As more and more competitors enter the streaming market to compete with Netflix (NASDAQ: NFLX), many have adopted plans for a hybrid model of subscription revenue and advertising revenue. Disney's (NYSE: DIS) Hulu pioneered the model, and it actually generates more revenue per ad-supported user than ad-free user. Disney is following the same model with ESPN+, which cost $5 per month but also contains ads. But Disney+ is completely ad-free.
"When you've got a lot of insight, really, into the model, you make certain choices," Netflix CEO Reed Hastings said at a conference earlier this month with regard to whether advertising makes sense for Netflix. He was keen to point out Disney's decision not to include ads in Disney+ despite its success with ad sales on Hulu. He used it as an example of why he thinks offering an ad-supported version of Netflix isn't the right strategic move for the company.
Indeed, an ad-free experience is a premium experience. That provides strength for a brand, something Disney and Netflix certainly want to communicate, and something analysts are worried AT&T (NYSE: T) might erode with the introduction of an ad-supported version of HBO Max in 2021. Ad-free is also more appealing to consumers if there's not a significant difference in price. (Consumers have shown a willingness to tolerate ads if they see value in the form of lower subscription pricing.)
But Hastings may be missing a key strategy behind Disney+. It's what enables it to charge just $7 per month without ads.
Disney+ is the advertisement.
Image source: Disney.
Selling the entire ecosystem
Disney is a much bigger operation than Netflix. Netflix does streaming video and that's it. And that's ostensibly what Disney+ is as well. But while Netflix can only monetize engagement with its streaming product through selling subscriptions, Disney has many more avenues to extract money from Disney+ subscribers.
Disney makes movies that spend more than a couple weeks in theaters before they're available for streaming. While those movies will eventually make their way to Disney+, the company has become adept at making films consumers want to see on the big screen. It managed to release five $1 billion movies this year already, and likely has a couple more coming in the next few weeks with Frozen 2 and Star Wars IX.
Disney also sells tickets to its theme parks, cruises, and resorts. It sells music, books, comics, and other media. It sells toys, apps, and games. Parks, experiences, and products accounted for 45% of the company's total revenue in fiscal 2019.
Disney+ gives Disney an opportunity to establish a more engaged audience. Instead of engaging with Disney brands for the occasional movie theater outing, Disney+ subscribers will engage with the brand every week, if not every day.
What's more, Disney+ will give Disney direct access to data on some of its biggest fans. Disney gets their payment information, their home address, their favorite shows and movies and what time they like to watch them. Disney will know if a household has kids, and it'll know whether those kids are more into Frozen or Toy Story.
All of that data will help it sell more movie tickets, theme park tickets, music albums, and toys. A simple email reminder to Mandalorian viewers that Star Wars IX comes out this weekend could result in a significant boost in box office sales.
Most of Disney's competitors like AT&T's WarnerMedia don't have the same powerful ecosystem of products that can monetize users. They rely entirely on revenue from their streaming services. On the other hand, Apple (NASDAQ: AAPL) is following the same strategy as Disney+ with Apple TV+. That's because the tech giant makes more money from selling hardware and other services than it would from increasing the price of Apple TV+ or including ads.
That doesn't mean Netflix should use advertising
As mentioned above, there are good reasons for avoiding ads. Netflix doesn't want to diminish its brand, for one. Plus, offering an ad-supported option would require significant investment from Netflix and distract it from the things it's really good at. It would need ad technology and a sales team.
AT&T already has those things for its existing ad products, so expanding HBO Max to include an ad-supported option doesn't put much of a burden on the company. Comparatively, Apple would have a much harder time making an ad-supported streaming service because its ad sales team and technology aren't on par with the competition.
Disney's decision to keep ads out of Disney+ shouldn't influence Netflix's decision to keep ads out of Netflix. They're two very different businesses and the strategy for both companies should differ as well, even if their products look very similar. That said, both came to the same conclusion as to what's best for their business.
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Adam Levy owns shares of Apple and Walt Disney. The Motley Fool owns shares of and recommends Apple, Netflix, and Walt Disney and recommends the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, long January 2021 $60 calls on Walt Disney, and short January 2020 $130 calls on Walt Disney. The Motley Fool has a disclosure policy.