Virgin Mobile Pricing for the First Time

Virgin Mobile Pricing for the First Time

Questions Given Virgin Mobile s target market, how should it structure its pricing Provide evidence of financial viability of your pricing strategy Sources of dissatisfaction in the cellular industry How do major carriers make money in this industry Opinion on Virgin s value proposition Opinion on Virgin s target market selection

Sources of Dissatisfaction in the Cellular Industry Contracts Customers must commit to one or two years of service in order to receive reasonable rates (pg 6) From Firms persp contracts tend to lower churn and boost retention rates Cust Persp leave consumers trapped within their plans Buckets Customers typically need to sign up for a pricing bucket fairly precise number of minutes that falls within a tight range in order to receive the given per minute rate Customers are penalized heavily for shortfalls and overages (Pg 6)

Sources of Dissatisfaction in the Cellular Industry Hidden Costs Cellular Carriers have a history of adding additional fees to rates Taxes Universal charges Off v/s on peak differentials Various one time costs Customers wind up paying 20-25% more than they expected on a per minute basis (Pg 7) Off Peak v/s On Peak Differentials Cellular carriers typically charge less for off peak than for on peak minutes off peak period has shrunk over time (pg 6) Various carriers have different off peak/on peak policies leading to customer confusion

Sources of Dissatisfaction in the Cellular Industry Credit Checks Elimination of roughly 30 % of the pool of applicants due to poor credit ratings (Pg 7) Consumers spend time and effort dealing with sales people deciphering various plans only to subsequently be rejected by a carrier Complex Sales Process Cell phones available only in proprietary retail outlets, mall kiosks and high end electronic stores (pg 4) Complexity of pricing plans requires a high touch, face to face sales interaction with a salesperson that many find frustrating and time consuming

Sources of Dissatisfaction in the Cellular Industry Privacy Concerns Consumers receive bills via mail; bills typically include call history Customers would prefer to keep call details private Poor Service Industry is not known for its customer service When customers have problems, response is typically poor

Cycle of Dissatisfaction

Pricing Structure from Carrier Perspective Many of the sources of customer dissatisfaction are also sources of carrier profit Contracts Annual churn rate WITH contracts =2% * 12 months = 24% (p.8) Annual churn rate WITHOUT contracts =6% * 12 months = 72% (p.8) The difference: 72% - 24% = 48%

Pricing Structure from Carrier Perspective Take AT&T example: customer base = 20.5 million (Case Exhibit 1) If AT&T abandons the contract based plan how many new customers would it need to acquire to offset customers from an increased churn rate? Additional customers lost to churn: 48% * 20.5 mln = 9.84 mln Acquisition cost per customer: $370 (case p.2) Total cost of offsetting higher churn rate: $370 * 9.84 mln =$3.64 bil. Not surprising that major players still continue to hold customers hostage thru the contracts.

Pricing Structure from Carrier Perspective Bucket Pricing Carriers have competed on price and most messages include a per minute price in ads Carriers cite lowest possible rates in their ads Then they require customers to estimate their usage within a tight range to experience these rates Customers are not always adept at estimating their future calling patterns Thus carriers are able to capture significantly higher rates from customers

Pricing Structure from Carrier Perspective

Pricing Structure from Carrier Perspective Customers using 700 minutes a month should be paying about 10 cents a min. In reality most consumers are paying more some upto 60 cents a minute Therefore the ones who are paying more are on the wrong plan The industry makes money from customer confusion Pricing buckets allow carriers to advertise low per minute rates But because most customers end up by choosing the wrong bucket, carriers are able to significantly capture high rates from these customers than they signed up for As Schulman says, if all customers signed up for the optimal plan usage, carriers would be making far less money than they are today (pg 6)

Pricing Structure from Carrier Perspective Hidden Fees, Credit Checks, Poor Customer Service By using hidden fees, carriers are able to promote low per min prices, but still collect additional revenue Industry cuts corners in areas like customer service and billing to boost operating margins Require credit checks to ensure that their uncollectibles and churn rates remain low Credit check becomes part of a complex sales process in turn have costly sales commissions in turn keeps acq costs high.

Acquisition costs Advertising per gross add: from $75 to $100 (p.5) Sales commission paid per subscriber: $100 (p.5) Handset subsidy provided to the subscriber: $100 to $200 (p.9) Total: from $275 to $405 (let s assume somewhere in the middle = $370)

Break Even point Monthly ARPU (average revenue per unit): $52 (p.3) Monthly Cost-to-Serve: $30 (p.3) Monthly Margin: $22 Time required to break even on the acquisition cost = $370/ $22= 17 months In the cellular industry the monthly margin is relatively fixed across periods, therefore the traditional LTV can be simplified (assuming M LTV infinite = horizon): - AC 1-r+i M = margin the customer generates in a year r = annual retention rate = (1-12*monthly churn rate) i = interest rate (assume 5%) AC = acquisition cost

