The Information reported over the weekend that Netflix executives have told employees to keep an eye on the bottom line:

In two separate meetings over the past few weeks, Netflix executives cautioned employees to be more mindful about spending and hiring, according to three people familiar with the discussions. The comments, made at an employee town hall on Monday as well as during a management offsite held last month in Anaheim, Calif., come as the streaming giant grapples with sharply slowing subscriber growth…

Netflix has also been pondering steps that could help offset the revenue impact of the subscriber slowdown, including cracking down on people sharing the passwords to their accounts. While Netflix has long allowed such password sharing, it has become more common in the U.S. and other parts of the world than executives anticipated, the people said. This effort has been underway for about a year, however, well before the slowdown became apparent.

These are presented as two different issues, but there is a connection between them: Netflix should be hiring more people — a lot of them — and those people should be building a product that increases subscriber numbers and revenue. That product is advertising.

Netflix’s Business Model: Subscriptions

Netflix is, incredibly enough, 24 years old, and a subscription model has served the company well. Not that Netflix had much choice when it started: the company briefly sold DVDs online, before focusing exclusively on renting them; neither approach offered much surface area for advertising, and besides, the subscription model was revolutionary in its own right.

DVDs-by-mail was, from a certain perspective, inconvenient: you couldn’t simply drive to your local Blockbuster and peruse the selection; on the other hand, Netflix’s model gave you access to nearly every movie ever released, not just those in stock at your local store. The real innovation, though, was that business model: instead of paying to rent a DVD and being gouged with late fees, you could pay a set amount each month and keep the DVDs Netflix mailed to you as long as you wanted; send one back to get the next one in your queue.

Consumers loved it, and Netflix has stuck with the model even as the shift to streaming flipped their value proposition on its head: streaming is even more convenient than hopping in your car, but only a subset of content (ever-expanding, to be sure) is on Netflix. That has been more than enough to fuel Netflix’s growth; the service had 222 million subscribers at the end of 2021.

Still, as The Information noted, that number isn’t increasing as quickly as it used to. Netflix sported over 20% year-over-year subscriber growth for years (usually more than that), but hasn’t broken the 20% mark since Q4 2020; growth for the last three quarters was in the single digits. Some of that is likely due to growth that was pulled forward by the pandemic:

The bigger problem, though, is saturation: Netflix has 75 million subscribers in the US and Canada, where there are around 132 million households. That is nearly as many subscribers as linear TV (84 million), and once you consider shared passwords, penetration may be higher. Other markets like India have more room to grow, but much lower household incomes, and Netflix’s relatively high prices have been an obstacle.

Netflix has ways to grow other than subscribers, most obviously by raising prices. The company has done just that on a mostly annual basis for eight years: in the U.S. the price of a Standard subscription (HD, 2 screens) has increased from $7.99 to $15.49. Netflix executives argue that customers don’t mind because Netflix keeps increasing the amount of content they find compelling; it’s an argument that is easier to accept when subscriber growth is up-and-to-the-right. Now the task is to keep raising prices while ensuring subscriber numbers don’t start going in the opposite direction.

Netflix’s New Initiative: Gaming

To accomplish this Netflix is not only continuing to invest in original programming, but also branching out into new kinds of content, including games. This may seem an odd idea at first: sure, Netflix is generating some new IP, but it would generally be much easier to license that IP than to become proficient at gaming. Netflix, though, believes it has a unique advantage when it comes to gaming: its business model. Chief Product Officer Greg Peters said in the company’s Q2 2021 earnings interview:

Our subscription model yields some opportunities to focus on a set of game experiences that are currently underserved by the sort of dominant monetization models and games. We don’t have to think about ads. We don’t have to think about in-game purchases or other monetization. We don’t have to think about per-title purchases. Really, we can do what we’ve been doing on the movie and series side, which is just hyper laser-focused on delivering the most entertaining game experiences that we can. So we’re finding that many game developers really like that concept and that focus and this idea of being able to put all of their creative energy into just great gameplay and not having to worry about those other considerations that they have typically had to trade off with just making compelling games.

Netflix’s gaming efforts to date have been fairly limited; the company launched with five titles in November, but the fact the company has bought three gaming studios suggests a strong appetite for more — at least amongst Netflix executives.

But what about consumers?

Netflix’s Job: TV

Consumers don’t care so much about business models; they have jobs that they want to get done, and the traditional cable bundle used to do a whole bunch of jobs: information gathering, education, sports, story-telling, escapism, background noise, and more. As I noted in The Great Unbundling, these jobs are increasingly done by completely different services: we get news on the Internet, education from YouTube, story-telling from streaming services, etc.

Netflix is obviously one of those streaming services, but the company is also investing in movies (escapism), and is increasingly the default choice when it comes to the under-appreciated “background noise” category: the service has oceans of low-brow content ready to be streamed while you are barely paying attention. This is a big reason why for many people their choice of streaming services is a matter of which service do they subscribe to in addition to Netflix.

Still, all of these jobs are about passively consuming content; from a consumer perspective gaming is something different, in that you are an active participant. To that end, it’s not clear to me why consumers would even think to consider Netflix when it comes to gaming: that’s not what the service’s job is, nor was it the job of the linear TV bundle that Netflix is helping replace.

