Hulu Has a Massive Advertising Opportunity

Hulu has three tiers of service: Hulu with ads costs $5.99 per month, Hulu ad-free costs $11.99 per month, and Hulu with Live TV costs $45 per month. It's a good bet its lowest-priced plan is its most profitable.

Hulu generates about $9 per subscriber per month in ad revenue, according to a report by The New York Times last month. That may be one reason it dropped the price of the ad-supported service earlier this year and recently offered a deal to bundle at no additional cost to Spotify Premium subscribers.

Hulu's ad business generated about $1.5 billion last year, but that could grow significantly now that Disney (NYSE: DIS) controls the business. Here's why Disney can provide a major boost to ads on Hulu.

Back to commanding premium ad prices

Earlier this year, Hulu made a change to its advertising policy. Instead of allowing networks to decide how long commercial breaks are for their content, it put a hard cap of 90 seconds per pod.

As commercial breaks on Hulu got longer, ad prices went from $30 or $40 per thousand impressions to as little as $20. Controlling the supply of ads and keeping commercial breaks short means Hulu can go back to commanding premium ad pricing. (Consumers are more likely to pay attention to ads if they don't have time to run to the bathroom or grab something from the kitchen.)

Additionally, shorter ad breaks provide a better viewing experience, especially compared to traditional television broadcasts, which could increase engagement over time. That should help offset the lower average ad loads on the platform.

Meanwhile, Hulu is experimenting with other ad formats such as banner ads when viewers pause their video. These ads that command consumer attention ought to result in higher average prices while keeping ad load at bay.

A single ad sales team for Disney

As part of Disney's deal to take full operational control of Hulu, Disney is now able to consolidate Hulu's ad sales with the rest of its advertising operations. Disney has digital ad sales for ESPN+ as well as its TV Everywhere apps, and it has a slew of TV networks to sell ads for as well.

Disney can now sell packages of ads across all of its properties, helping bring big brands that spend a lot of money on television ads further into the digital video ad market. Hulu CEO Randy Freer says Hulu's active advertiser base will grow from 2,500 today to over 10,000 within the next few years.

Driving greater demand for Hulu's advertising product gives Disney flexibility to grow ad revenue in various ways. It can simply allow average ad prices to climb higher, it could balance demand with longer ad breaks, or it could work with advertisers to develop more effective ad products. Getting the demand, however, is an important step that can't be overlooked.

The secular growth of digital video ads

At Disney's investor day last month, Freer said the digital video ad industry is expected to surpass $50 billion within the next three years. That's up from about $28 billion last year. Much of that ad spend will come out of traditional TV ad budgets.

The natural shift in ad spending ought to be a huge driver for Hulu, which offers the best analog for television advertising. With all the privacy and brand safety concerns circling bigger digital advertising companies, Hulu offers a bastion for big brand advertisers.

Disney's ability to integrate Hulu's ad sales with its other platforms and the secular growth in digital video ads ought to support strong ad prices for the streaming service. Combined with strong subscriber growth (Disney expects to reach 40 million to 60 million subscribers by 2024), Hulu should see ad revenue grow considerably over the next few years.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool has a disclosure policy.