Virgin Mobile

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  • Topic: Price, Costs, Economic cost
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AEM 4160: STRATEGIC PRICING PROF.: JURA LIAUKONYTE

VIRGIN CELL CASE: EXCERCISES

Pricing Structure from the Carrier Perspective
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Contracts:
¤  ¤  ¤ 

Annual churn rate WITH contracts Annual churn rate WITHOUT contracts The difference:

=2% * 12 months = 24% (p.8) =6% * 12 months = 72% (p.8) 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: Total cost of offsetting higher churn rate:

48% * 20.5 mln = 9.84 mln $370 (case p.2) $370 * 9.84 mln =$3.64 bil.

Not surprising that major players still continue to hold the contracts.

“Menu” pricing: Actual Usage

Bucket/”Menu” pricing
In reality most consumers are paying more than their optimal rate = if they new 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
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Able to promote low per minute prices, but still collect additional revenues

Acquisition costs
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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 ¤ 

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(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): ¨ 

LTV =

M

1-r+i

- AC

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 with contracts
¨ 

The annual retention rate in the industry

= 1-12*0.02=0.76

LTV =

22 * 12 1- .76 + .05

- 370 = $540

LTV without contracts
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Eliminate contracts -> churn rate increases to 6% Calculate the LTV:

¨ 

LTV =

22 * 12 1- .28 + .05

- 370 = -27.14

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
LTV = 18.18 * 12 1- .76 + .05 - 370 = 382

¨ 

Without hidden costs and without contracts
LTV = 18.18 * 12 1- .28 + .05 - 370 = -86.68

Elimination of contracts drives LTV below zero ¨  Hidden costs boost the bottom line ¨ 

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
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Advertising costs per customer
¤  ¤ 

Industry=from $75 to $100 Virgin planned ad costs = 60 mil/1min= $60 (p.5) 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

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Handset subsidies:
¤  ¤  ¤ 

¤  ¤ 

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
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Break Even...
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