Case Debriefing – Virgin Mobile USA

SynopsisObjective – To develop a pricing

strategy for a new wireless serviceTarget Segment – Teens and TwentiesBusiness Model – MVNO – No fixed cost

or investment in physical infrastructureVirgin’s Brand Personality – Innovative,

fun, pro-active and challengingIdentify and enter areas, where

competitors are complacent or customers taken for a ride by existing players

Cellular industry analysis Market is overcrowded with many national

and regional carriers

Market is in maturity phase and fiercely competitive

Penetration was significantly lower in the 15-29 segment. Growth rate among this segment is projected to be robust for the next 5 years.

Existing players ignored this segment due to poor credit quality, irregular usage etc

Cellular provider sold their services in their own proprietary outlets, kiosks in malls high end electronic stores etc

High sales commission paid to sales people

Carriers subsidize hand sets and that is considered as a part of customer’s acquisition cost

Industry not known for customer service

Complex sales process

Virgin Mobile’s Value PropositionText messagingWake up callRing tonesFun clipsMusic messengerMoviesRescue ringThe Hit list

Business modelMVNO – was successful in UK not

in SingaporeAd budget – Approx $ 60 millionLower commissions - $ 30 per

phone as against industry average of $ 100

Different channel strategy where youth shop

Facts given In the case Industry cost to acquire a customer is $370 Average monthly cell phone bill for national

carriers is $ 52 Cost to serve a customer was roughly $ 30 a

month Cost of hand sets priced between $150 to $ 300 Ad spending by national carriers ranged from $

75 to 105 per customer acquired ( refer page 5, foot note)

90 % of all subscribers in the US had contractual agreements with their cellular providers

Annual churn rate with contracts is 2 %

Annual churn rate without contracts is 6 %

Sales commission paid per subscriber is $ 100

Hand set subsidy provided to subscriber is $ 100 to $ 200

Monthly ARPU is $ 52Monthly cost to serve is $ 30

Options – Which one and why?Pricing approach similar to

competitorsPricing below competitorDifferential plan

Discuss the pros and cons of each plans?

Contracts – From a firm’s perspective it leads to lower churn rate also boosts retention rates. However from a customer’s perspective it leaves them trapped in their plans

Buckets – Customers are penalized heavily for shortfalls or overages

Hidden costs – Taxes, universal service charges, various one time costs etc.

Credit checks – Industry eliminates 30 % of the applicants due to poor credit ratings

Complex sales process – Requires lot of face to face interaction

Pricing approach similar to competitors

Message – Priced competitively with everyone else but with few advantages like apps and superior customer service.

Rationale

Easy to promote since customers are already used to it

Given the limited ad budget, it may be a better thing to do

Pricing below competitor

Actual prices slightly below those of competition

Price per minute would be set slightly below the competition for some key buckets ( $100-300)

Question is, will it be profitable considering the usage pattern of the youth?

A whole new planShorten the contract or even eliminate them

altogether? What are the risks?Pre paid Vs post paid – Attracts only low

usage customers – Poor credit customers- no credit checks required – Stigma attached

Pre paid customers - High churn rate, exhibit no loyalty and there is a danger of not being able to recoup company’s acquisition cost because of the above factors

Eliminating all hidden fees and off peak hours

Lowering or increasing the subsidy

Why contracts? Annual churn rate with contracts: 2 % * 12 months

= 24% Annual churn rate without contract : 6 % * 12 = 72

%

The difference is 48%

For AT & T with a customer base of approx 20.5 million, this would mean that it would have to acquire an additional of 9.84 million customers at the cost of 3.64 billion to offset customers lost to the higher churn rate.

How?

Additional customers lost o churn : 48 % * 20.5 million = 9.84 m customers

Acquisition cost per customer $ 370 per customer

Total cost of offsetting higher churn rate: $ 370 * 9.84m = 3.64 billion

Hence a strong reason to hold customers through contracts regardless of the customer dissatisfaction

Pricing levelsBreak even analysis

Monthly ARPU $ 52Monthly cost to serve is $ 30

Monthly margin is $ 22 ( 52-30)

Time required to break even on the acquisition cost is

$ 370/22 = 17 months

Annual retention rate in this industry is .76

Calculated as

1- ( Monthly churn rate * 12 months) = 1 – 0.02 * 12 = .76

LTV of customers Assuming an interest rate of 5 % and an

infinite economic life ( N) Formula for LTV

LTV = M / 1- r +1) – AC where

M - Margin customers generates in year aR - Annual retention rateI - Interest rateAC - Acquisition costN - Number of years over which the

relationship is calculated

LTV calculation 22 * 12/ 1-.76+.05 minus 370 = $ 540

If eliminating contracts, the LTV would be negative

22 * 12 / 1-.28 + .05 minus 370= -27.14

The industry would lose money on the average customer given current acquisition costs if it abandon the practice of requiring contracts from their customers

It appears that LTV would be positive, if Virgin mobile were to enter the industry with a pricing structure similar to that of the major carriers

However few questions arise in this strategy

Target segment - Youth Loathe to enter in to contracts Fail credit checks Limited disposable income and uneven usage pattern Weak credit history Segment currently underserved – An opportunity for

virgin to offer a product with highly differentiated features

Is it possible to devise a customer friendly pricing plan without affecting the profitability of the company?

If so, How?

A customer friendly plan – Potential problems

Consumer want But the Problem is

No contracts Increased Churn

No hidden fee , Pricing buckets, Off and on peak hrs

Lower operating margins

No credit checks More receivables

Great service Increased costs

How to counter the negatives?Lowering acquisition cost such as sales

commission, advertising costs and handset subsidies

Do a math

Current industry hand set cost is 225 ( Average taken) 150+300/2 = 225

Current industry subsidy is 150 ( 100+200/2)

Subsidy as a % is 67 ( 150 / 225)

Virgin’s acquisition costsHandset cost is 60-100 ( 80 on an

average)If virgin were to subsidize handsets by

40% its subsidy would equal to $ 30

Sales commission is $ 30Ad per gross add is $ 60Hand set subsidy is $ 30

Total acquisition cost is $ 120

Could it achieve profitability ?Acquisition costs of virgin is $

120 versus the industry average of $ 370

Given the acquisition costs, what would virgin have to charge consumers on a per minute basis to equal the industry’s break eve time of 17 months?

Assumptions Virgin’s monthly ARPU 200 minutes ( A mid point

is taken given Virgin’s estimate of 100-300 minutes per month)

Monthly cost to serve is 45% of revenues ( see exhibit 11)

Virgin’s Monthly ARPU = 200 minutes Monthly cost to serve = .45 * 200 * p where p is

price per minute Virgin’s monthly margin = 200-90 = 110p Virgin’s acquisition costs = 120 To break even in 17 months = 110/17 = 6.4 is

the Price per minute

LTV at 6.4 cents(1-.45) (200*12*.064) / 1-.28 + .05

Minus 120 = - 10.29

Customers would not last the 17 months to cover the acquisition costs. In order to have a positive LTV, Virgin should charge more than 6.4.

Try any where between 10 cents and 25 cents and see the LTV

What happened A pre paid plan No contracts, hidden charges, peak or off peak hours Very low hand set subsidies No credit checks No monthly bills Price 25 cents foe the first 10 minutes and 10

cents/minute for the rest of the day A 3 month period in which to use pre paid minutes,

plus an additional 2 month grace period Handsets with one button access to view current

balance/remaining minutes Customers could purchase additional minutes via the

phone or credit card. Users can also purchase a top-off card through virgin’s retail channels