Netflix’s Market: Attention

Then again, as founder and co-CEO Reed Hastings likes to say, Netflix’s competition is much broader than TV; Hastings wrote in the company’s Q4 letter to shareholders:

In the US, we earn around 10% of television screen time and less than that of mobile screen time. In 2 other countries, we earn a lower percentage of screen time due to lower penetration of our service. We earn consumer screen time, both mobile and television, away from a very broad set of competitors. We compete with (and lose to) Fortnite more than HBO. When YouTube went down globally for a few minutes in October, our viewing and signups spiked for that time. Hulu is small compared to YouTube for viewing time, and they are successful in the US, but non-existent in Canada, which creates a comparison point: our penetration in the two countries is pretty similar. There are thousands of competitors in this highly-fragmented market vying to entertain consumers and low barriers to entry for those with great experiences. Our growth is based on how good our experience is, compared to all the other screen time experiences from which consumers choose. Our focus is not on Disney+, Amazon or others, but on how we can improve our experience for our members.

Hastings point was that analysts should not be overly focused on the threat posed by other streaming services; Netflix has been fighting for attention for years. This is correct, by the way: thanks to the Internet everything from television to social networking to gaming can be delivered at zero marginal cost; the only scarce resource is time, which means attention is the only thing that needs to be competed for.

Well, that and money: companies competing for customer money need a way to communicate to customers what they have to sell and why it is compelling; that means advertising, and advertising requires attention. It follows, then, that the most effective business model in the attention economy is advertising: if customers rely on Google or Facebook to navigate the abundance of content that is the result of zero marginal costs, then it is Google and Facebook that are the best-placed to sell effective ads.

Notice, though, the trouble this Internet reality presents to Netflix: if content is abundant and attention is scarce, it’s easier to sell attention than content; Netflix’s business model, though, is the exact opposite.

Netflix’s Differentiation: Unique Content

Netflix, of course, sees this as a differentiator, and for a long time it was: linear TV had commercials, while Netflix had none. Linear TV made you wait for your favorite show, while Netflix gave you entire seasons at once. This was particularly compelling when Netflix had similar content to linear TV: why would you put up with commercials and TV schedules when you could just stream what you wanted to?

However, as more and more content has moved away from TV and to competing streaming services, differentiation is no longer based on the user experience, but rather uniqueness; on-demand no-commercials is no longer unique, but Stranger Things can only be found on Netflix.

Here Netflix’s biggest advantage is the sheer size of its subscriber base: Netflix can, on an absolute basis, pay more than its streaming competitors for the content it wants, even as its per-subscriber cost basis is lower. This advantage is only accentuated the larger Netflix’s subscriber base gets, and the more revenue it makes per subscriber; the user experience of getting to that unique content doesn’t really matter.

All of these factors make a compelling case for Netflix to start building an advertising business.

First, an advertising-supported or subsidized tier would expand Netflix’s subscriber base, which is not only good for the company’s long-term growth prospects, but also competitive position when it comes to acquiring content. This also applies to the company’s recent attempts to crack down on password sharing, and struggles in the developing world: an advertising-based tier is a much more accessible alternative.

Second, advertising would make it easier for Netflix to continue to raise prices: on one hand, it would provide an alternative for marginal customers who might otherwise churn, and on the other hand, it would create a new benefit for those willing to pay (i.e. no advertising for the highest tiers).

Third, advertising is a natural fit for the jobs Netflix does. Sure, customers enjoy watching shows without ads — and again, they can continue to pay for that — but filler TV, which Netflix also specializes in, is just as easily filled with ads.

Above all, though, is the fact that advertising is a great opportunity that aligns with Netflix’s business: while the company once won with a differentiated user experience worth paying for, today Netflix demands scarce attention because of its investment in unique content. That attention can be sold, and should be, particularly as it increases Netflix’s ability to invest in more unique content, and/or charge higher prices to its user base.

This, I will note, is an about face for me; I’ve long been skeptical that Netflix would ever sell advertising, or that they should. The former may still be warranted, particularly in light of Netflix’s gaming initiative. This feels like solipsism: Netflix’s executives think a lot about their business model, so they are looking for growth opportunities that seem to leverage said business model; I’m not convinced, though, that customers appreciate or care about the differentiation that Netflix claims to be leveraging in gaming, whereas they would appreciate lower prices for streaming, and already have the expectation for ads on TV.

Meanwhile, subscriber growth has stalled, even as the advertising market has proven to be much larger than even Google or Facebook can cover. Moreover, the post-ATT world is freeing up more money for the sort of top-of-funnel advertising that would probably be the norm on a Netflix advertising service. In short, the opportunity is there, the product is right, and the business need is pressing in a way it wasn’t previously.

Of course this would be a lot of work, and a big shift in Netflix’s well-defined value proposition; Netflix, though, has made big shifts before: the entire reason why advertising is a possibility is because Netflix is a streamer, not a DVD mailer. In that view a new (additional) business model is just another rung on Netflix’s ladder.