F. Jallat CFVG - 2011Virgin Mobile USA

Pricing for the Very First Time

F. Jallat CFVG - 2011

Questions of the Case

The cellular industry is notorious for high customer dissatisfaction -churn roughly is 24% of the customer each year. How have the various pricing variables (contracts, pricing buckets, hidden fees, off-peak hours, etc.) affected the consumer experience? Why havent the big carriers responded more aggressively to customer dissatisfaction?

How do the major carriers make money in this industry?

Do you agree with Virgin Mobiles target market selection (14 to 24 year old)? What are the risks associated with targeting this segment?

Questions of the Case

4. What do you think of Virgin Mobiles value proposition (The Virgin Xtras, etc)? What do you think of its channel and merchandising strategy?

5. Given Virgin Mobiles target market, how should it structure its pricing? Which option would you choose and why?

Provide evidence of the financial viability of your pricing strategy

Teaching ObjectivesTo cover two main aspects of pricing Price levels i.e., the overall amount a consumer paysPrice structure i.e., how a payment is presented to the consumer

To examine the interplay between pricing, target market selection, and a firms overall value proposition.

To demonstrate the multiple ways firms can create paths to profitability.

To illustrate the importance of adopting a long-term strategic perspective in choosing a pricing structure.

Pricing Structure from the Customer Perspective Despite the fact that the mobile communications industry is mature, over-crowded and fiercely competitive, a truly consumer-friendly cellular plan has still not been introduced.

Major carriers continue to hold customers "hostage" through contracts and leave them feeling trapped in their plans (capture).

Customers, being obliged to sign up for pricing buckets, are penalized, often heavily, for shortfalls and overusages (decommoditization and consumption penalties).

Due to hidden costs (taxes, extra charges, service costs, etc.), customers often wind up paying 20-25% more than they expected on a per minute basis (lack of transparency).

Pricing Structure from the Customer Perspective Despite the fact that the mobile communications industry is mature, over-crowded and fiercely competitive, a truly consumer-friendly cellular plan has still not been introduced.

Off-Peak/On-Peak differentials add to customer confusion and off-peak period has shrunk over time (constrained consumer behaviour patterns).

Credit checks eliminate roughly 30% of the pool of applicants due to poor credit rating, after consumers spent time and effort dealing with sales people (increased consumer rage).

Pricing Structure from the Customer Perspective Despite the fact that the mobile communications industry is mature, over-crowded and fiercely competitive, a truly consumer-friendly cellular plan has still not been introduced.

Complex sales process in most of the traditional channels (proprietary retail outlets, mall kiosks, high-end electronic stores) requires a face-to-face sales interaction that many find frustrating and time-consuming (increased sacrifice).

Consumers received their bills via mail. These bills typically include a detailed record of customers call history (no respect for privacing concerns).

When consumers experience problems or have questions about their bill, the service response has been historically very poor (poor management of moments of truth).

Pricing Structure from the Carrier Perspective Many of the sources of customer dissatisfaction are also sources of carrier profit!

1. Contracts

customers under contract generate monthly churn rates of 2% while customers without contracts generate a churn rate of 6%...

For a firm like ATT (with a customer base of 20.5 million) this would mean to acquire an additional 9.84 million customers a year at a cost of $3.64 billion- just to offset customers lost to the higher churn rate!

Pricing Structure from the Carrier Perspective Many of the sources of customer dissatisfaction are also sources of carrier profit!

2. Bucket Pricing

While consumers using 700 minutes a month, for example, should be paying about 10 cents a minute, most consumers are paying more some to them up to 60 cents a minute...

Pricing buckets allow the carriers to advertise low per-minute rates but "if all customers actually signed up for the optimal plan for their usage, the carriers would be making far less money than they are today"!

