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)


• 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


• 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


• 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

Undefined Target Market

Complex Sales Process

Complex Pricing Plans

Customer Dissatisfaction

Continuous Churn and High Acquisition Costs

Financial Pressure to Lock in Customers, Reduce

Service, Use Hidden Fees

Pricing Structure from Carrier Perspective

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

• ContractsAnnual 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 (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.


• 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



• 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)


• 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 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

LTV with contracts

• The annual retention rate in the industry

= 1-12*0.02=0.76

LTV = 22 * 12

- 370 = $5401- .76 + .05

LTV without contracts

• Eliminate contracts -> churn rate increases to 6%

• Calculate the LTV:

LTV = 22 * 12

- 370 = -27.141- .28 + .05

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

Without hidden costs and without contracts

Elimination of contracts drives LTV below zeroHidden costs boost the bottom line

LTV = 18.18 * 12

- 370 = 3821- .76 + .05

LTV = 18.18 * 12

- 370 = -86.681- .28 + .05

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 approachCustomers Want But the problem is…….

No contracts Increased Churn

No Pricing Buckets

Lower Operating MarginsNo Hidden Fees

No Peak/off Peak Hours

No Credit Checks More Uncollectibles

Simple Sales Process Customer Confusion

Great Service 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

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 - 90p = 110p

p > 0.07

LTV = 12*110p

- 120 > 01- .28 + .05

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:

– At 25 cents:LTV =

12*110*.1- 120 = $51

1- .28 + .05

LTV = 12*110*.25

- 120 = $3091- .28 + .05

Virgin’s Pricing Plan: What happened

A prepaid planNo contractsNo hidden chargesNo peak off peak hoursVery low handset subsidies No credit checksNo Monthly billsPrice: 25 cents per minute for the first 10 minutes; 10

cents/minute for the rest of the dayNo exact numbers, but churn rate lower than 6%

Documents

Virgin Mobile – Pricing for the First Time