F. Jallat – CFVG - 2011Virgin Mobile USAPricing for the Very First Time
Questions of the Case• The cellular industry is notorious for high customerdissatisfaction -churn roughly is 24% of thecustomer each year. How have the various pricingvariables (contracts, pricing buckets, hidden fees,off-peak hours, etc.) affected the consumerexperience? Why haven’t the big carriers respondedmore aggressively to customer dissatisfaction?• How do the major carriers make money in thisindustry?• Do you agree with Virgin Mobile’s target marketselection (14 to 24 year old)? What are the risksassociated with targeting this segment?
Questions of the Case4. What do you think of Virgin Mobile’s valueproposition (The Virgin Xtras, etc)? What do youthink of its channel and merchandising strategy?5. Given Virgin Mobile’s target market, how should itstructure its pricing? Which option would youchoose and why?6. Provide evidence of the financial viability of yourpricing 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 theconsumer2. To examine the interplay between pricing, targetmarket selection, and a firm’s overall valueproposition.3. To demonstrate the multiple ways firms can createpaths to profitability.4. To illustrate the importance of adopting a long-termstrategic perspective in choosing a pricing structure.
Pricing Structure from the Customer Perspective• Despite the fact that the mobile communicationsindustry is mature, over-crowded and fiercelycompetitive, a truly consumer-friendly cellular plan hasstill not been introduced.1. Major carriers continue to hold customers "hostage"through contracts and leave them feeling trapped in theirplans (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 thanthey expected on a per minute basis (lack oftransparency).
Pricing Structure from the Customer Perspective• Despite the fact that the mobile communicationsindustry is mature, over-crowded and fiercelycompetitive, a truly consumer-friendly cellular planhas still not been introduced.4. Off-Peak/On-Peak differentials add to customer confusionand off-peak period has shrunk over time (constrainedconsumer behaviour patterns).5. Credit checks eliminate roughly 30% of the pool ofapplicants due to poor credit rating, after consumers spenttime and effort dealing with sales people (increasedconsumer rage).
Pricing Structure from the Customer Perspective• Despite the fact that the mobile communicationsindustry is mature, over-crowded and fiercelycompetitive, a truly consumer-friendly cellular plan hasstill not been introduced.6. Complex sales process in most of the traditional channels(proprietary retail outlets, mall kiosks, high-end electronicstores) requires a face-to-face sales interaction that manyfind frustrating and time-consuming (increased sacrifice).7. Consumers received their bills via mail. These bills typicallyinclude a detailed record of customers’ call history (norespect for privacing concerns).8. When consumers experience problems or have questionsabout their bill, the service response has been historicallyvery poor (poor management of moments of truth).
Pricing Structure from the Carrier Perspective• Many of the sources of customer dissatisfaction arealso sources of carrier profit!1. Contracts• customers under contract generate monthly churn rates of2% while customers without contracts generate a churnrate of 6%...• … For a firm like ATT (with a customer base of 20.5 million)this would mean to acquire an additional 9.84 millioncustomers a year –at a cost of $3.64 billion- just to offsetcustomers lost to the higher churn rate!
Pricing Structure from the Carrier Perspective• Many of the sources of customer dissatisfaction arealso sources of carrier profit!2. Bucket Pricing• While consumers using 700 minutes a month, for example,should be paying about 10 cents a minute, mostconsumers are paying more –some to them up to 60 centsa minute...• … Pricing buckets allow the carriers to advertise low per-minute rates but "if all customers actually signed up for theoptimal plan for their usage, the carriers would be makingfar less money than they are today"!
Pricing Structure from the Carrier Perspective3. Hidden Fees, Credit Checks, Poor Customer Service• By using hidden fees, the carriers are able to promote lowper-minute pricing levels but still collect additionalrevenues. The industry is also notorious for cutting costs inareas like customer service and billing to boost operatingmargins.• Besides, the carriers also require a rigorous credit check toensure that their uncollectibles and churn rate remainlow...• … generating a vicious circle through complex salesprocess, which in turn drives costly sales commissions($100 per customer), which in turn keeps acquisition costshigh, etc.
