Virgin mobile final

F. Jallat – CFVG - 2011

Virgin Mobile USA

Pricing for the Very First Time

Questions of the Case• The cellular industry is notorious for high customer

dissatisfaction -churn roughly is 24% of the customer each year. How have the various pricing variables (contracts, pricing buckets, hidden fees, off-peak hours, etc.) affected the consumer experience? Why haven’t the big carriers responded more aggressively to customer dissatisfaction?

• How do the major carriers make money in this industry?

• Do you agree with Virgin Mobile’s target market selection (14 to 24 year old)? What are the risks associated with targeting this segment?

Questions of the Case

4. What do you think of Virgin Mobile’s value proposition (The Virgin Xtras, etc)? What do you think of its channel and merchandising strategy?

5. Given Virgin Mobile’s target market, how should it structure its pricing? Which option would you choose and why?

6. Provide evidence of the financial viability of your pricing strategy

Teaching Objectives1. To cover two main aspects of pricing

• Price levels – i.e., the overall amount a consumer pays• Price structure – i.e., how a payment is presented to the

consumer

2. To examine the interplay between pricing, target market selection, and a firm’s overall value proposition.

3. To demonstrate the multiple ways firms can create paths to profitability.

4. To illustrate the importance of adopting a long-term strategic perspective in choosing a pricing structure.

Pricing Structure from the Customer Perspective • Despite the fact that the mobile communications industry

is mature, over-crowded and fiercely competitive, a truly consumer-friendly cellular plan has still not been introduced.

1. Major carriers continue to hold customers "hostage" through contracts and leave them feeling trapped in their plans (capture).

2. Customers, being obliged to sign up for pricing buckets, are penalized, often heavily, for shortfalls and overusages (decommoditization and consumption penalties).

3. Due to hidden costs (taxes, extra charges, service costs, etc.), customers often wind up paying 20-25% more than they expected on a per minute basis (lack of transparency).

Pricing Structure from the Customer Perspective

• Despite the fact that the mobile communications industry is mature, over-crowded and fiercely competitive, a truly consumer-friendly cellular plan has still not been introduced.

4. Off-Peak/On-Peak differentials add to customer confusion and off-peak period has shrunk over time (constrained consumer behaviour patterns).

5. Credit checks eliminate roughly 30% of the pool of applicants due to poor credit rating, after consumers spent time and effort dealing with sales people (increased consumer rage).

Pricing Structure from the Customer Perspective • Despite the fact that the mobile communications industry

is mature, over-crowded and fiercely competitive, a truly consumer-friendly cellular plan has still not been introduced.

6. Complex sales process in most of the traditional channels (proprietary retail outlets, mall kiosks, high-end electronic stores) requires a face-to-face sales interaction that many find frustrating and time-consuming (increased sacrifice).

7. Consumers received their bills via mail. These bills typically include a detailed record of customers’ call history (no respect for privacing concerns).

8. When consumers experience problems or have questions about their bill, the service response has been historically very poor (poor management of moments of truth).

Pricing Structure from the Carrier Perspective

• Many of the sources of customer dissatisfaction are also sources of carrier profit!

1. Contracts

• customers under contract generate monthly churn rates of 2% while customers without contracts generate a churn rate of 6%...

• … For a firm like ATT (with a customer base of 20.5 million) this would mean to acquire an additional 9.84 million customers a year –at a cost of $3.64 billion- just to offset customers lost to the higher churn rate!


• Many of the sources of customer dissatisfaction are also sources of carrier profit!

2. Bucket Pricing

• While consumers using 700 minutes a month, for example, should be paying about 10 cents a minute, most consumers are paying more –some to them up to 60 cents a minute...

• … Pricing buckets allow the carriers to advertise low per-minute rates but "if all customers actually signed up for the optimal plan for their usage, the carriers would be making far less money than they are today"!

Industry Pricing Plans vs. Actual Prices Paid


3. Hidden Fees, Credit Checks, Poor Customer Service

• By using hidden fees, the carriers are able to promote low per-minute pricing levels but still collect additional revenues. The industry is also notorious for cutting costs in areas like customer service and billing to boost operating margins.

• Besides, the carriers also require a rigorous credit check to ensure that their uncollectibles and churn rate remain low...

