Monday, November 29, 2021, 11:53 AM ET|Posted by Will Richmond
All of the Cyber Monday and Black Friday deals flying around are reinforcing an idea I’ve been thinking about for much of 2021: not too long from now, some streaming media players/devices will be offered for free to certain consumers under specific circumstances.
There are three fundamental reasons why this is likely to happen 1) The gross profit margins on these players is negligible if not non-existent, 2) The gross margin on advertising revenue for player providers is significant, and likely to strengthen even further, and 3) the entire streaming player / streaming services industry is in a massive land grab that isn’t close to being over.
Following is how I look at the three reasons, and what comes next:
1) The gross profit margins on streaming media players are negligible if not non-existent.
The best insights to be gleaned about streaming media player profitability are from Roku, because it’s the only publicly-traded company that actually breaks out its players’ financials. In Q3 ’21, Roku had player revenue of approximately $112 million which produced a gross loss of $14.6 million, or a minus 15% gross margin. Roku attributed the loss to “supply chain disruptions that have impacted the U.S. TV market” and its decision “to insulate our customers from these increased costs to prioritize account growth.” Roku noted it believes its Player gross margin pressure is temporary and the steps it is taking to improve margins going forward.
The challenge is that, looking back over the last 8 quarters (see here and here), to the one ending September ’19, gross margin on players has been negative 3 times (ranging from minus .5% to minus 15%) and sub-10% 3 times (ranging from 2.6% to 7.6%). Player gross margin has only been double digit percentage positive twice, in Q1 ’20 (11.9%) and Q1 ’21 (13.8%).
I have no doubt Roku is doing everything possible to improve its players’ profitability, but there are no “glory days” in the past to return to. Low end players in particular are likely a breakeven’ish product at best. So the best case scenario is to restore the lumpy pattern of the past two years. The likely scenario is it’s going to be worse, not just because of lingering supply chain issues, but also because of intensifying player competition from Amazon Fire TV, and smart TV competition from everyone under the sun.
2) The gross margin on advertising revenue for player providers is significant, and likely to strengthen even further.
The good news for Roku, and all streaming media player providers, is that despite the uncertainty in player profitability, the CTV advertising business is strong, and likely to only get stronger. Roku includes its ad business in its “Platform” segment, which has enjoyed robust and remarkably consistent gross margins, only dipping below 60% in the two worst Covid quarters, Q1 ’20 (56.2%) and Q2 ’20 (56.6%) when advertisers were pulling a lot of campaigns down. In all of the other 6 recent quarters Platform gross margin has been between 62.5% and 66.9% (note, Roku’s Platform segment also includes Roku OS licensing revenue).
In addition, I’d assert that for player providers, gross margins on CTV advertising are actually going to increase, at least in the short term, because they have the best first-party data on users (not only the account set-up data, that includes credit card numbers, but also all of the viewers’ usage as well) aside from Google, Facebook and Amazon. This data matters so much because it improves targeting and because it helps unlock CTV advertising as a lower funnel / full funnel medium. This is partly why player providers have benefited so much from the boom in SVOD/AVOD services; they are the most cost effective way for these services to add new subscribers/viewers. And controlling the user experience means player providers build/control the actual enablement of lower funnel actions (e.g. click here to subscribe, etc.) so they can optimize for their own services (e.g. The Roku Channel and IMDb TV), providing cutting edge solutions for advertisers.
3) The entire streaming player / streaming services industry is in a massive land grab that isn’t close to being over.
We all know the past couple years have seen a proliferation of new streaming services. Some smart analysts have predicted that with their launches behind us, ad spending by these services will decline. I think the opposite is going to happen. With streaming services’ budgets for originals soaring (ViacomCBS alone has said it will spend $5 billion per year on streaming originals by 2024), and competition for viewers more intense than ever, these services are going to be compelled to spend even more on advertising. All of this directly benefits player providers.
Now put yourself in the shoes of an executive at Roku or Amazon Fire TV, for example. The above are the likely dynamics of the streaming media player / CTV market at least for the short term. This should motivate you to want to get as many players deployed, and used, as quickly as possible. With advertising’s healthy margins, it’s more than worthwhile to simply give away certain players, with some type of incentive program for viewers to either watch a certain amount of AVOD or subscribe to certain SVOD services. While I haven’t done the business case analysis, intuitively it seems correct that giving free players to certain viewers would yield a strong ROI.
This would be achieved through clever loyalty programs (just like airlines and credit cards) and clever bundling/partnerships/promotions. Streaming services providers are going to be increasingly open to these partnerships. Just consider Disney’s situation; with anemic Disney+ subscriber growth in its latest quarter, a strong bundle of Disney+/Hulu/ESPN+ in market and intense promotion of its current $.99/month offer, it will be highly motivated to partner to help reignite growth.
In fact, the low prices we’ve seen on Black Friday and Cyber Monday, provide more evidence that what I’m suggesting should be just ahead. Roku, for example, is offering its Roku LE exclusively at Walmart for just $15. The Roku Express is everywhere for $20. The Amazon Fire TV stick is $20 or less from various retailers.
Heavy holiday discounting has been happening for years and will always be a part of the landscape, contributing to gross margin lumpiness. Giving certain streamign media players away to certain consumers, under the types of incentives I’ve outlined, would not only address this lumpiness but importantly, help to expand addressable audiences, which would in turn drive more high-margin CTV ad revenue. To be clear, I don’t envision a time comparable to the late 90s, when free AOL sign-up discs were sprayed all over the place, overflowing our mailboxes (though who knows what the long term could bring). Rather, I believe the starting point will be precise offers to highly-qualified target consumers, where enhanced profitability can be quickly proven in. As that happens the offers will broaden.