Surprise Netflix-Microsoft Ad Partnership May Be the First Step in a Larger Strategy | Analysis

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Netflix’s announcement that it had selected Microsoft as its global advertising technology and sales partner came as a shock to the media industry, but the decision could be the first step in a larger strategic battle plan for the company.

Since Netflix announced in April that it would be introducing an ad-supported tier, many assumed that the existing infrastructure of major players such as Google, Amazon, Comcast and Roku would be natural fits for the company. Microsoft, while boasting a $10 billion advertising business and the ad-support system company Xandr, is considered a smaller player by comparison. Yet the potential synergies between the two companies and the lack of direct competition may pave the way for even larger moves ahead.

“There are so many more ways Microsoft and Netflix can be working together,” David Offenberg, associate professor of entertainment finance at LMU’s College of Business Administration, told TheWrap. “They could move this relationship into gaming. They could move Netflix off Amazon Web Services to the Microsoft Cloud storage system Azure. And if you want to get really crazy, Microsoft could eventually buy Netflix.”

The unexpected pairing looks to be a strategic decision on Netflix’s part to forgo higher revenue in order to maximize new areas of business and, crucially, protect its data.

Netflix declined to comment for this story.

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There may be more than meets the eye

Microsoft is an unexpected ad partner for Netflix. But with 100 million active monthly Xbox users and the looming acquisition of Activision Blizzard for $69 billion, this partnership could converge with Netflix’s growing ambitions in the video game field. (Netflix COO Greg Peters, who also oversees games, made the announcement Wednesday).

“Aren’t there always additional economics at play?” one media analyst told TheWrap. “Here, it’s probably that Netflix will have its gaming partner in Microsoft and Xbox.”

In March, Netflix acquired game developer Boss Fight Entertainment, the third game studio snatched up by the company after “Oxenfree” developer Night School and “Stranger Things” puzzle game developer Next Games. Netflix’s push into gaming is an attempt to provide added value to subscribers at no extra cost, though it also represents a tantalizing new prospective revenue stream down the line. Plus, now Netflix and Microsoft can team on film and TV adaptations of Xbox’s biggest titles.

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Zooming out, this move may also set the stage for Netflix to depart Amazon Web Services, the cloud computing storage service that currently houses several major streamers. Given the chance, it makes sense for Netflix to remove an asset from a competitor by taking its business to Microsoft’s Azure, though an individual with knowledge of the situation said that “nothing has changed in that partnership or the overall approach to infrastructure management.”

Still, speculation continues to spike throughout the industry.

“The financial terms likely include a migration away from AWS to Azure. It could be the unseen thing they’re not saying out loud,” the media analyst said.

It’s also difficult to ignore the current realities of both companies. Netflix has shed roughly $200 billion in value since November. Its market cap currently sits at $77 billion while its share price has plunged 75% from its 52-week high of $700.99. (Netflix stock rebounded 5% Wednesday after the Microsoft announcement). Should company leadership ever look to sell, Microsoft and its nearly $2 trillion market cap — not to mention its growing GamePass business — would be a logical landing spot. Consumers can probably expect the two companies to roll out an attractive bundle in the near future anyway.

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Why Netflix made a surprising pick

Netflix leadership has already told employees that it wants to introduce its ad-supported tier by the end of 2022, and there’s a massive moneymaking opportunity available if the streamer can get it up-and-running in time for Fall’s midterm elections. Google, Amazon, Comcast and Roku already have technology in place that could simply be plugged into the Netflix system. Yet industry confidence in Microsoft’s ability to quickly ramp up in this arena is uneven.

“Xandr tech is not really suited for this,” an ad executive told TheWrap.

It certainly helps that Netflix co-CEO Reed Hastings previously served on Microsoft’s board and Microsoft executive Brad Smith currently sits on Netflix’s board.

The thinking behind the deal may come down to three key criteria:

  1. Can Microsoft develop the advertising infrastructure up to Netflix standards in time?

  2. How much revenue will be generated and how much will they have to share?

  3. How much of the data are they going have to share with their partner and can it be used against Netflix in the future?

Microsoft — unlike Google (YouTube), Amazon (Prime Video, Freevee), Comcast (NBCU) and Roku (Roku Channel) — isn’t a direct competitor in the video space.

“By choosing Microsoft, Netflix is minimizing its data risk and maximizing its revenue risk,” Offenberg said. “They keep the data and money out of the hands of a rival. However, the Googles, Amazons and Comcasts of the world would probably generate the most revenue for them.”

Regarding the data swap, Microsoft president of web experiences Mikhail Parakhin even wrote in a blog post that Netflix “endorses Microsoft’s approach to privacy.”

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Microsoft put very aggressive minimum guarantees on the table, according to individuals with knowledge of the situation. Revenue splits can be all over the place from a more standard 70/30 to a 90/10 and sometimes 50/50. It remains to be seen how Netflix and Microsoft will divvy up the pot.

Microsoft declined to comment further beyond Parakhin’s blog post.

One last immediate question that still hangs over Netflix’s march into advertising is what the company plans to do about ratings. To sell ads, Netflix will need to become far more transparent when it comes to viewership and the streamer’s current global hours viewed metric isn’t going to cut it.

“Netflix will have to get comfortable revealing exactly how many people viewed a title in order to sell ads,” Ian Greenblatt, J.D. Power’s managing director and GM, tech/media/telecom Intelligence, said. “Otherwise, they’re about to announce a new business model that’s never been used before.”

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