Multiple Target CustomersBusiness, Consumer, Heavy/Light Users, etc.Multiple Target CustomersBusiness, Consumer, Heavy/Light Users, etc.Complex SalesProcessComplex Pricing Plans:-Multiple options-Multiple buckets-Hidden FeesPoor serviceCredit ChecksA Cycle of Consumer DissatisfactionSources of Consumer DissatisfactionForcedContractsCustomerDissatis-factionContinuous Industry churnHigh churn rates mean that carriers must re-acquire 24% of their customer base each year,just to stay evenHigh Customer Acquisition CostsBecause of high customer dissatisfactionrates, acquiring new customers is a tough sellFinancial pressure to …Lock-in customers using contracts,Cut corners in customer service to reduce costs,Aggressively promote low prices to attract cutomersUse hidden fees and pricing buckets to increase marginsSources of Industry Dissatisfaction
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model1. 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
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model2. 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 / $22 = 17 months
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model3. Lifetime Value (LTV) Analysis• From transactional to relationship marketing
From Transactional to Relationship MarketingTimeSales VolumeNatural growth of customers and market sizeGrowth only possible at competitors’ expenses
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model3. Lifetime Value (LTV) Analysis• From transactional to relationship marketing• Why should a company take into consideration the long-term value of its customers?
Reducing Defections 5% Boosts Profits 25% to 85%30%85%75%25%50%45% 45% 40%35%0%10%20%30%40%50%60%70%80%90%Auto-servicechainBranchdepositsCreditcardCreditInsuranceInsuranceBockerageIndustrialdistributionIndustriaLaundryOffice-bidgmanagementSoftware* Calculated by comparing the net present values of the profit streams for the average customer life at current defectionrates with the net present values of the profit streams for the average customer life at 5% lower defection rates.
Relationship Marketing and Profitability• Savings in advertising, costs of promotion and costs offinding new clients• Favourable interpersonal communication• Increase in “client’s share”• Reduction in price sensitivity and increase in markets’“opacity”• Service bundling & “global solutions”
LIFE TIME VALUE CALCULATIONSVisits/month (Ex.9)Visits/year$ per transaction (Ex.9)revs/yearUnsatisfied3.946.8$3.88$182Satisfied4.351.6$4.06$210Highly Satisfied7.286.4$4.42$382Avg life (Ex.9)Revs/lifeUnsatisfied1.1 years$200Satisfied4.4 years$922Highly Satisfied8.3 years$3170Difference = $28/yr Difference = $172/yrDifference = $722 Difference = $2248
Customer Life Time Value - LTV Calculation( )( )ACLTV(1)i1)(Ma1-aaN1a−=+∑=r( )ACLTV(2)ir-1M −=+
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model3a. Lifetime Value (LTV) Analysis – Current BusinessModel. 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
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model3b. LTV Analysis – Eliminating Contracts. r (annual retention rate): 1 - (0.06 * 12) = 0.28. LTV: [(264) / (1 – 0.28 + 0.05)] – 370 = - $27.14The resulting LTV would become negative, i.e. theindustry would lose money on the average customer!
Behind Prices and Pricing Levels:Looking at the Economics of a Business Model3c. 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 bereduced to: (22 / 1.21) * 12 = $218.16. Break-even would then become: 370/18.18 = 20months. 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 Approach1. Entering a crowded industry with yet another undifferentiatedoffer could make the goal of acquiring 1 million customers bythe end of the first year (p. 1) extremely difficult…2. … Furthermore, the youth market is a segment that isparticularly loathe to enter into contracts and very likely to failcredit 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 anopportunity for Virgin to offer these consumers a productwith highly-differentiated features (e.g., VirginXtras) designedto meet their specific needs…4. … and still be able to compete "below the radar screens" ofthe big players.
No contractsA Consumer Friendly Plan: Potential ProblemsIncreased ChurnIncreased ChurnConsumers want….. But the problem is …..No Pricing BucketsNo Hidden FeesLowerOperatingMarginsLowerOperatingMarginsNo Peak/Off Peak HrsNo Credit Checks More UncollectiblesMore UncollectiblesSimple Sales Process Consumer ConfusionConsumer ConfusionGreat Service Increased CostsIncreased Costs
Virgin Mobile – A Different Approach1. From a customer perspective, an "ideal" plan would probablyinclude a number of elements which would have a potentiallynegative impact of the company’s financial…2. … but Virgin can use a number of different managerial tools tocounter these negatives, for example:• Lowering Customer Acquisition Costs• Embracing Additional Pricing Elements• Developing a Highly-Differentiated Competitive Positioningthrough a new services package and a new pricing proposition
Lowering Customer Acquisition Costs1. On sales commissions• Because of a different channel and merchandising strategywhere "consumers can pick up the phone without a salespersonhelping 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 toacquire 1 million customers during this period, the advertisingcost will be $60 per gross ad, compared to the industry averageof $75 to $100 (p. 9).
