflix Have Advertising In Its Sights?
Netflix mentions both TikTok and Facebook in its 2021 letter. But it does not mention YouTube nor does it mention HBO Max, which is four months into its AVOD service.
Both YouTube and HBO Max are now part of the “staggeringly large set of activities for consumers’ time and attention”.
HBO Max With Ads competes on price and perceived value, as WarnerMedia CEO Jason Kilar told an analyst on AT&T’s Q3 2021 earnings call:
So this is the first full quarter. And we're happy not just in terms of the absolute response, in terms of subscribers, but also because advertising helps lower the price and increase the value for an HBO Max subscription.
YouTube’s new metric suggests YouTube is especially competitive with Netflix on time spent on Connected TVs, and Netflix is “still less than 10% of US television screen time”.
Netflix’s competitive position is objectively static in the U.S., and it openly discusses “a lot of opportunity for growth”. Both YouTube and HBO Max are finding growth in Connected TV with ad-supported models, especially at a time when advertisers are beginning to shift $68B in annual spend away from linear TV.
The shift to an “hours viewed” is the acknowledgement from Netflix that its competition — especially in TV — increasingly will come from ad-supported services. Meaning, Netflix will have to tell its competitive story in those terms.
Given these two facts, the logical question is whether an ad-supported model may be the best opportunity for growth for Netflix in the U.S., too. I heard a powerful media executive say off-the-record that ads are “low-hanging fruit” for Netflix to find growth.
Management still openly dismisses advertising as a model: COO Greg Peters described advertising and in-app monetization in gaming as “distractions from the core enjoyment experience associated with other models” in the Q3 earnings call.
But, if HBO Max finds growth and boosts ARPU with its AVOD model, as it has projected, and Netflix continues to be stuck at less than 10% of TV households, Netflix management will face their inevitable “Sophie’s choice”.
The shift to “hours viewed” from total households seems to be an implicit acknowledgement of the inevitable.