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Netflix doesn’t have commercial breaks, but that doesn’t mean it won’t have ads

Netflix logo: Will Netflix start showing ads?
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Netflix doesn’t have commercials—and it won’t any time soon. But that doesn’t mean it won’t embrace advertisers.

The streaming service had 193 million global subscribers as of June. That number is likely to surpass 200 million by the end of the year. For now, the only substantial way it monetizes that massive audience is from subscriptions. But many observers—including marketers who want to reach those subscribers—believe the company needs to find other means through which it can capitalize on its legions of binge-watchers in the event subscriptions stop growing.

Netflix is still saying no to traditional ads

One way Netflix could leverage that huge audience is by adding a cheaper, ad-supported option in addition to its standard ad-free offering. (Disney’s Hulu and NBCUniversal’s Peacock offer both options.) That way, viewers who want to keep their Netflix free of ads can do so, and those who want to save some money can opt for the version with commercials.

Netflix could add $1 billion in advertising revenue to its $6 billion of annual subscription revenue if it launched a free tier with ads, according to a report from Instinet, the equity trading arm of the Japanese financial company Nomura. The firm thinks the extra revenue would help Netflix improve cash flow and be less reliant on raising debt to fund its expensive programming.

There’s just one problem: Netflix is not interested.

“When you read speculation that we are moving into selling advertising, be confident that this is false,” Reed Hastings, Netflix’s co-CEO, said on a call with investors last year.

The ad-free experience is arguably the most important tenet of Netflix’s business philosophy. It is written into the company’s “Long-term View“—its version of a constitution. “We don’t offer pay-per-view or free ad-supported content,” it reads. “Those are fine business models that other firms do well. We are about flat-fee unlimited viewing commercial-free.”

Constitutions, of course, can be amended. (In fact, Netflix’s changes often.) But everything the company’s executives have said suggests being an ad-free service is not something up for amending.

“Advertising looks easy until you get in it,” Hastings told Variety last week while promoting his new book, No Rules Rules: Netflix and the Culture of Reinvention. “Then you realize you have to rip that revenue away from other places because the total ad market isn’t growing, and in fact right now it’s shrinking. There’s much more growth in the consumer market than there is in advertising.”

Hastings is right about the advertising market. As a result of the coronavirus pandemic, ad budgets have diminished, leading to declining revenues at legacy media companies that rely on advertising more than any other revenue stream. As an ad-free service—and an indispensable source of entertainment for many quarantined consumers—Netflix has generally been insulated from the devastating effects of the pandemic.

Still, Netflix can profit from advertising in several ways without actually running ads. By working with brands, it can create new revenue streams without the classic advertising experience you’re used to seeing on traditional television.

Netflix is already working with advertisers

The streaming service is transparent about its desire to produce the next big movie and TV franchises. It continues to invest heavily in action, science fiction, and fantasy properties with global appeal in order to build out its own library of intellectual property—rather than rely on licensed content from other studios. Hastings and co-CEO Ted Sarandos have said on numerous occasions the ultimate goal is to turn these investments into sustainable franchises that last for a long time.

But franchises aren’t just created on the screen. They require merchandise, events, and marketing to transcend the medium. (Disney’s parks and products division, for instance, regularly generates twice the revenue of its movie studio.) So that’s where Netflix is increasingly putting its energy.

The company has steadily grown its consumer products and brand partnerships divisions, two areas in which it can work directly with advertisers. Netflix says these budding divisions are about growing the audience, not making more money.

Netflix has made several deals in recent years with brands like Coca-Cola, Ben & Jerry’s, and Sephora to collaborate on products. After New Coke was written into the third season of Stranger Things, Netflix approached the soda giant about a partnership. The result: Coke re-launched the “New Coke” brand for a limited time as a promotion for the TV show.

“Both companies benefit from what the other brings to the table: new audiences, new marketing channels, cultural influence and, together, an opportunity to do something exciting for fans,” Aarti Thiagarajan, Netflix’s director of brand partnerships, said. All of these partnerships are what Netflix calls “joint marketing.” No money changes hands.

Money does change hands, however, in Netflix’s licensing deals. Brands pay the streaming service a fee to incorporate elements of its series into products. Nike launched a Stranger Things collection last year. The Italian brand Diesel partnered with Netflix on a collection that borrowed names and color schemes from the series Casa de Papel (released as Money Heist in the US).

Still, Netflix claims it’s not doing all this for the extra revenue. In a job posting for a licensing specialist, the company says it’s only interested in the sector insofar as it boosts engagement with subscribers. “We are pursuing consumer products and associated promotion because we believe it will drive meaningful show awareness/buzz with more tangible, curated ways to interact with our most popular content and in effect, drive long term value,” the listing reads.

