Lecture 6 Virgin cell solution

8/11/2019 Lecture 6 Virgin cell solution

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AEM 4160: STRATEGIC PRICINGPROF.: JURA LIAUKONYTE

VIRGIN CELL CASE: EXCERCISES

1


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Pricing Structure from the CarrierPerspective

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%

Take AT&T example: customer base = 20.5 million

If AT&T abandons the contract based plan how many new customers wouldit need to acquire to offset customers from an increased churn rate?

Additional customers lost to churn: 48% * 20.5 mln = 9.84mln

Acquisition cost per customer: $370 (case p.2)

Total cost of offsetting higher churn rate: $370 * 9.84 mln =$3.64 bil.


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Menu pricing: Actual Usage


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Bucket/Menu pricing

In reality most consumers are paying morethan their optimal rate = if they new exactlyhow much they will consume

industry makes money from consumerconfusion

Pricing menus allow carriers to advertise low

per minute rates But most consumers end up choosing the

wrong menu.


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Hidden Fees

Able to promote low per minute prices, but stillcollect additional revenues


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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

(lets assume somewhere in the middle = $370)


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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 relativelyfixed across periods, therefore the traditional LTV can be

simplified (assuming infinite horizon):

M = margin the customer generates in a yearr = annual retention rate = (1-12*monthly churn rate)i = interest rate (assume 5%)

AC = acquisition cost

LTV =M

- AC1-r+i


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LTV with contracts

The annual retention rate in the industry

= 1-12*0.02=0.76

LTV =22 * 12

- 370 = $5401- .76 + .05


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LTV without contracts

Eliminate contracts -> churn rate increases to6%

Calculate the LTV:

LTV =22 * 12

- 370 = -27.14

1- .28 + .05


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Eliminate Hidden Costs

$ 29 cellular bill becomes $35 due to hiddencosts

Increase of 21%

If these costs were eliminated, the $22 marginwould be reduced to $18.18= $22/1.21

Break even would become 20 months =370/18.18


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What happens to LTV?

Without hidden costs, but with contracts

Without hidden costs and without contracts

Elimination of contracts drives LTV below zero

Hidden costs boost the bottom line

LTV =18.18 * 12

- 370 = 3821- .76 + .05

LTV = 18.18 * 12 - 370 = -86.681- .28 + .05


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Option 3: different pricing approach

Target audience: Youth

Loathe contracts

Fail credit checks

Ideal plan: no contracts, no menus, no hiddenfees

How to differentiate itself, and have a positive LTV

Look at the factors that affect LTV


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Options for Lowering AcquisitionCosts

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%

Virgins handset cost: $60 to $100 (assume $80)

Assume Virgins subsidy around 30% = $30


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Consumer friendly plan: how toachieve profitability

Break Even analysis: at what per minute pricewould Virgin break even: Virgins monthly ARPU: (200 minutes)*(p), where p=price per

minute

Monthly cost to serve: .45 * 200 * p

Monthly margin: 200p - 90p = 110p

p > 0.07

LTV =12*110p

- 120 > 0

1- .28 + .05


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Other price points

What if Virgin charged per minute price comparable to otherindustry prices, somewhere in between 10 and 25 cents:

At 10 cents:

At 25 cents:

LTV =12*110*.1

- 120 = $511- .28 + .05

LTV =12*110*.25

- 120 = $3091- .28 + .05


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Virgins 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%

Documents

Lecture 6 Virgin cell solution