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AEM 4160: Strategic Pricing Prof.: Jura Liaukonyte Virgin CeLL CASE: EXCERCISES

AEM 4160: Strategic Pricing Prof.: Jura Liaukonyte Virgin CeLL CASE: EXCERCISES. 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)

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AEM 4160: Strategic Pricing Prof.: Jura Liaukonyte Virgin CeLL CASE: EXCERCISES

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  1. AEM 4160: Strategic PricingProf.: Jura LiaukonyteVirgin CeLL CASE: EXCERCISES

  2. 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: 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: 48% * 20.5 mln = 9.84 mln • Acquisition cost per customer: $370 (case p.2) • Total cost of offsetting higher churn rate: $370 * 9.84 mln =$3.64 bil. Not surprising that major players still continue to hold the contracts.

  3. “Menu” pricing: Actual Usage

  4. 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.

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

  6. 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)

  7. 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): 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

  8. LTV with contracts • The annual retention rate in the industry = 1-12*0.02=0.76

  9. LTV without contracts • Eliminate contracts -> churn rate increases to 6% • Calculate the LTV:

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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 p > 0.07

  16. 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:

  17. 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%

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