Roku Is the Latest Victim of the "Amazon Effect"

As Roku (NASDAQ: ROKU) continues to ramp up its advertising business as part of its ongoing platform expansion, a new risk that threatens to derail its progress has just emerged: (NASDAQ: AMZN). Any time investors even catch a hint that Amazon is about to encroach on another company's territory, the incumbent's stock invariably falls. That's why Roku shares are under pressure today, as the e-commerce giant is reportedly looking to launch its own ad-supported over-the-top (OTT) streaming service that offers free content to viewers.

How worried should Roku be?

The latest in Amazon's growing ad business

The Information (subscription required) reports that Amazon is developing a service called Free Dive. It would be available on Fire TV streaming devices, which has a reported installed base of approximately 48 million. Much like The Roku Channel, Free Dive would feature older licensed content that is monetized through advertising. This is a fairly obvious strategy that others have tried before, but Roku is executing well on growing viewership of its new first-party channel that was launched almost exactly a year ago.

Amazon's IMDb subsidiary, the popular repository for information on TV and movies, is taking the lead in developing the service, according to the report. Free Dive would be independent of Amazon's Prime Video service, its flagship OTT streaming service that is included as part of its Prime program.

The move would be part of Amazon's current efforts to grow its advertising business, which takes many forms. Sponsored listings on product queries on the main e-commerce site are the most prominent part of that business, but Amazon has also explored ad-supported programming on IMDb, and advertising is a critical monetization tool for its Twitch live-streaming platform. Prime members previously were able to remove ads on Twitch, but Twitch recently announced it was nixing that perk effective Sept. 14.

Ad budgets are shifting away from linear TV

One ironic dynamic of the news is that Roku has been aggressively expanding beyond its platform, announcing last month that The Roku Channel would soon become available as a stand-alone app and be viewable on the broader web, effectively untethering The Roku Channel from its first-party devices. Amazon's rumored move would specifically be tied to its first-party Fire TV streaming devices. That suggests that part of Amazon's motivation is to sell more Fire TV devices, while Roku has been increasingly relying on third-party manufacturers that license its platform for active account growth.

While Amazon will be competing with Roku for ad dollars, the bigger picture is that the overall market for digital TV advertising is growing rapidly as advertisers shift their spending away from traditional linear TV advertising toward digital platforms. Roku believes that "the vast majority of the $70 billion annual U.S. TV advertising market will shift to streaming" over the long term. In other words, while Amazon is always a mighty contender, both companies can succeed if they execute well, growing their viewership while maintaining a balance of ad load and compelling content.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Evan Niu, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.