LTV with contracts The annual retention rate in the industry = 1-12*0.02=0.76 LTV = 22 * 12 1-.76 +. 05-370 = $540

LTV without contracts Eliminate contracts -> churn rate increases to 6% Calculate the LTV: LTV = 22 * 12 1-.28 +.05-370 = -27.14

Eliminate Hidden Costs $ 29 cellular bill becomes $35 due to hidden costs Increase of 21% If these costs were eliminated, the $22 margin would be reduced to $18.18= $22/1.21 Break even would become 20 months = 370/18.18

What happens to LTV? Without hidden costs, but with contracts LTV = 18.18 * 12-370 = 382 1-.76 +.05 Without hidden costs and without contracts LTV = 18.18 * 12-370 = 1-.28 +.05-86.68 Elimination of contracts drives LTV below zero Hidden costs boost the bottom line

Option 3: different pricing approach It would appear that if Virgin Mobile were to enter the industry with a pricing structure similar to that of the other carriers, the LTV would be positive, all else being equal. But this approach may not make sense for Virgin Market is overcrowded with wireless plans that are undifferentiated Customers are dissatisfied and confused with current offerings This could make Virgin s goal of acquiring 1 million customers difficult

Option 3: different pricing approach Virgin would like to target the youth market a segment that is loath to enter into contracts and very likely to fail credit checks It appears that Virgin has chosen to target the most unattractive segment in the market Young people Have limited disposable income Uneven usage patterns Weak credit histories Why has Virgin chosen to target this segment?

Option 3: different pricing approach This segment is underserved. None of the other major carriers has offered plans specifically for this segment Thus there appears to be an opportunity for Virgin to offer these customers an product with highly differentiated features designed to meet specific needs (Virgin Xtras) Also because the segment has been largely ignored up to now, Virgin may be able to compete below the radar screens of the big players at least in the short term

Option 3: different pricing approach Is it possible to offer these young customers a consumer friendly pricing plan? What would such a plan look like? An ideal plan would have: No contracts No pricing buckets Fair pricing levels No hidden fees etc. The problem is that if Virgin were to adopt such a plan, each one of these elements would have a potentially negative impact on its financials

Option 3: different pricing approach Customers Want No contracts No Pricing Buckets No Hidden Fees No Peak/off Peak Hours No Credit Checks Simple Sales Process Great Service But the problem is. Increased Churn Lower Operating Margins More Uncollectibles Customer Confusion Increased Costs

Option 3: different pricing approach But there are a number managerial tools that Virgin could use to offset these negatives Lowering Acquisition Costs (Sales Commissions) Virgin has decided to adopt a different channel and merchandising strategy Decided to opt for channels where customers can pick up the phone without a salesperson (pg 5) Thus sales commissions will be lower than the industry average ($30 per phone against $ 100 per phone)

Option 3: different pricing approach Lowering Acquisition Costs (Advertising) Virgin plans to spend much less than its competitors $60 mill for the year (pg 5) If target is 1 mill cust, this implies an advertising cost of $60 per gross ad compared to the industry average of $75 -$ 100 (pg 9) Lowering Acquisition Costs (Handset Subsidy) Virgin handsets will cost the firm between $60 to $100 compared to the industry average of $150 to $300 (pg 5) Thus Virgin can still sell its phones within an acceptable price range if it decides not to offer subsidies If Virgin decides to offer a subsidy at half the rate of the industry average, subsidy would roughly be $30 resulting in a handset price of $30 to $70

Options for Lowering Acquisition Costs Advertising costs per customer Industry=from $75 to $100 Virgin planned ad costs = 60 mil/1min= $60 (p.5) Handset subsidies: Current industry handset cost: $150 to $300 (assume $225) (p.5) Current industry handset subsidy: $100 to $200 (assume $150) (p.9) Current industry handset subsidy as a %: 67% Virgin s handset cost: $60 to $100 (assume $80) Assume Virgin s subsidy around 35% to 40% = $30

Acquisition costs Then Virgin s AC would be just $120 vs. industry average $370 Sales commission: $30 Advertising per gross add: $60 Handset Subsidy $30 Total: $120

p > 0.07 Consumer friendly plan: how to achieve profitability Break Even analysis: at what per minute price would Virgin break even: Virgin s monthly ARPU: (200 minutes)*(p), where p=price per minute Monthly cost to serve:.45 * 200 * p Monthly margin: 200p 12*110p - 90p = 110p LTV = 1-.28 +.05-120 > 0

Other price points What if Virgin charged per minute price comparable to other industry prices, somewhere in between 10 and 25 cents: At 10 cents: LTV = At 25 cents: 12*110*.1 1-.28 +.05-120 = $51 LTV = 12*110*.25-120 = 1-.28 +.05 $309

Virgin s Pricing Plan: What happened A prepaid plan No contracts No hidden charges No peak off peak hours Very low handset subsidies No credit checks No Monthly bills Price: 25 cents per minute for the first 10 minutes; 10 cents/minute for the rest of the day No exact numbers, but churn rate lower than 6%