• … generating a vicious circle through complex sales process, which in turn drives costly sales commissions ($100 per customer), which in turn keeps acquisition costs high, etc.

Multiple Target CustomersBusiness, Consumer, Heavy/Light Users, etc.

Multiple Target CustomersBusiness, Consumer, Heavy/Light Users, etc.

Complex Sales Process

Complex Pricing Plans: -Multiple options-Multiple buckets

-Hidden Fees

Poor serviceCredit Checks

A Cycle of Consumer Dissatisfaction

Sources of Consumer Dissatisfaction

Forced Contracts

Customer Dissatis-faction

Continuous Industry churnHigh churn rates mean that carriers must re-

acquire 24% of their customer base each year, just to stay even

High Customer Acquisition CostsBecause of high customer dissatisfaction

rates, acquiring new customers is a tough sell

Financial pressure to …Lock-in customers using contracts,

Cut corners in customer service to reduce costs,Aggressively promote low prices to attract cutomers

Use hidden fees and pricing buckets to increase margins

Sources of Industry Dissatisfaction

Behind Prices and Pricing Levels:Looking at the Economics of a Business Model

1. Acquisition Costs

. Advertising per gross add (p.5): $75 - $100. Sales commission paid per suscriber: $100. Handset subsidy: $100 - $200

. Total: $275 - $400

. Acquisition cost is roughly (p.2) $370


2. Break-Even Analysis

. Monthly ARPU (average revenue per user): $52

. Monthly cost-to-serve: $30

. Monthly margin: $22

. Time to break-even on the acquisition cost:

$370 / $22 = 17 months


3. Lifetime Value (LTV) Analysis

• From transactional to relationship marketing

From Transactional to Relationship Marketing

Time

Sales Volume

Natural growth of customers and market size

Growth only possible at competitors’ expenses


3. Lifetime Value (LTV) Analysis

• From transactional to relationship marketing

• Why should a company take into consideration the long-term value of its customers?

Reducing Defections 5% Boosts Profits 25% to 85%

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* Calculated by comparing the net present values of the profit streams for the average customer life at current defection rates with the net present values of the profit streams for the average customer life at 5% lower defection rates.

Relationship Marketing and Profitability

• Savings in advertising, costs of promotion and costs of finding new clients

• Favourable interpersonal communication

• Increase in “client’s share”

• Reduction in price sensitivity and increase in markets’ “opacity”

• Service bundling & “global solutions”

LIFE TIME VALUE CALCULATIONS

Visits/month (Ex.9)

Visits/year

$ per transaction (Ex.9)

revs/year

Unsatisfied

3.9

46.8

$3.88

$182

Satisfied

4.3

51.6

$4.06

$210

Highly Satisfied

7.2

86.4

$4.42

$382

Avg life (Ex.9)

Revs/life

Unsatisfied

1.1 years

$200

Satisfied

4.4 years

$922

Highly Satisfied

8.3 years

$3170

Difference = $28/yr Difference = $172/yr

Difference = $722 Difference = $2248

Customer Life Time Value - LTV Calculation

ACLTV (1)i1

)(Ma

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r

ACLTV (2)ir-1

M


3a. Lifetime Value (LTV) Analysis – Current Business Model

. r (annual retention rate): 1 - (0.02 * 12) = 0.76

. M (yearly margin): $22 * 12 = $264

. i (interest rate – assuming 5%): 0.05

. AC (acquisition costs): $370

. LTV: [(264) / (1 – 0.76 + 0.05)] – 370 = $540


3b. LTV Analysis – Eliminating Contracts

. r (annual retention rate): 1 - (0.06 * 12) = 0.28

. LTV: [(264) / (1 – 0.28 + 0.05)] – 370 = - $27.14

The resulting LTV would become negative, i.e. the industry would lose money on the average customer!


3c. LTV Analysis – Eliminating Hidden Costs

. A $29 bill becomes $35 due to hidden costs (p.7) which translates into a 21% decrease.. If the costs were eliminated, then M would be reduced to: (22 / 1.21) * 12 = $218.16

. Break-even would then become: 370/18.18 = 20 months. LTV: [(218.16) / (1 – 0.76 + 0.05)] – 370 = $382. And LTV (without contract): [(218.16) / (1 – 0.28 + 0.05)] – 370 = - $86.68

Virgin Mobile – A Different Approach

1. Entering a crowded industry with yet another undifferentiated offer could make the goal of acquiring 1 million customers by the end of the first year (p. 1) extremely difficult…

2. … Furthermore, the youth market is a segment that is particularly loathe to enter into contracts and very likely to fail credit checks: young people have limited disposable income, uneven usage patterns, and weak credit histories.

