Netflix and Microsoft: A match made for gaming?

Netflix is quietly expanding its gaming empire, and Microsoft is expected to be playing a leading role.

The tech companies announced a partnership to build Netflix’s advertising offering in July, but people familiar with the deal suggest this is likely just one element of their alliance.

Netflix executives have talked up the company’s gaming ambitions for several years — naming Epic Games as one of its biggest rivals in a shareholder letter last year — but its offering has so far struggled to scale. Less than 1% of subscribers have downloaded any of the 22 mobile games Netflix rolled out since November last year, according to an Apptopia report for CNBC. Still, the company said it plans to double the size of its mobile gaming portfolio by the end of 2022. 

Recent job postings suggest Netflix may be looking to expand beyond mobile and into cloud gaming. It is searching for a rendering engineer “to support our cloud gaming service,” according to one job ad. The role will assist with building SDKs to enable developers to write games for the Netflix cloud games ecosystem. Other ads for senior games and tools engineers discuss how Netflix is “building a new internal game studio” for social party video games. Netflix did not return a request for comment.

In cloud gaming, games run on remote servers and stream to a user’s device, bypassing the need to download. Also referred to as “gaming on-demand,” this market is expected to nearly double in 2022 to $3 billion and grow to a $41 billion industry by 2029, according to Fortune Business Insights.

It is opportune, then, that Microsoft has both cloud gaming expertise and infrastructure to support such a venture for Netflix. With Xbox Game Studios, which generated $16 billion in revenue in 2021, Microsoft is the world's second-largest video game company. Microsoft’s gaming offer could soon balloon if its deal to purchase Activision Blizzard for $68.7 billion is approved — although it still has a lot of regulatory concerns to appease.

Microsoft officially launched its cloud gaming service in September 2020 and runs it on Microsoft Azure, the world’s second-largest cloud computing service.

Cloud motivations

Netflix has a long-time cloud computing relationship with Amazon Web Services (AWS), but it is reportedly seeking to control rising costs from the service as part of a broader strategy to reduce expenses. Using a rival cloud provider like Azure for some of its computing and storage needs could be one way to cut costs, as well as reduce its reliance on AWS.

“The motivation to move off AWS over to Microsoft would make sense, because there's a lingering concern on the Netflix side that they've built their entire tech stack on what is now a huge streaming competitor,” said Travis Lusk, director of Ebiquity Tech, North America. It’s also been rumored that Amazon is interested in purchasing EA Games.

Moving away from AWS will also be crucial for Netflix to lure big retailers to its ad offering. One ad expert, speaking anonymously, said retailers such as Walmart are seeking to keep their data off AWS due to competition concerns with Amazon.

Netflix executives have poured cold water on rumors that its deal with Microsoft is more extensive than just an ad partnership. During its second-quarter earnings call with investors, chief operating officer Greg Peters said it was a “great ads partnership deal at the end of the day.” But he did add that Netflix “will look for those opportunities as they exist with Microsoft.”

“It seems to me like advertising is the smallest part of this deal,” said Tal Chalozin, cofounder and CTO of ad tech firm Innovid.

Since Microsoft will use its own tools and systems to build Netflix’s ad-supported layer, having the same underlying technology across multiple services would “makes things smoother,” Lusk noted. “I would be shocked if everything that Microsoft offers isn’t trying to get installed at Netflix.”

One person familiar with the deal said a cloud partnership is “pretty certain,” as tech giants like Amazon, Google, Microsoft and Salesforce generally bake cloud elements into large-scale deals. 

“If you have cloud computing space to offer, that's a pretty powerful currency you can bring to the table in any type of business partnership or discussion,” said Seth Schachner, managing director of Strat Americas and a former Microsoft Advertising exec.

The two companies also have long-running board-level ties. Microsoft’s president and vice chair Brad Smith is a Netflix board member, while Netflix CEO Reed Hastings sat on Microsoft’s board from 2007 to 2012. “I think there was a handshake,” the anonymous source said.

Plugging gaps

Gaming and advertising experts that Campaign US spoke with believe a cloud gaming partnership between Netflix and Microsoft is a “no brainer” given their complementary technology and business ambitions.

