Welcome back to What I’m Hearing+, coming to you from Brooklyn, where I’ve been swept up (no pun intended) in one hell of an incredible run by the Denver Nuggets. Sorry to all the Lakers fans after a rough series.

In tonight’s edition, a deep dive into the Netflix upfront numbers that mistakenly sent the stock soaring, and the metrics behind why the pivot-to-streaming-profitability will take longer than anticipated.

But first…

Zaz noted recently that “five shows are 90 percent of what people are watching on HBO Max, and if we put it to 20 shows, it’s 98 percent of what people are watching.” His point, in response to a question about exclusivity, was that Max has a handful of crown jewels that they’re not gonna give away. But if those numbers are accurate—and they seem hyperbolic, at best—they also highlight the incredible challenge for the platform as it grows. Sure, there’s the Succession crowd, and the Big Bang Theory crowd, but how do you satisfy those audiences after they’re done with their favorite five shows, keeping them hooked ad infinitum in service of a growing advertising business?

Zaslav has set up a fascinating philosophical question: Does Max simply not offer enough broadly appealing content (a creative issue), or are its recommendation tools flawed (a technology issue)? Based on his remarks, Zaz seems to be betting on the magic of “repackaging” Discovery content alongside the HBO catalog, essentially reducing the hurdles to discovering series like Dr. Pimple Popper (a marketing issue, perhaps, for customers unaware of what’s really on the platform).

The next year or so will ultimately be animated by the path that Zaz chooses, though presumably he will attempt to address all three issues by greenlighting work more efficiently (after the strike), obsessing about the internal algorithm, and programming wisely to expand audience (acquisition), increase engagement (retention), and cement the perceived value of a subscription whose monthly price, Zaz warned, needs to increase.

In the meantime, the recommendation engine is perhaps the most underappreciated lever for success when consummating two services as different as HBO Max and Discovery+. (As Zaz mentioned, there really was no recommendation tech at all when he first stepped in to run the combined company.) Merging content from two platforms only works if the algo is able to better satisfy those audience segments, instead of serving them more of the same.

This is an extremely tough aspect of streaming. Netflix spends an exorbitant amount of time running A/B tests, including concocting up to 30 or 40 icon photos for series and films, to try to appeal to as many different tastes as possible. Are Zaz & Co. willing to do the same? Whatever happens next, Disney’s Bob Iger is surely watching.

Of course, Netflix upended all this and brought the transformation full circle last week with its first appearance at the upfronts, albeit via a virtual showcase, touting some strong numbers for its advertising tier, which only launched six months ago. Netflix’s main argument coalesced around 5 million global monthly active users, but… five million of what exactly?

In retrospect, it wasn’t entirely clear what the company has achieved. Netflix either added 5 million customers or 5 million monthly active users. A subscription is measured per account (like subscriber figures presented in financial earnings). Monthly active users effectively include all profiles watching on one account. This is key to ensuring that ads aren't shown on children's profiles. The difference may seem pedantic, but the breakdown of those users within the advertising tier, including whether or not they descended from the ad-free tier or were net new subscribers, is key to understanding the platform’s momentum.

I’m not suggesting that Netflix’s ad tier isn’t promising. The company noted in its recent earnings that average revenue per member is already higher on the ad-supported tier, which blends ads and subscription revenue for a figure the company hasn’t disclosed. Currently, Netflix makes $16.18 per user in the U.S. and Canada region, but that isn’t broken into ads or no-ads in the company’s financials. Netflix hasn’t actually stated how many members in that plan are in the U.S. and Canada. With a little more than one million domestic customers joining Netflix since the ad-tier launched, we can presume two things: 1) most additions to the ad-supported tier are likely coming in from other territories, including Europe/Middle East/Asia (EMEA), which saw an additional 3 million new customers in the quarter when the ad tier launched; and 2) even if cannibalization were to occur within Netflix’s U.S. market, the stronger average revenue per member wouldn’t negatively impact the business per se.