3. But this market segment is underserved and there may be an opportunity for Virgin to offer these consumers a product with highly-differentiated features (e.g., VirginXtras) designed to meet their specific needs…

4. … and still be able to compete "below the radar screens" of the big players.

No contracts

A Consumer Friendly Plan: Potential Problems

Increased ChurnIncreased Churn

Consumers want….. But the problem is …..

No Pricing Buckets

No Hidden Fees

Lower Operating

Margins

Lower Operating

Margins

No Peak/Off Peak Hrs

No Credit Checks More UncollectiblesMore Uncollectibles

Simple Sales Process Consumer ConfusionConsumer Confusion

Great Service Increased CostsIncreased Costs

Virgin Mobile – A Different Approach

1. From a customer perspective, an "ideal" plan would probably include a number of elements which would have a potentially negative impact of the company’s financial…

2. … but Virgin can use a number of different managerial tools to counter these negatives, for example:

• Lowering Customer Acquisition Costs

• Embracing Additional Pricing Elements

• Developing a Highly-Differentiated Competitive Positioning through a new services package and a new pricing proposition

Lowering Customer Acquisition Costs

1. On sales commissions

• Because of a different channel and merchandising strategy where "consumers can pick up the phone without a salesperson helping them" (p. 5), Virgin expect its sales commissions to be $30 per phone, as opposed to $100 for the industry average.

2. On advertising costs

• Virgin plans to spend much less than its competitors (approx. $60 million for the year (p. 5). Given the company’s target to acquire 1 million customers during this period, the advertising cost will be $60 per gross ad, compared to the industry average of $75 to $100 (p. 9).

Lowering Customer Acquisition Costs

3. On handset subsidies

• Virgin handsets cost the firm between $60 to $100 compared to an industry average of $150 to $300 (p. 5) because the company plans to stay away from selling high-end phones to young customers.

• If Virgin is decided to offer subsides at half the rate of the industry average (current industry handset cost / subsidy = 67%), then this subsidy would be roughly ($80 * 35%) = $30

4. Virgin total acquisition costs: $120

• Sales commission: $30• Advertising per gross ad: $60• Handset subsidy: $30

Embracing Additional Pricing Elements

1. Pre-paid requirement – no contract

• Eliminate the problem of uncollectible• Eliminate the need for credit check• Simplify the selling process• Encourage trial (and therefore potentially lower customer

acquisition costs)• Lower costs-to-serve (simplified billing, reduced number of

service calls related to pricing disputes)

2. A completely transparent, simple (one-size fits-all) per-minute price – no form of pricing discrimination being practiced by the competition (pricing buckets, on/off-peak policies, hidden fees, etc.)

Developing a Highly-Differentiated Positioning

1. A highly-differentiated service proposition

• Rescue Rings• Wake-Up Calls• VirginXtras…

2. A highly-differentiated pricing proposition

3. An opportunity to tap into the consumer resentment with a non-cynical, non-manipulative and radically different pricing approach, one that promises full transparency, no traps and no (bad) surprises, all at a fair price (customer rage management)

No contracts Increased ChurnIncreased Churn

Consumers want… But the problem is …..

No Pricing Buckets

No Hidden Fees

Lower Operating

Margins

Lower Operating

Margins

No Peak/Off Peak Hrs

No Credit Checks More UncollectiblesMore Uncollectibles

Simple Sales Process Consumer ConfusionConsumer Confusion

Great Service Increased CostsIncreased Costs

A Consumer Friendly Plan: Potential Solutions

Lower Acquisition Costs

Offsets Loss in LTV

Lower Acquisition Costs

Offsets Loss in LTV

Simplified Pre-paid Plan

eliminates confusion, no uncollectibles, fewer service calls

Simplified Pre-paid Plan

eliminates confusion, no uncollectibles, fewer service calls

Lower SubsidiesLower Subsidies

A possible solution is …..

