The Rise of AVOD (Advertising Video on Demand) and What it Means
Over the last five years, one of the largest trends within the world of TMT has been the rise of streaming services and the continued decline of linear television.
However, the streaming of today and the streaming of five years ago are fundamentally different. Not only from a market composition perspective – given that nearly every traditional media player with significant media assets now has started a streaming platform – but also from an economics perspective.
While most began by offering subscription video on demand (SVOD), more recently many of the largest streaming platforms are now offering an advertising video on demand (AVOD) option as well. The AVOD option comes along with a lower monthly cost than the SVOD option, but in return you’ll normally be required to watch between four and ten minutes of ads per hour.
As we’ve discussed many times when it comes to SaaS companies, the economics of a subscription business begins and ends with its ability to hold retention. So retaining customers is essential for streaming services and the best way to do this is by minimizing the amount you’re charging each month.
As it looks increasingly likely that we’ll be entering into a recession, all companies that earn their revenue through subscriptions (i.e., most media companies) need to try to ensure that they’re maximizing the retention of their customers (as someone with five streaming subscriptions facing hard times is going to look to cut at least a few of them back).
However, there’s no free lunch when it comes to pivoting your business model. For streaming platforms, they may lower churn by offering an AVOD option alongside SVOD. However, in a recessionary environment the amount their earning on their ads (CPMs) will be declining. Indeed, digital advertising rates have already fallen significantly this year as brands pull back their advertising. This is especially true of startups that aren’t currently profitable, as they need to rely on continued equity funding, which has increasingly died up both on the private and public side.
What is AVOD?
The rise of advertising video on demand (AVOD) is a natural evolution of the streaming model. Instead of only offering an ad-free option, now consumers can decide whether they’d like to choose an ad-supported that lowers their monthly cost.
This is a natural evolution not only because some consumers are ad-agnostic and price sensitive, but also because there’s a natural limit to how many streaming services any given individual will sign up for if they need to pay the higher SVOD amount.
Bank of America expects AVOD annual revenue to grow to $70b by 2027 with $31b coming from the US. This is a rise from $33b and $9b, respectively.
Why Wasn't AVOD Introduced Sooner?
It’s easy to look at the following chart and to say that streaming platforms have really been behind the curve when it comes to offering AVOD alongside traditional SVOD. After all, surely it’s been obvious to everyone that linear TV advertising dollars have been stagnant while digital advertising dollars have been increasing exponentially.
However, what this disregards are the CPMs (cost per thousand impressions) between linear TV and digital advertising. While the top-line level of digital advertising has grown tremendously, digital advertising CPMs have historically been much lower.
So, the introduction of AVOD by streaming services coincided with when it began to slightly make sense to introduce a cheaper priced option due to CPMs being high enough to make up some of that pricing differential (between the AVOD and SVOD option).
The reality is still that the CPM levels most streaming services are getting are lower than with linear TV but they are trending in the right direction. Further, when one of your competitors opts to introduce an AVOD option, you’re somewhat forced to do the same to reduce your churn (as once consumers get a taste of AVOD, many want all their streaming to be AVOD).
Just to put some numbers on here, with linear broadcast TV you’re looking at CPMs of around $35. And while there’s a great deal of variability with AVOD CPMs depending on the streaming platform we’re finally getting roughly in the same ballpark today (most are still well below the $35 mark on average but some are close or even a bit above).
Legacy Media is Not Afraid to Disrupt Themselves Anymore...
While a decade ago many legacy media companies were hellbent on trying to keep their moat around the cash cow of linear TV, the past decade has taught the painful lesson of sometimes needing to dispute yourself preemptively.
In other words, sometimes you need to change your business model and give up maximizing revenue today in order to maximize revenue into the future.
This is certainly true of companies like Walt Disney. After acquiring 21st Century Fox in March of 2019, they’ve arguably had the most AVOD success via Hulu. There are four options with Hulu: ads ($7.99/mo), no ads ($14.99/mo), Hulu and Live TV ($69.99/mo), and Hulu and Live TV with no ads ($82.99/mo).