Industry Pricing Plans vs. Actual Prices Paid

Pricing Structure from the Carrier Perspective

3. Hidden Fees, Credit Checks, Poor Customer Service

By using hidden fees, the carriers are able to promote low per-minute pricing levels but still collect additional revenues. The industry is also notorious for cutting costs in areas like customer service and billing to boost operating margins.

Besides, the carriers also require a rigorous credit check to ensure that their uncollectibles and churn rate remain low...

generating a vicious circle through complex sales process, which in turn drives costly sales commissions ($100 per customer), which in turn keeps acquisition costs high, etc.

Multiple Target CustomersBusiness, Consumer, Heavy/Light Users, etc.Complex Sales ProcessComplex Pricing Plans: -Multiple options-Multiple buckets-Hidden FeesPoor serviceCredit ChecksA Cycle of Consumer DissatisfactionSources of Consumer DissatisfactionForced ContractsCustomer Dissatis-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 dissatisfaction rates, 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 ModelAcquisition 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 ModelLifetime Value (LTV) Analysis

From transactional to relationship marketing

From Transactional to Relationship Marketing Natural growth of customers and market sizeGrowth only possible at competitors expenses

Behind Prices and Pricing Levels:Looking at the Economics of a Business ModelLifetime 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%* Calculated by comparing the net present values of the profit streams for the average customer life at current defection rates with the net present values of the profit streams for the average customer life at 5% lower defection rates.

Graph3

0.3

0.85

0.75

0.25

0.5

0.45

0.45

0.4

0.35

Percent Increase In Customer Value*

Feuil1

Auto-service chain30%

Branch deposits85%

Credit card75%

Credit Insurance25%

Insurance Bockerage50%

Industrial distribution45%

Industria Laundry45%

Office-bidg management40%

Software35%

Feuil1

Percent Increase In Customer Value*

Feuil2

Feuil3

Relationship Marketing and ProfitabilitySavings in advertising, costs of promotion and costs of finding new clients

Favourable interpersonal communication

Increase in clients 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/yrDifference = $172/yrDifference = $722Difference = $2248

Customer Life Time Value - LTV Calculation

Behind Prices and Pricing Levels:Looking at the Economics of a Business Model3a. Lifetime Value (LTV) Analysis Current Business Model

. 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 = - $27.14

The resulting LTV would become negative, i.e. the industry 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 be reduced to: (22 / 1.21) * 12 = $218.16

. Break-even would then become: 370/18.18 = 20 months. 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 ApproachEntering a crowded industry with yet another undifferentiated offer could make the goal of acquiring 1 million customers by the end of the first year (p. 1) extremely difficult

Furthermore, the youth market is a segment that is particularly loathe to enter into contracts and very likely to fail credit checks: young people have limited disposable income, uneven usage patterns, and weak credit histories.

But this market segment is underserved and there may be an opportunity for Virgin to offer these consumers a product with highly-differentiated features (e.g., VirginXtras) designed to meet their specific needs

and still be able to compete "below the radar screens" of the big players.

No contractsA Consumer Friendly Plan: Potential ProblemsIncreased ChurnConsumers want..But the problem is ..No Pricing BucketsNo Hidden FeesLower Operating Margins

No Peak/Off Peak HrsNo Credit ChecksMore UncollectiblesSimple Sales ProcessConsumer ConfusionGreat ServiceIncreased Costs

Virgin Mobile A Different ApproachFrom a customer perspective, an "ideal" plan would probably include a number of elements which would have a potentially negative impact of the companys financial

but Virgin can use a number of different managerial tools to counter these negatives, for example:

Lowering Customer Acquisition Costs

Embracing Additional Pricing Elements

Developing a Highly-Differentiated Competitive Positioning through a new services package and a new pricing proposition

Lowering Customer Acquisition CostsOn sales commissions

Because of a different channel and merchandising strategy where "consumers can pick up the phone without a salesperson helping them" (p. 5), Virgin expect its sales commissions to be $30 per phone, as opposed to $100 for the industry average.

