1. Lecture 9 HBS Case: Virgin Mobile

2. Lecture Plan
HW2
Exam 1
Virgin Case

3. 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

4. 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

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

6. Clone Industry Prices
Pros
Cons

7. 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

8. 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

9. Price Below Competition
Pros
Cons

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

11. 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

12. A Whole New Plan: Prepaid Pricing
Pros
Cons

13. 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

14. 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

15. 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: % - 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.

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

17. “Menu” Pricing: Actual Usage

18. 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.

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

20. 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)

21. 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

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

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

24. 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 _________= __________

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

26. 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 =

27. 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

28. 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

29. 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: _______

30. 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

31. 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 =
- _____ = ____

32. 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%