Digitized product placement could be the next frontier

Advertisers and their media partners are privy to the fact that TV viewers hate commercials, and so they must reinvent the ad experience or risk losing access to more and more consumers. The most promising area for growth, many observers say, is in product placement, the business of slipping brands’ products and logos into TV and movie scenes. If done well, they’re ads you don’t realize are ads.

Product placement is a $20 billion industry. According to market research firm PQ Media, global product placement revenues have increased for 10 consecutive years, including more than 14% in 2019. The more the entertainment industry gets from sneaky brand integrations, the less it has to depend on outdated forms of advertising viewers are increasingly rejecting.

The concept of characters using branded products in films and TV series isn’t new—think James Bond driving an Aston Martin. But companies are trying to revolutionize the making, buying, and selling of those product placement ads. Rather than use physical products on set, they want to digitize the entire process, growing it into an even larger slice of the overall advertising pie.

One such company is Mirriad, which combines artificial intelligence with data collected about viewers to optimize the product placement process. It works like so: A content company—hypothetically, we’ll say Netflix—sends an episode to Mirriad, whose AI analyzes the emotions within each scene and predicts where your eye will move in order to find the best time and place for a brand to appear. Once Netflix okays the placement, Mirriad then digitally renders the brand in that space, creating multiple versions depending on information gleaned from audience preferences. So one Netflix viewer could see a billboard for T-Mobile in the background of a scene, while another sees one for Verizon in the very same moment.

“We have the ability to create new kinds of experiences for the consumer,” Mirriad CEO Stephan Beringer said. “That’s absolutely necessary nowadays. The market has been overwhelmed with an execution of an advertising idea that has become poorer and poorer. People have just become annoyed by the way they’re bombarded in an intrusive manner by ads.”

Beringer would know—he worked on the agency side of the advertising industry for many years before joining Mirriad. He believes digital, AI-based product placement provides an entirely new canvas outside the paradigm through which the ad industry has operated for decades.

“After the big changes in search and social, there’s a new wave now coming in entertainment-based advertising,” Beringer said. “That’s where [marketers] know they have to go, otherwise they don’t reach people anymore. We haven’t even scratched the surface.”

There appears to be interest. Advertising executives at both Disney and NBCUniversal said digital product placement could be a significant business, and that they were exploring deals to expand into the space.

The third season of Stranger Things included brands like Burger King and Cadillac, among dozens of others. Netflix wasn’t paid by those companies, and therefore turned down an estimated $15 million worth of brand integrations, according to ad tracker Concave Brand Tracking. A Netflix spokesperson said the company rarely profits off of product placement, and that the large majority of brand appearances in its content are written in by creators for a sense of realism—not to provide Netflix with a new revenue stream.

But imagine if every season, of every show, could itself generate millions of dollars in extra revenue without Netflix really having to do anything but give a brand a presence within the world of the show. Those in the product placement space think it’s a matter of “when,” not “if,” Netflix and other ad-free services fully embrace product placement as the technology allows for it to occur with less hassle.

“I don’t think it’s an opportunity that any CEO can continue to tell the shareholders that they can ignore,” said Roy Taylor, the CEO of Ryff, another AI-based brand integration platform.

Taylor believes that the speed and seamlessness with which Ryff can improve the product placement business will lead to something of a revolution. Normally, product placement deals can take from six months up to a year. For films, they can take two years. During that time, a brand can change its packaging, style, design, and message. A lot of potential deals fall apart because what may have made sense to an advertiser a year ago no longer gels with the ad philosophy du jour. The placements themselves require physical TV and film sets to be altered. But companies like Mirriad and Ryff make all that digital.

“In the history of commerce, every single time an industry goes from analog to digital, it always gets bigger, it grows for everybody, and it never goes back to analog,” Taylor argued.

Digital product placement inserted after post-production is clearly an opportunity both marketers and content companies are interested in. But the major hang up is licensing: Distributors have to clear the rights to content with the studio that made the show or movie in order to sell the ad inventory within scenes. That’s much easier when the distributor also owns the content (as Netflix increasingly does), but much harder when it has to negotiate with another studio about adding ads into existing shows and films.

“There’s a learning curve the industry needs to go through, but then it will become commonplace,” Beringer said.

Forrester Research predicted advertisers will double their investment in product placement and with Netflix this year. Netflix called the prediction inaccurate. But it has not denied that product placement could eventually become more abundant on the service—whether it’s being monetized or not. Beringer and Taylor, of course, think the company would be insane not to turn that into another revenue stream.

“If you have a brand in your show, you should be paid for it,” Taylor said. “Those brands should always, always deliver revenues to the content maker. I don’t know why I would ever put an Apple product in my show for free.”