On advertising costs

Virgin plans to spend much less than its competitors (approx. $60 million for the year (p. 5). Given the companys target to acquire 1 million customers during this period, the advertising cost will be $60 per gross ad, compared to the industry average of $75 to $100 (p. 9).

Lowering Customer Acquisition CostsOn handset subsidies

Virgin handsets cost the firm between $60 to $100 compared to an industry average of $150 to $300 (p. 5) because the company plans to stay away from selling high-end phones to young customers.If Virgin is decided to offer subsides at half the rate of the industry average (current industry handset cost / subsidy = 67%), then this subsidy would be roughly ($80 * 35%) = $30

Virgin total acquisition costs: $120

Sales commission: $30Advertising per gross ad: $60Handset subsidy: $30

Embracing Additional Pricing ElementsPre-paid requirement no contract

Eliminate the problem of uncollectibleEliminate the need for credit checkSimplify the selling processEncourage trial (and therefore potentially lower customer acquisition costs) Lower costs-to-serve (simplified billing, reduced number of service calls related to pricing disputes)

A completely transparent, simple (one-size fits-all) per-minute price no form of pricing discrimination being practiced by the competition (pricing buckets, on/off-peak policies, hidden fees, etc.)

Developing a Highly-Differentiated PositioningA highly-differentiated service proposition

Rescue RingsWake-Up CallsVirginXtras

A highly-differentiated pricing proposition

An opportunity to tap into the consumer resentment with a non-cynical, non-manipulative and radically different pricing approach, one that promises full transparency, no traps and no (bad) surprises, all at a fair price (customer rage management)

No contractsIncreased ChurnConsumers wantBut the problem is ..No Pricing BucketsNo Hidden FeesLower Operating Margins

No Peak/Off Peak HrsNo Credit ChecksMore UncollectiblesSimple Sales ProcessConsumer ConfusionGreat ServiceIncreased CostsA Consumer Friendly Plan: Potential SolutionsLower Acquisition CostsOffsets Loss in LTV

Simplified Pre-paid Planeliminates confusion, no uncollectibles, fewer service calls

Lower SubsidiesA possible solution is ..

How Could Virgin Achieve Profitability? Is there a per-minute price that would allow the company to attract young customers and reach a financial viability at the same time?

1. Break-Even AnalysisGiven the acquisition Virgins $120 acquisition cost, what would the company have to charge on a per-minute basis (P) to equal the industrys break-even time of 17 months, assuming that Virgins customers use 200 minutes per month (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: $120Price 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 a LTV significantly lower than the industry:The other carriers are building a significant war chest (LTV=$540) and Virgin would be at competitive disadvantage if the company was obliged to fight against them directly.Virgin could also trigger a price war and defeat their own goal of competing "under the radar screen" with a new segment but a low price point.

Virgin Mobile USA : What Happened?Virgin Mobile USALive Without a planPre-Paid Plan3 months to use your minutesNo Contracts(+2 months grace period)No Hidden ChargesNo Peak/Off-Peak HouseOne-button access to currentNo Long-Distance Chargesbalance/remaining minutes

Lower Handset SubsidiesCan add more minutes via webor phone using a credit card or25 cents/minute/1st 10 min. of daya Top Up card purchased10 cents/every min. thereafterfrom a retailer

Virgin Mobile USALive Without a PlanNo Credit Checkincreases the size of the target market

No Billing no monthly bills lower cost to serve fewer customer service calls lower cost to serve no uncollectibles

Lots of customer interactionVirgin Mobile USALive without a PlanSimple Pricing No sales complexity No salesperson needed opens up new channels lowers sales commissions lowers acquisition cost

For 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?

