If you have been following the market recently, you have surely heard of the PR disaster that Netflix (NFLX) has managed to create. Having doubled the price of their service, NFLX has recently stated that they have initially lost 1.4 million customers since the announcement in late July. This triggered the stock price to fall from a high of $298 in mid July to a close of $155.19 on Friday afternoon, for a total market cap loss of $8 billion. Although the price increase was attributed to an increase in the cost of providing their service, the way that Reed Hastings, the CEO, handled the press release and subsequent backlash has left little to be desired in this overvalued, hyped up stock. Mr. Hastings casually brushed off the 60% price increase in interviews, and has said that the company should continue to add subscribers throughout 2012 and beyond. This is a bold statement, considering that they are hemorrhaging customers at this point. And, to add fuel to the fire, NFLX also announced that they would no longer be providing content from STARZ network, which was a favorite among their subscribers.

The backlash, in my opinion, was not related to the overall price increase, which amounted to $6 for most subscribers. It was due to the way that Hastings handled the situation. Hastings shrugged off the increase as “insubstantial” and he claimed that the value of it far outweighed the $6 more that NFLX will charge for combined streaming and mail-in DVD services. However, a quick economics lesson is that increasing the price of ANY good by 60% will turn many consumers away. The MBAs on the board clearly didn’t expect such a drastic response.

Now, in terms of the financial consequences, we will have to wait until November to find out the full impact of the change. Since subscribers now get to choose between streaming/DVD or both, it is unclear how many will stay with both. Since one service only costs $7.99, if most of the subscribers stick with one option, NFLX will lose money that way. Until Q3 results come out, the composition of subscriber services will be left for speculation.

Both revenues and operating margin have been increasing for NFLX the past 3 years, and this will likely change for the second half of 2011 and 2012 as the company faces challenges from the producers in terms of higher costs for their content. NFLX’s ridiculous valuation has been predicated upon the fact that their business model put Blockbuster out of business and that they would be able to consistently increase their subscriber base over the years. Now, they cut their forecast by $1 million subscribers for Q3, and the market will react harshly to any more negative news should it come out.

NFLX will go down in MBA textbooks in 2-3 years as a lesson of how NOT to treat your customer base. If the company were to gradually increase their pricing structure over a 6-12 month period, there would not have been such a huge backlash, However, by completely restructuring their pricing plan and increasing rates by 60%, they completely and utterly misconstrued the demand for their product, which seems to be quite elastic so far. As an investor, I would wait until Q3 results come out to gauge the depth of this wound. As usual, DYODD and take this as a lesson of how fast market sentiment can turn around even with Wall Street’s most favored stocks.

Disclosure: I have no position in NFLX and do not plan on initiating one.