How Could Virgin Achieve Profitability? • Is there a per-minute price that would allow the

company to attract young customers and reach a financial viability at the same time?

1. Break-Even Analysis• Given the acquisition Virgin’s $120 acquisition cost, what

would the company have to charge on a per-minute basis (P) to equal the industry’s break-even time of 17 months, assuming that Virgin’s customers use 200 minutes per month (a midpoint of estimate p. 7)?

• Monthly ARPU: 200(P)• Monthly cost-to-serve (45% - Ex. 11): (0.45)*[200(P)]• Monthly margin: [200(P)] - [90(P)] = 110(P)• Virgin Acquisition Cost: $120• Price to Break-Even: 120 / 110(P) = 17 --- P = 6.4 cents

How Could Virgin Achieve Profitability?

2. LTV Analysis – Eliminating Contracts. r (annual retention rate): 1 - (0.06 * 12) = 0.28

. LTV (6.4): [(0.064 * 110 * 12) / (1 – 0.28 + 0.05)] – 120 = - $10.29. LTV (10): [(0.10 * 110 * 12) / (1 – 0.28 + 0.05)] – 120 = $51. LTV (25): [(0.25 * 110 * 12) / (1 – 0.28 + 0.05)] – 120 = $ 309

. Virgin should not consider a price point that would generate a LTV significantly lower than the industry:

1. The other carriers are building a significant war chest (LTV=$540) and Virgin would be at competitive disadvantage if the company was obliged to fight against them directly.

2. Virgin could also trigger a price war and defeat their own goal of competing "under the radar screen" with a new segment but a low price point.

Virgin Mobile USA : What Happened?Virgin Mobile USA

« Live Without a plan »Pre-Paid Plan 3 months to use your minutesNo Contracts (+2 months grace period)No Hidden ChargesNo Peak/Off-Peak House One-button access to currentNo Long-Distance Charges balance/remaining minutes

Lower Handset Subsidies Can add more minutes via webor phone using a credit card or

25 cents/minute/1st 10 min. of day a « Top Up » card purchased10 cents/every min. thereafter from a retailer

Virgin Mobile USA« Live Without a Plan »

No Credit Check→increases the size of the target market

No Billing→ no monthly bills →lower cost to serve→ fewer customer service calls → lower cost to serve→ no uncollectibles

Lots of customer interaction

Virgin Mobile USA« Live without a Plan »

Simple Pricing→ No sales complexity → No salesperson needed

– opens up new channels– lowers sales commissions– lowers acquisition cost

For consumers, on any given day→ the more you consume, the lower you rate…→ the more $$ Virgin makes…

No Lock-In (other than the handset)The only thing that keeps customers coming back is satisfaction.

Virgin Mobile USA: What Happened?

1. Virgin was able to surpass its goal of acquiring 1 million customers within a year launch – becoming the fastest cell phone service to reach the 1 million mark in US history.

2. Virgin ended the year 2003 with a revenue run rate of $500 million.

3. Virgin enjoys the lowest churn rate in the prepaid world.4. Virgin eliminated the dual problem of having both a high credit

rejection rate and large uncollectibles by requiring payment up-front.

5. It substituted contracts with lower phone subsidies, thereby ensuring that customers had "skin in the game" while lowering its own acquisition costs.

6. Virgin made the pricing structure so easy to understand that it was able to eliminate the sales complexity, which delighted its customers and lowered its own sales commission expenses.

Narrow Target Segment Young people between the ages of 14 and 24

Narrow Target Segment Young people between the ages of 14 and 24

Simple Sales Process

Simple Pricing Plans-Full transparency

-Easy to understand- No Hidden Fees

Great ServiceNo Credit

Checks

A Cycle of Consumer Satisfaction

Sources of Consumer Satisfaction

No Contracts

Customer Satisfaction

Lower-Than-Expected Churn Rates Lower Customers Acquisition Costs

Financial flexibility to …Eliminate contracts,

Offer great customer service,Offer competitive per-minute rates

What Lies Behind a Price?

1. Price as a service (fair & transparent pricing structure)

2. Price as a ‘value signal’ (market positioning)

3. Price as the ‘growth engine’ of a business model (ROE)

4. Price as a major differentiation factor (well-differentiated value proposition on a marketing / strategic level)

5. Price as a main driver of consumption patterns (Yield Management)