Microsoft brings everything Netflix needs to kickstart an ad-supported gaming business: a comprehensive game library, cloud capabilities and an ad tech solution. 

“While Netflix dominates in video streaming, so far the gaming offering isn't luring in subscribers. It comes back to an important qualifier — who has the best content?” said Kelsey Chickering, principal analyst at Forrester.

Gaming could become an important subscription and ad revenue stream for Netflix, which has seen revenue slow substantially and lost more than 1 million subscribers so far this year.

“Netflix’s step into gaming is a natural way to engage an already rapt consumer base in a whole new way,” said Lewis Smithingham, SVP of innovation at Media.Monks.

“The key reason for Netflix being interested in gaming is to create a new growth engine,” said David Jones, founder and CEO The Brandtech Group. “Netflix invented a category and had several years being the only player until it became the most competitive category out there. This play can allow Netflix to reassert their lost dominance.”

“In my view, this may well be a better revenue generating opportunity than their slightly odd decision to take advertising,” Jones added.

Netflix offers premium IP that can be converted into new gaming franchises. Many of its mobile games center around its original hits such as Stranger Things, The Queen’s Gambit and Too Hot To Handle. Netflix could also take its gaming IP and convert it into streaming content. Microsoft’s previous bid to acquire TikTok demonstrates its interest in becoming a content owner.

The duo also have complementary business models that allow for easy integration. Microsoft’s gaming division is moving closer to a subscription model with Xbox Game Pass, which provides access to hundreds of games for a monthly fee. The company recently rolled out a family plan allowing users to share an account with four other people.

Media expert Evan Shapiro said in a blog post he believes that Microsoft could bundle Xbox Game Pass with a Netflix subscription “as soon as this fall.” Shapiro, like several industry experts we spoke with, believes the ad deal could even be a precursor to Microsoft potentially acquiring Netflix down the road.

“Depending on when Activision closes, I believe Microsoft and Netflix will consummate a marriage some time next year,” he wrote.

Advertisers are interested in the potential of such a tie-up. “I would love to see a combined Activision, Xbox and Netflix offering. It would be something that reaches and engages with a younger audience in a far better manner than just Netflix or gaming,” said Bharad Ramesh, executive director of research and investment analytics at GroupM.

It’s important not to overlook the culture fit too. Both are technology companies “first and foremost” with advertising a secondary consideration, where traditional media companies are more advertising-centric and perhaps less concerned with customer experience, according to Schachner.

A formidable opportunity for advertisers

A Netflix-Microsoft gaming empire would present a formidable opportunity for advertisers and allow Netflix to cross-sell opportunities, experts believe. 

Where advertising in gaming has been limited by technology, requiring hard-coded ads or product placements, cloud gaming allows for dynamic ad insertion and more ad opportunities, says Innovid’s Chalozin. “When gaming moves to streaming you can scale up and standardize advertising so much more,” he said.

Gaming also enables brands to activate in highly interactive environments, said Forrester’s Chickering. In Forrester's 2022 Media and Marketing Benchmark Recontact Survey, over half of US online adults say they play video games weekly. For adults under 25, that number jumps to 85%.

Where streaming content can often be passive, gaming is a “smart way for Netflix — and brands — to get that lean-in engagement,” said Marika Roque, COO of Kerv Interactive.

But gaming requires new ad formats beyond basic interstitials.

“The real power for brands in gaming is to be part of the game in a meaningful way, rather than interrupt an experience with a full-screen ad that's a forced view,” said Harley Block, cofounder and CEO of Gen Z brand consultancy IF7.

Gaming platforms have seen success with ads that offer a value exchange, such as incentivized play — where users are able to unlock new levels or game credits by watching ads. Innovid offers a “limited commercial interruption” product which allows TV viewers to engage with ads up front to avoid them for the remainder of a show. Chalozin said the product has been successful across brand metrics like recall and awareness.

Kerv Interactive’s Roque suggests Netflix could innovate on the ad experience by giving consumers choice and control. For example, it could offer subscription discounts if viewers agree to consume a certain number of ads. 

“One thing that millennials and younger people want are options, especially as we head into a potential recession,” Roque said.