Netflix could drastically cut its cash burn with a Spotify-like model that includes an ad-supported free tier

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  • Netflix has resisted introducing advertising to its platform, but it could be missing out on a lucrative source of revenue.
  • The streaming service could bring more than $1.3 billion in revenue per year by 2021, if it introduced a free tier akin to Spotify in the US next year, analysts at Nomura’s Instinet estimate.
  • Much of that revenue would be pure profit.
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Ads aren’t coming to Netflix any time soon, but the streaming service could make a lot more money if it considered adding a free tier, analysts at Nomura’s Instinet research firm estimate. And most of it would be pure profit.

Netflix could bring in $1.3 billion per year in advertising revenue by 2021 from adding a free tier of programming that features advertisements in the US, Instinet estimated in a Jun. 28 note. About 70% of that revenue, or $700 million, would likely be profit.

That’s based on the $1.5 billion that US competitor Hulu said it made from advertising in 2018.

“Hulu has proven that there is demand for an ad-supported model,” the note said. “We think that, over time, Netflix would be able to command premium ad pricing, due to its broader subscription base, but that it would track competitors in the near term.”

The model assumes Netflix could launch a free tier with ads, similar to Spotify, in the US in 2020, and grow the plan to represent roughly a quarter of its paid subscriber base by 2021.

The note estimates there are roughly 180 million to 190 million people in the US who might be interested in a free tier of Netflix. It also assumes that Netflix would be able to make close to as much money from advertising off its lowest paying subscribers — folks on the basic plan that costs $8.99 per month — as it currently does from subscriber fees.

Spotify’s free, ad-supported tier has also encouraged more people to sign up for its paid service. The ad-supported service has driven more than 60% of Spotify’s total gross paid subscriber additions since February 2014, when Spotify started tracking conversions from its free to its paid service,the company reported.

Netflix has repeatedly said it does not plan to introduce ads to the service any time soon. But someadvertising and media execs have argued that Netflix is destined to get into the ad business one day.

The streaming company has warmed to working with brands in other ways. It ispartnering with big advertisers like Coca-Cola and Burger King to tap into more ad dollars and marketing channels for tentpole originals like “Stranger Things.”

Read more:Inside Netflix’s marketing strategy for ‘Stranger Things,’ the show that supercharged its work with brands like Lyft and Coca-Cola

The analyst note comes as reports suggest Netflix is becoming more budget conscious. Ted Sarandos, chief content officer at Netflix, advised content-development execs this past month to be more cost effective in their spending,The Information reported.

The streaming giant is also moving toward funding its own operations. So far, Netflix has taken on debt and burned cash by the hundreds of millions to support its eight-figure annual content budget. It told investors it would start reducing its free cash flow deficit by 2020.

Netflix brought in $4.5 billion in revenue in the first quarter of 2019. It had a free cash flow deficit of around $460 million, up 60% from a year earlier. Streaming content obligations, or Netflix’s estimates of what it owes for content based on its existing contracts, were $18.9 billion.

Advertising, as well as potential revenue streams like product placement or licensing IP, could help improve free cash flow and lessen the company’s debt load, which was about $10.3 billion last quarter.

Instinet assumes that Netflix would run fewer ads on its free tier than Hulu or traditional TV do now, with about five minutes of ads per hour.

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