By Sue Zeidler

LOS ANGELES (Reuters) - Netflix Inc (NFLX.O: Quote, Profile, Research) needs to start charging customers for its free online streaming service, said analysts on Tuesday after the DVD rental company's shares fell on news its gross margins will continue to be impacted by increased spending for Web-only content.

Netflix's stock tumbled over 20 percent on Tuesday, one day after it warned gross margins, which fell 210 basis points in the first quarter, would remain flat for the next two quarters as it continues to spend more for online content for its Watch Instantly streaming service it offers to subscribers for free.

"The real question is how long investors should expect these spending increases to persist before the company feels compelled to generate revenues from online streaming in order to offset the increasing costs," said Michael Pachter, analyst with Wedbush Morgan.

Netflix on Monday said it would raise pricing this year for customers who choose to rent Blu-ray high-definition DVDs. A spokesman said Netflix is always testing pricing but declined comment on whether a surcharge for the Watch Instantly feature was under consideration.

Netflix shares which have outperformed rival Blockbuster (BBI.N: Quote, Profile, Research) by a wide margin this year. Netflix stock had been up nearly 45 percent since early this year, while Blockbuster has fallen 20 percent.

Analysts said Netflix's plans for a Blu-ray surcharge hints at a potential surcharge for its online streaming.

Jefferies & Co analyst Youssef Squali said the premium for Blu-ray reflects much improved competitive dynamics for Netflix, which over time could allow it to raise prices and introduce hybrid pricing plans for its various offerings.

"As online streaming grows in popularity, it's likely to put further pressure on margins, prompting management to come up with a suitable pricing model," Squali said.