1
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
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

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

(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

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
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 20.5 months ~= 370/18
What happens to LTV?

Without hidden costs, but with contracts
LTV =


- 370 = 374.82
Without hidden costs and without contracts
LTV =

18 * 12
1- .76 + .05
18 * 12
1- .28 + .05
- 370 = -89.48
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/1mil= $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
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

Break Even analysis: at what per minute price would
Virgin break even:



Virgin’s 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
p > 0.07
- 120 > 0
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
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%