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."
If customers choose to abandon DVD-by-mail and downgrade to the streaming-only plan, average retail per users would fall, but profitability would rise. If subscribers retain both DVD-by-mail and streaming, then average retail per user will rise, and the profitability of the DVD service will also rise to be more in-line with that of streaming. According to Goldman Sachs analyst Ingrid Chung, a very high number of subscribers would have to cancel their membership to offset the price increases. Netflix has been forthright about its ultimate goal to become a streaming company. Separating the DVD and streaming subscriptions is yet another turn of the wrist to convince subscribers to abandon the disc. But the introduction of a new pricing model may also be a move to help lower content costs. "In our view, the company is facing increasing pressure from content providers to base streaming content costs on the number of overall subscribers," said Wedbush analyst Michael Pachter. "By bifurcating its subscriber base into streaming and non-streaming plans, the company may be able to successfully argue that a lesser number of subscribers access streaming content, and may be able to control streaming content costs. Our central thesis has been that the company's streaming content costs are rising faster than its revenues; today's move reinforces our conviction that this thesis is correct." - Reported by Jeanine Poggi in New York. Follow TheStreet.com on Twitter and become a fan on Facebook.