Virgin Mobile USA: Pricing for the Very First Time
Dan Schulman, the CEO of Virgin Mobile USA, must develop a pricing strategy for a new wireless phone service targeted toward consumers in their teens and twenties, many of whom are believed to have poor credit quality and uneven usage patterns. Contrary to conventional industry wisdom, Schulman is convinced that he can build a profitable business based on this underrepresented target segment. The key is pricing. Schulman is currently debating three pricing options: 1) adopting a pricing structure that is roughly equivalent to the major carriers, 2) adopting a similar pricing structure, but with actual prices below the major carriers, or 3) coming up with a radically different pricing structure. With respect to the third option, Schulman is considering various alternatives, including a reliance on prepaid (as opposed to post-paid) plans and the total elimination of contracts. The case study includes images and charts.
The above case was provided through Harvard Business School Case Study
CASE REVIEW & ANSWERING QUESTIONS
To understand this case, you would need to have an access to HBS Case study- Virgin Mobile USA. In this case study, there were four major questions involved and these questions were answered in this post. This post is an example of the case study review & answer (an abbreviated version).
- Given Virgin Mobile’s target market (14-24 year old) how should it structure its pricing? The case lays out three pricing options. Which options would you choose and why? In designing your pricing plan be as specific as possible with respect to the various elements under consideration (e.g. contracts, the size of the subsidies, hidden fees, average per-minute charges, etc.)
The pricing plan would be chosen as the second option, which allows the customers to have the contract but at the lower overage charge per minutes.
ContractBy charging less in the peak hours, the large target market of age 14-24 Yrs old can join into the phone usage community, but also provide the added benefit of being charged less in their after-school phone conversation (between 6-9pm). For the parents or individuals with contract, they see the obvious benefits of less charged hours and feel comfortable adding in their daughters/sons into the phone usage.
We can outline what some of the added costs are – including the obvious state/federal taxes, and other universal service charges. These costs can be rationalized to the young audience since taxes and universal charges are always followed in most of their purchases (unavoidable costs of having a phone in any phone carriers).
Size of the Subsidies
We can provide the expensive phone at the subsidized cost of $90, while the low-end phone at $60. We wouldn’t be making money on the phone, but allowing the customized component to be added, we can naturally create a secondary market of the custom faceplate for one-time cost from desired customers. Average per-minute charges
Since the target customers (age 14-24) uses most of their phones during 6pm-9pm, we can expect is at 100 -300 minutes. By lowering the minutes specifically on those hours, we create the psychological benefits of savings. Since young adults tend to use more than they think, they would be charged in long minutes. Although the cost of a phone bill would be similar to the traditional contract, because the customers used more hours, they would feel psychologically comfortable paying the bills.
- How confident are you that the plan you have designed will be profitable? Provide evidence of the financial viability of your pricing strategy. (Hint: In calculating the LTV as per Exhibit 11, be sure to use the retention rate and the discount rate that would correspond to the same time period (annual or monthly) – the interest rate of 5% is annual).
Best Scenario: 5% Market PenetrationLTV = [M/(1-r-i)] – AC = [$360M/(1-0.02-0.05)] – [($90 x 0.8M x3)+($120 x 0.2M x 3) = $360/0.93 – [216M + 72M]= $387.1M – [$288M] = $99.1M
$99.1M/1M = $99.1 LTV
LTV refers to the Life-Time Value of a customer.
Therefore, the single customer’s Life time value is $99.1 in a year.Acquisition Cost = (Handheld carrier: $60 ~ $90/user) + ($30/phone sales commission) = $90 ~ 120/month
Advertising Cost = $60M; With potential 20 million viewers, if we divide the $60M/20M views = $3 per impression
Total Target Potential users are assumed at 20M users;
Target potential users in 1year are at 1M users, as of 5% market share.
M is the yearly margin the customer brings = $30 x 12 Months = $360 x 1M users = $360M
- How do the major carriers make money in this industry? Is there a financial logic underlying their pricing approach?
The majority carriers make money by rolling their customers into contracts, providing both buckets of minutes usage and post-paid service. Bucket of minutes meant that individuals had usually 300 minutes and overage would be charged at 40cents/minute. Post-Paid service allows monthly billing on basis of the customers’ contract. This contract agreement allows a hedge against churn and a guaranteed annuity stream.
Under the contract, the U.S cellular phone subscribers had to be in a period of 1-2 year agreement with the cellular providers, and require the rigorous credit check. The credit check allows eliminating individuals who don’t have good credit or have a credit card. Most carriers knew that people used more minutes than they actually use, and the extra overage minutes used by the cellular subscribers made the phone companies profitable. People assumed that they would use only the minutes bucketed, but they used more overage on average. Plus, the hidden extra costs of taxes, universal service charges, and other fees increased the profits to the cellular companies.
- What do you think of Virgin Mobile’s value proposition? What do you think of its channel and merchandising strategy?
The value proposition made by the Virgin Mobile is very straight-forward, honest and customer-friendly, which go along with Virgin brand image. Because the young customers are savvy, they understand the hidden charges. Additionally, the added features allow the young audience to increase their phone usage and make the phone as a part of necessity. Added Features and the interchangeable faceplates can increase the attractiveness of the phone usage, as well as customization of the phone. The channel and merchandising strategy are more affordable to the young audience since they can purchase the phone on their own or attract middle-age parents with young teenage children. Because the young parents and children have the option of seeing which phones they can buy through a starter packet and avoid speaking with the sales representative, they feel more comfortable and have the option of purchasing the product more carefully. When people invest more time in purchase thinking, they feel more empowered and obligated/favored to using the products. (It’s similar to advertising effect of seeing the same product over and over, except you can touch and read the content in details – which is powerful hands-on experience for customers.
- Do you agree with Virgin Mobile’s target market selection? What is the relative attractiveness of the mainstream segment and the niche segment that Virgin Mobile is targeting? What are the risks associated with targeting this segment?
Yes, I agree with the Virgin Mobile target market selection.
Market Size: Growth & Early Opportunity
The relative attractiveness of the mainstream segment is that this is a growing market, which allows the Virgin mobile to continuous gain market share growth in the next five years. Additionally, the niche market allows the Virgin mobile to be competitive different from the rest, creating an extremely powerful brand for teenagers and young adults.
By setting the industry standard early and differentiating from the other carriers, Virgin brand can easily capture the largely young audience and allow them to create “teenagers” phone usage culture. Added-Features, phone customizations, and lower pricing all fit the teens and increase brand-association to Virgin Mobile Phone
Development of cellular culture in texting, messaging and daily phone usage. The phone is no longer the business-only requirement, but important part of the people’s life – Wakeup Call, Social connection, Music Device, and monitors phone bills.
Long-term Users (Teens & Young Adults)
Customer satisfaction would increase the less hidden fees and honest pricing. Association of positive brand recognition among teens and young adults influence them to be much more loyal than other cellular brands.
1. Marketing/Advertising – Branded as the “Young/Teen” cellular company; Don’t necessarily capture the older audience;
2. Profit Loss – Allowing decreased per minute cost in overage will decrease profit.
3. Price War – Invites other competitors to lower their bills or overage price during peak hours