Lowering Customer Acquisition Costs3. On handset subsidies• Virgin handsets cost the firm between $60 to $100 compared toan industry average of $150 to $300 (p. 5) because the companyplans to stay away from selling high-end phones to youngcustomers.• If Virgin is decided to offer subsides at half the rate of theindustry average (current industry handset cost / subsidy = 67%),then this subsidy would be roughly ($80 * 35%) = $303. Virgin total acquisition costs: $120• Sales commission: $30• Advertising per gross ad: $60• Handset subsidy: $30
Embracing Additional Pricing Elements1. 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 customeracquisition costs)• Lower costs-to-serve (simplified billing, reduced number ofservice calls related to pricing disputes)2. A completely transparent, simple (one-size fits-all) per-minute price – no form of pricing discrimination beingpracticed by the competition (pricing buckets, on/off-peakpolicies, hidden fees, etc.)
Developing a Highly-Differentiated Positioning1. A highly-differentiated service proposition• Rescue Rings• Wake-Up Calls• VirginXtras…2. A highly-differentiated pricing proposition3. An opportunity to tap into the consumer resentment with anon-cynical, non-manipulative and radically different pricingapproach, one that promises full transparency, no traps andno (bad) surprises, all at a fair price (customer ragemanagement)
No contracts Increased ChurnIncreased ChurnConsumers want… But the problem is …..No Pricing BucketsNo Hidden FeesLowerOperatingMarginsLowerOperatingMarginsNo Peak/Off Peak HrsNo Credit Checks More UncollectiblesMore UncollectiblesSimple Sales Process Consumer ConfusionConsumer ConfusionGreat Service Increased CostsIncreased CostsA Consumer Friendly Plan: Potential SolutionsLower AcquisitionCostsOffsets Loss in LTVLower AcquisitionCostsOffsets Loss in LTVSimplified Pre-paidPlaneliminates confusion,no uncollectibles,fewer service callsSimplified Pre-paidPlaneliminates confusion,no uncollectibles,fewer service callsLower SubsidiesLower SubsidiesA possible solution is …..
How Could Virgin Achieve Profitability?• Is there a per-minute price that would allow thecompany to attract young customers and reach afinancial viability at the same time?1. Break-Even Analysis• Given the acquisition Virgin’s $120 acquisition cost, whatwould 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 permonth (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 aLTV 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 companywas obliged to fight against them directly.2. Virgin could also trigger a price war and defeat their own goal ofcompeting "under the radar screen" with a new segment but alow 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 minutesLower Handset Subsidies Can add more minutes via webor phone using a credit card or25 cents/minute/1st10 min. of day a « Top Up » card purchased10 cents/every min. thereafter from a retailerVirgin Mobile USA« Live Without a Plan »No Credit Check→increases the size of the target marketNo Billing→ no monthly bills →lower cost to serve→ fewer customer service calls → lower cost to serve→ no uncollectiblesLots of customer interactionVirgin Mobile USA« Live without a Plan »Simple Pricing→ No sales complexity → No salesperson needed– opens up new channels– lowers sales commissions– lowers acquisition costFor 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 customerswithin a year launch – becoming the fastest cell phone service toreach the 1 million mark in US history.2. Virgin ended the year 2003 with a revenue run rate of $500million.3. Virgin enjoys the lowest churn rate in the prepaid world.4. Virgin eliminated the dual problem of having both a high creditrejection rate and large uncollectibles by requiring payment up-front.5. It substituted contracts with lower phone subsidies, therebyensuring that customers had "skin in the game" while lowering itsown acquisition costs.6. Virgin made the pricing structure so easy to understand that itwas able to eliminate the sales complexity, which delighted itscustomers and lowered its own sales commission expenses.
Narrow Target SegmentYoung people between the ages of 14 and 24Narrow Target SegmentYoung people between the ages of 14 and 24Simple SalesProcessSimple Pricing Plans-Full transparency-Easy to understand- No Hidden FeesGreat ServiceNo CreditChecksA Cycle of Consumer SatisfactionSources of Consumer SatisfactionNo ContractsCustomerSatisfactionLower-Than-Expected Churn Rates Lower Customers Acquisition CostsFinancial 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 (YieldManagement)