Netflix may be the new normal in entertainment, but its ad business is still simply just new. It’s actually late to the party of combining advertising and subscription revenue; Peacock launched with an ad-tier focus, HBO Max and Paramount+ added advertisements early into their existence, and Hulu has championed blended revenue for years. But it’s also, of course, the most significant entrant into the market, by virtue of its size. Now that Netflix has released its first tranche of data, let’s examine three of the bigger questions about advertising and streaming as it stands today, and where it’s headed.

How many customers, trained for years to experience Netflix without ads, will sign up to do so going forward? Many analysts still see strong upside for Netflix in the ad market, even at a time of softening rate cards in the marketplace. I do, too. For one, Netflix is cracking down on password sharing in earnest. Emails are going out to customers in the U.S. today alerting households with users outside the home that those viewers will have to pony up $8 to continue streaming. Some may see it as a potential churn crisis at a time when all eyes are on streaming stability. Some view it as the perfect opportunity to capture more price-sensitive users, with a possibility of 30 million customers in the U.S. and Canada alone using but not paying for Netflix.

Netflix is also smart to get its ad-supported product in place, and work out the kinks, before raising prices again—an inevitability given the pressure on streamers to pay off debt, balance their P&Ls, and produce more content. As Warner Bros. Discovery C.E.O. David Zaslav noted publicly the other day (and every streaming executive privately agrees), pricing across the entire industry is way too low to be sustainable. Especially with the current wave of consolidation (Disney+ and Hulu, HBO Max and Discovery, etc.), the expectation is that more households will transition from premium plans to cheaper, ad-supported tiers.

Of course, Netflix is also an outlier in the market. Whereas endless M&A chatter attends WBD, Paramount, and NBCUniversal, Netflix has already achieved both scale and profitability in streaming. It’s also one of the streamers that customers are least likely to cancel (it still maintains one of the lowest churn rates in the industry, even as that rate continues to increase industrywide) —which means it may also be the service that customers are least likely to downgrade. After all, the platforms we spend the most time on are the ones where the experience matters most. If Netflix continues to dominate in consumption (Netflix maintained 6.9 percent of all streaming time in April, according to Nielsen), it’s possible that fewer subscribers than expected will ultimately switch from the more expensive ad-free version (which presumably generates less revenue for Netflix than the combined version, based on Netflix’s recent earnings report) to the cheaper ad-supported tier (which actually generates more), at least in the U.S. and Canadian market. Globally, however, it’s a different story…

Part of the difficulty is that emerging markets haven’t yet built a real culture around streaming. In the U.S., scripted content on pay TV makes up less than a quarter of what people are viewing, in large part because most of that programming is now being made for streaming, not cable. In the U.S., we’ve pushed a majority of the audience to streaming, which has consequently affected the entire content development pipeline.

Internationally, however, where pay TV is much cheaper on average, and the best content is still being made for linear, there are fewer reasons to cut the cord—especially in key regions, like India, where Netflix and others have struggled. To build a culture around streaming, you first need significant market adoption. Historically, that’s meant operating at a loss to onboard hesitant customers. But this may actually provide an opportunity for Netflix to accelerate the growth of its ad-tier footprint outside the U.S.

Sure, lowering one hurdle (price) doesn’t take down the other hurdle, which is content. Netflix still needs to acquire and program for hyper-regional tastes. But offering a cheaper ad-supported tier could be a gamechanger in more price-conscious households in new international markets, which is the first step toward mass adoption—and, eventually, rising pricing power and stronger advertising CPMs.

Nevertheless, Netflix may be one of the few streamers in a position to make advertising work. As my colleague Bill Cohan pointed out, Netflix is the only major platform generating a profit (an expected minimum of $3.5 billion of free cash flow by the end of the year, an increase in guidance per the most recent earnings report). The counterargument, of course, is that Netflix is currently offering advertisers one of the smallest potential audiences for their product. No wonder Netflix’s recent upfronts pitch was so focused on future opportunities, rather than who they can reach right now. Ted Sarandos and Greg Peters are essentially asking advertisers to trust them, to get in on the ground floor of something new and exciting, and potentially very valuable. If industry veterans are nervous, it’s because they’ve seen this movie before.