Lecture 9 HBS Case: Virgin Mobile

Lecture Plan HW2 Exam 1 Virgin Case

Issue Situation Young (15-29) Trendy Problem: How should Virgin Mobile price its plans Entering a highly saturated cell phone service industry, while targeting an unsaturated market segment Attempting to earn a profit from a limited income market Target Market Young (15-29) Trendy Different than traditional cell phone users Different spending habits Different usage Different needs Limited purchasing power “According to marketing research, target market does not trust industry pricing plans.” -Dan Schulman, CEO, Virgin Mobile USA

Objectives Create value and profitability in cell phone service industry Target market ages 15-29, opportunity for growth with this market segment 1 million subscribers by year 1 and 3 million by year 4 Be different:“By focusing on the youth market from the ground up, we’re putting ourselves in a position to serve these customers in a way they have never been served before” -Dan Schulman, CEO, Virgin Mobile USA

Discussed Alternatives Clone Industry Prices: contracts Set prices below competition: contracts A whole new plan: prepaid pricing

Clone Industry Prices Pros Cons

Clone Industry Prices Pros Cons Give customers more features for the same price Easy to promote, use current models Limited spending power on promotion may be a justifiable factor Viable with Virgin Mobile’s limited advertising budget

Clone Industry Prices Pros Cons Give customers more features for the same price Easy to promote, use current models Limited spending power on promotion may be a justifiable factor Viable with Virgin Mobile’s limited advertising budget May drive margins down if additional features are costly Reduces competitive advantage Difficult to penetrate saturated market with similar offer as competitors Competitive with other cell phone providers and packages; does not support strong market differentiation

Price Below Competition Pros Cons

Price Below Competition Drive sales and market share Accounts for limited spending power of target market Pros Cons

Price Below Competition Drive sales and market share Accounts for limited spending power of target market Margins and profitability will be driven down Inconsistent with company goal of profitability Cannot compete in price wars Not a long term solution Pros Cons

A Whole New Plan: Prepaid Pricing Pros Cons

A Whole New Plan: Prepaid Pricing Differentiate from competition Cater to the needs of target market Flexibility is attractive to target market Profitability is key Eliminates risk of missed payments Pros Cons

A Whole New Plan: Prepaid Pricing Differentiate from competition Cater to the needs of target market Flexibility is attractive to target market Profitability is key Eliminates risk of missed payments Risk of limited returns and loyalty Churn rate may increase Pros Cons

Pricing Structure from the Carrier Perspective 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 would it need to acquire to offset customers from an increased churn rate? Additional customers lost to churn: __________________ Acquisition cost per customer: $370 (case p.2) Total cost of offsetting higher churn rate: __________________ Not surprising that major players still continue to hold the contracts.

Different Acquisition Costs across industries Travel: Priceline.com: $7 Telecom: Sprint PCS: $315 Retail: Barnesandnoble.com: $10 Financial: TD Waterhouse: $175

“Menu” Pricing: Actual Usage

Bucket/“Menu” Pricing In reality most consumers are paying more than their optimal rate = if they knew exactly how much they will consume “Industry makes money from consumer confusion” Pricing menus allow carriers to advertise low per minute rates But most consumers end up choosing the wrong menu.

Hidden Fees Able to promote low per minute prices, but still collect additional revenues

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 = __________________ 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 year r = annual retention rate = (1-12*monthly churn rate) i = interest rate (assume 5%) AC = acquisition cost LTV = M 1- r+ i - AC

LTV With Contracts The annual retention rate in the industry = ______________ LTV = - 370 =

LTV Without Contracts Eliminate contracts -> churn rate increases to 6% Calculate the LTV: LTV = - 370 =

Eliminate Hidden Costs $ 29 cellular bill becomes $35 due to hidden costs If hidden costs were eliminated, the margin would certainly be reduced. Assume that it would be reduced to $18 from $22. Break even would become _________= __________

What Happens to LTV? Without hidden costs, but with contracts Without hidden costs and without contracts LTV = - 370 = LTV = - 370 =

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 = - 370 = LTV = - 370 =

Option 3: Different Pricing Approach Target audience: Youth Loathe contracts Fail credit checks Ideal plan: no contracts, no menus, no hidden fees… How to differentiate itself, and have a positive LTV Look at the factors that affect LTV

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 30% = $30

Acquisition Costs Then Virgin’s AC would be just ____vs. industry average $370 Sales commission: $30 Advertising per gross add: $60 Handset Subsidy $30 Total: _______

Consumer Friendly Plan: How to Achieve Profitability Break Even analysis: at what per minute price would Virgin break even: Virgin’s monthly ARPU: ______________ where p=price per minute Assume Virgin’s customers use 200 minutes per month (midpoint of estimate between 100 and 300, p.7) Monthly cost to serve: ______________ Assume monthly cost to serve is 45% of revenues (Exhibit 11) Monthly margin: _______________ p > ________ LTV = _____ > 0

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 = - ____ = _____ LTV = - _____ = ____

Virgin’s 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%