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Netflix Price Hike Reflects Strategy Cracks

Stocks in this article: NFLX

NEW YORK ( TheStreet) -- Netflix's (NFLX) subscription rate hike is revealing some cracks in the company's business model.

"We believe the move shows that Netflix's old pricing model was unsustainable as the company was losing money on a cash basis, which it masked through accounts payable increases and accounting treatments on the income statement," wrote Janney Capital Markets analyst Tony Wible, in a note.

Netflix CEO Reed Hastings

According to Wible, Netflix has seen a 275% increase in its off-balance sheet obligations over the past year, and the quality of earnings has eroded with its push into streaming.

>Click here to take our Netflix price hike poll.

Netflix will be further pressured by its expansion into Latin America and the looming Starz deal, which Wible said were likely factors in management drastically increasing pricing.

Netflix's prior pricing model was clearly faulty. Streaming-only subscriptions stood at $7.99, becoming a popular option for new subscribers. The combo package (DVD and streaming) was $9.99, which meant consumers were essentially paying just $2 for the DVD aspect of the subscription.

According to Bank of America analyst Nat Schindler, Netflix pays about 80 cents to ship a single DVD, and the average customer on the one-DVD plan had historically rented three DVDs per month. This puts the average monthly shipping cost for one DVD plan at $2.40, costing Netflix 40 cents a month per subscriber.

"Clearly not a supportable long-term business model," Schindler noted.

While it is too early to know whether this new pricing structure will be successful, there has already been an outcry from subscribers on the Internet, with many declaring they are going to cancel their membership altogether.

There's some fear that higher prices will drive consumers elsewhere, like to Amazon's (AMZN) streaming service or to Coinstar's (CSTR) Redbox DVD kiosks.

>7 Netflix Deals: Will Content Costs Bust Its Bottom Line?

But the consensus on Wall Street is Netflix will be able to offset any churn in subscribers.

"A price increase at Netflix is not something done haphazardly," Morgan Keegan analyst Justin Patterson noted. "This is a company that tests seemingly every element on its site and has strict return on investment thresholds on content licensing and subscriber acquisition. Raising prices therefore only occurs if management believes subscribers can be nudged toward streaming-only plans or pricing power exists on the hybrid side. Either scenario enables Netflix to license more streaming content, which we view as a long-term positive for subscriber growth, retention and free cash flow."

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