While the data is somewhat murky and bounces around quite a bit, it seems clear that the average revenue per user (ARPU) of the ad-free tier is higher than that of the no-ad tier. However, what Hulu is betting on is that some would not opt for signing up for Hulu unless there was the ad-tier discount. So they’re capturing more market share, even if they’re potentially diluting their overall revenue and locking in a lower ARPU.
But insofar as you bet that the future of all television consumption is streaming, by introducing AVOD you’re betting that over time the CPM revenue you’re getting from the ad-tier will close that ARPU gap that currently exists with SVOD.
A point in favor of this is what is happening with Disney+. For Disney+ there’s an ad-lite tier at $7.99/mo and ad-free at $10.99. Early estimates are that the Disney+ ad-tier could have such high CPMs that the ARPU is actually higher than the ad-free tier.
Some Stats and Things Worth Considering About AVOD...
When thinking through the transition from linear to streaming, it’s important to keep everything in context. Yes, streaming revenues are growing, but look at the revenue composition from the major networks below.
While the transition toward streaming has been significant over the past three years – and networks aren’t completely afraid to cannibalize some of their legacy revenue – the linear business is still absolutely crucial to network viability moving forward.
Another important thing to keep in mind is how reluctant many streamers were to introduce a AVOD offering alongside their SVOD offering. This is largely because they were worried about too many switching over from SVOD, thus lowering their top-line revenue as it was unlikely CMPs would be enough to create equivalent ARPUs between AVOD and SVOD (unless the AVOD discount was very modest).
An interesting bellwether case is that of HBO Max. They’re now seeing around 30% of their subscribers opt for the AVOD offering. Since this offering was only introduced in Q2 2021 you can get a feel for how adoption has grown as people became more aware of the offering.
What HBO executives will be focusing most on are the level of those who have downgraded to the ad-supported model. In a recessionary environment, this level could really pick up and if CPMs fell significantly then it could blow quite a hole in top-line revenue. But this would need to be balanced against the fact that some percent of those who downgraded would have simply cancelled their subscription if not for this alternative, cheaper option.
Finally, another thing I’d point out – that everyone knows intuitively but is worth seeing numbers around - is just how much of a demographic cliff is facing linear TV. While revenue numbers are reasonably well supported now, the 2-17 and 18-34 age groups have irrevocably changed their consumption habits (while the 50-64 and 65+ age groups have stayed relatively sticky and the 35-49 have suffered a more modest decline).
Without a doubt, part of what is driving the desperate need to create streaming options that have relatively wide appeal is to get ahead of this demographic cliff that is coming for linear TV in the next few decades.
So far, the strategy is working reasonably well from an adoption perspective. The charts below are exactly what Hulu and Paramount executives want to see: more adoption by younger generations which will hopefully reduce the revenue drop off in linear TV in the years to come as cord-cutting persists.
As I’ve written about a number of different times, the defining theme of the past five years in the world of media has been the so-called “streaming wars” as legacy players and new entrants try to grow their market share.
The next frontier for streaming is grappling with AVOD and, since this touches on the world of digital advertising, it has implications for the technology sector as well. In the future it wouldn’t be surprising to see some tech acquisitions occurring as streaming companies grapple with how to segment consumers, show them the best possible ads, and boost up their CPMs.
Because the reality is that the adoption of AVOD makes every streaming platform now reliant on getting the highest CPMs possible to boost their ARPU numbers. Given just how much adoption of streaming services has already occurred – accelerated, obviously, by the pandemic – the question over the next few years becomes how to get the most revenue out of those watching on ad-supported tiers while still minimizing churn.
Hopefully this has been an interesting post. Talking about the transition toward AVOD in an interview would be really interesting regardless of if you’re interviewing for a media banking group or a TMT group. This is certainly something a bit more on the frontier and so it wouldn’t be brought up by many other candidates.
If you’re interested in media banking, be sure to check out the media investment banking primer I put together (there’s also the TMT investment banking primer too). Also, if you have interviews coming up, be sure to check out the list of TMT interview questions that I put together to give you the feel for what kinds of TMT-specific questions to expect.