Virgin was able to surpass its goal of acquiring 1 million customers within a year launch becoming the fastest cell phone service to reach the 1 million mark in US history.Virgin ended the year 2003 with a revenue run rate of $500 million.Virgin enjoys the lowest churn rate in the prepaid world.Virgin eliminated the dual problem of having both a high credit rejection rate and large uncollectibles by requiring payment up-front.It substituted contracts with lower phone subsidies, thereby ensuring that customers had "skin in the game" while lowering its own acquisition costs.Virgin made the pricing structure so easy to understand that it was able to eliminate the sales complexity, which delighted its customers and lowered its own sales commission expenses.

Narrow Target Segment Young people between the ages of 14 and 24Simple Sales ProcessSimple Pricing Plans-Full transparency-Easy to understand- No Hidden FeesGreat ServiceNo Credit ChecksA Cycle of Consumer Satisfaction Sources of Consumer Satisfaction No ContractsCustomer SatisfactionLower-Than-Expected Churn RatesLower Customers Acquisition CostsFinancial flexibility to Eliminate contracts,Offer great customer service,Offer competitive per-minute rates

What Lies Behind a Price?Price as a service (fair & transparent pricing structure)

Price as a value signal (market positioning)

Price as the growth engine of a business model (ROE)

Price as a major differentiation factor (well-differentiated value proposition on a marketing / strategic level)

Price as a main driver of consumption patterns (Yield Management)

En phase de maturit du march, la croissance du chiffre daffaires ne peut seffectuer par larrive de nouveaux clients (saturation du march). Par consquent, une entreprise devra acqurir des clients de ses concurrents. Ds lors, le cot dacquisition dun nouveau client est croissant car il faut convaincre des clients qui ont fait un premier choix en dfaveur de lentreprise. Do lide, que plutt que dacqurir de nouveaux clients, il est judicieux de chercher augmenter le chiffre daffaires sur la base existante de clients. Donc la premire ide de la GRC consiste retenir les clients existants afin damortir les frais dacquisition et daugmenter la valeur de ces clients. Lannexe 9 met en vidence la stagnation des parts de march des trois oprateurs du march, illustrant la saturation du march et la difficult conqurir de nouveaux clients. En effet, si lon observe les taux dattrition (taux de non renouvellement de labonnement), celui-ci se situe pour Orange 18,6 % en 2003 (annexe 1). Le taux de rotation entre oprateur est faible (6% des clients cf. annexe 5), malgr des taux de satisfaction trs moyens (annexe 6). Ceci est li aux clauses contractuelles qui gnrent de la rtention passive des clients (les clients ne peuvent partir sans un cot de sortie important, effet de lock-in ou verrouillage).Cette diapositive nest utiliser quen cas de besoin (si vous navez pas trait la question de la valeur dun client en cours par exemple). La gestion de la relation client a pour vocation daugmenter la valeur du portefeuille clients. Il est donc ncessaire de calculer la valeur de ce portefeuille. Le calcul de la valeur dun client est rsum dans la formule de la diapositive. Il sagit dune valeur actualise des flux de revenus gnrs par un client sur une priode donne moins les cots dacquisition initiaux et les cots de maintenance du client dans la base. Le problme concret est la mise en uvre oprationnelle dune telle formule. Comment obtenir les cots de chaque client, sur quelle priode calculer cette valeur, quel taux dactualisation retenir?Pour ce qui concerne la tlphonie, les flux de revenus sont facilement identifiables (facture mensuelle), les cots de maintenance galement (rabais sur rabonnement, cots des minutes de fidlisation, rabais sur terminal), la priode considrer est celle de la dure de labonnement (2 ans), seul le taux dactualisation est plus complexe dfinir. En premire approximation on peut utiliser les cot moyen pondr du capital (CMPC), qui ncessite toutefois de nombreux calculs. A la date laquelle Mr Durand demande un rabais de 96, le client est largement rentable puisque prsent dans le portefeuille client depuis 7 ans. Si lon regarde les cots dacquisition (annexe 1) et les flux de revenus (tableau 8),mme sans actualisation, on peut estimer grosso modo que le client est rentable et se situe dans la moyenne des clients (annexe 7).