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AEM 4160: STRATEGIC PRICING PROF.: JURA LIAUKONYTE

VIRGIN CELL CASE: EXCERCISES

Pricing Structure from the Carrier Perspective

Contracts:

Annual churn rate WITH contracts Annual churn rate WITHOUT contracts 72% (p.8) The difference:

=2% * 12 months = 24% (p.8) =6% * 12 months =

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: mln Acquisition cost per customer: Total cost of offsetting higher churn rate:

48% * 20.5 mln = 9.84

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

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

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

(lets 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 =

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

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

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% Virgins handset cost: $60 to $100 (assume $80) Assume Virgins subsidy around 30% = $30

Handset subsidies:

Acquisition costs

Then Virgins 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

Break Even analysis: at what per minute price would Virgin break even:

Virgins monthly ARPU: (200 minutes)*(p), where p=price per minute Monthly cost to serve: .45 * 200 * p Monthly margin: 200p - 90p = 110p

LTV =

12*110p 1- .28 + .05

- 120 > 0

p > 0.07

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:

LTV =

12*110*.1 1- .28 + .05

- 120 = $51

At 25 cents:

LTV =

12*110*.25 1- .28 + .05

- 120 = $309

Virgins 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%