Virgin 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?

6. Provide evidence of the financial viability of

your pricing strategy

Teaching Objectives
1. To cover two main aspects of pricing

Price levels i.e., the overall amount a consumer pays

Price structure i.e., how a payment is presented to the
consumer

2. To examine the interplay between pricing, target

market selection, and a firms overall value
proposition.
3. To demonstrate the multiple ways firms can create
paths to profitability.
4. 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.
1.

Major carriers continue to hold customers "hostage"

through contracts and leave them feeling trapped in their
plans (capture).

2.

Customers, being obliged to sign up for pricing buckets,

are penalized, often heavily, for shortfalls and overusages
(decommoditization and consumption penalties).

3.

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, overcrowded and fiercely competitive, a truly
consumer-friendly cellular plan has still not
been introduced.
4.

Off-Peak/On-Peak differentials add to customer

confusion and off-peak period has shrunk over time
(constrained consumer behaviour patterns).

5.

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.
6.

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).

7.

Consumers received their bills via mail. These bills typically

include a detailed record of customers call history (no
respect for privacing concerns).

8.

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 billionjust 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.

A Cycle of Consumer
Dissatisfaction
Multiple Target Customers

Business, Consumer, Heavy/Light

Users, etc.

Sources of Consumer Dissatisfaction

Complex
Sales Process

Credit
Checks

Complex Pricing Plans:

-Multiple options
-Multiple buckets
-Hidden Fees

Poor
service

Custome
r
Dissatisfaction

Sources of Industry
Dissatisfaction

Continuous Industry churn

High churn rates mean that carriers
must re-acquire 24% of their
customer base each year, just to
stay even

High Customer Acquisition

Costs
Because of high customer
dissatisfaction rates, acquiring new
customers is a tough sell

Financial pressure to
Lock-in customers using contracts,
Cut corners in customer service to reduce costs,
Aggressively promote low prices to attract cutomers
Use hidden fees and pricing buckets to increase
margins

Forced
Contracts

Behind Prices and Pricing Levels:

Looking at the Economics of a
Business Model
1. Acquisition 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 Model
2.

Break-Even Analysis
. Monthly ARPU (average revenue per
user): $52
. Monthly cost-to-serve:
$30
. Monthly margin:
$22
. Time
to
break-even
acquisition cost:
$370 / $22 = 17 months

on

the

Behind Prices and Pricing Levels:

Looking at the Economics of a
Business Model
3. Lifetime Value (LTV) Analysis

From
transactional
marketing

to

relationship

From Transactional to Relationship

Marketing
Sales Volume

Growth only possible at competitors expenses

Natural growth of customers and market size

Time

Behind Prices and Pricing Levels:

Looking at the Economics of a
Business Model
3. Lifetime Value (LTV) Analysis

From
transactional
marketing

Why should a company take into

consideration the long-term value of its
customers?

to

relationship

Reducing Defections 5% Boosts Profits

25% to 85%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

85%

75%
50%

30%

25%

45% 45% 40%

35%

* 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.

Relationship Marketing and

Profitability
Savings 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 CALCULATIONS

Unsatisfied

Satisfied

Highly Satisfied

Visits/month (Ex.9)

3.9

4.3

7.2

Visits/year

46.8

51.6

86.4

$ per transaction (Ex.9)

$3.88

$4.06

$4.42

revs/year

$182

$210

$382

Difference = $28/yr

Unsatisfied
Avg life (Ex.9)
Revs/life

Difference = $172/yr

Satisfied

Highly Satisfied

1.1 years

4.4 years

8.3 years

$200

$922

$3170

Difference = $722

Difference = $2248

Customer Life Time Value - LTV

Calculation
(1) LTV a 1
N

(M )r
1i

a -1

M
(2) LTV
1-r i

AC

AC

Behind Prices and Pricing Levels:

Looking at the Economics of a
Business Model
3a. 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 Model
3b. 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 Model
3c. 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

Approach
1.

Entering
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

2.

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.

3.

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

4.

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

the big players.

A Consumer Friendly Plan: Potential Problems

Consumers
want..
No contracts

But the problem is

..
Increased Churn

No Pricing Buckets
No Hidden Fees

Lower
Operating
Margins

No Peak/Off Peak
Hrs
No Credit Checks

More
Uncollectibles

Simple Sales
Process

Consumer
Confusion

Great Service

Increased Costs

Virgin Mobile A Different

Approach
1.

From a customer perspective, an "ideal" plan would

probably include a number of elements which would
have a potentially negative impact of the companys
financial

2.

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

Costs
1. On 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.

2. 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

Costs
3. On 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 highend 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

4.

Sales commission: $30

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

Embracing Additional Pricing

Elements
1.

Pre-paid requirement no contract

2.

Eliminate the problem of uncollectible

Eliminate the need for credit check
Simplify the selling process
Encourage 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
Positioning
1.

A highly-differentiated service proposition

Rescue Rings
Wake-Up Calls
VirginXtras

2.

A highly-differentiated pricing proposition

3.

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)

A Consumer Friendly Plan: Potential Solutions

Consumers
want
No contracts

But the problem is

..
Increased Churn

No Pricing Buckets
No Hidden Fees

Lower
Operating
Margins

No Peak/Off Peak
Hrs
No Credit Checks

More
Uncollectibles

Simple Sales
Process

Consumer
Confusion

Great Service

Increased Costs

A possible
solution is ..
Lower Subsidies
Lower
Acquisition
Costs
Offsets Loss in
LTV
Simplified Prepaid Plan
eliminates
confusion, no
uncollectibles,
fewer service
calls

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 Analysis

Given the acquisition Virgins $120 acquisition cost,

what would the company have to charge on a perminute 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: $120
Price 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

1.
2.

. 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 USA
Live Without a plan
Pre-Paid Plan
minutes
No Contracts
No Hidden Charges
No Peak/Off-Peak House
No Long-Distance Charges

3 months to use your

Lower Handset Subsidies

web

Can add more minutes via

(+2 months grace period)

One-button access to current
balance/remaining minutes

or phone using a credit card

or
Virgin Mobile USA
25 cents/minute/1st 10 min. of day
Live
Without a Plan
card purchased
No
Credit
Check
10 cents/every min. thereafter
increases 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 interaction
Virgin Mobile USA
Live without a Plan
Simple 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.

a Top Up
from a retailer

Virgin Mobile USA: What

Happened?
1.
2.
3.
4.
5.
6.

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.

A Cycle of Consumer
Satisfaction

Narrow Target Segment

Young people between the ages of 14
and 24

Sources of Consumer Satisfaction

Simple Sales
Process

No Credit
Checks

Simple Pricing Plans

-Full transparency
-Easy to understand
- No Hidden Fees

Great
Service

Custome
r
Satisfact
ion

Lower-Than-Expected
Churn Rates

Lower Customers
Acquisition Costs

Financial flexibility to
Eliminate contracts,
Offer great customer service,
Offer competitive per-minute rates

No
Contracts

What Lies Behind a Price?

1. Price as a service (fair & transparent pricing structure)
2. Price as a value signal (market positioning)
3. Price as the growth engine of a business model (ROE)
4. Price as a major differentiation factor (welldifferentiated value proposition on a marketing /
strategic level)
5. Price as a main driver of consumption patterns (Yield
Management)