MEMO: INITIAL PRICING FOR VIRGIN MOBILE USA

To: Virgin Mobile USA

Overview

The current options available in the cellular carrier industry have created a high level of

customer dissatisfaction and an extremely high attrition rate for vendors. The primary concerns in

this industry are the hidden fees associated with purchases, poor customer service, lengthy

contracts, and an underserved population. Our pricing model recommendation will alleviate

several of these issues, while providing Virgin Mobile with significant profits.

Target Market

The target market for Virgin Mobile is between the ages of 14-24 years old. This

demographic is currently an underserved population at approximately 25% saturation in the

cellular carrier market. This is compared to over 50% market saturation for the US population as

a whole. Several factors contribute towards this chasm. First, this demographic has not had wide-

spread access to cell phones in the past, and therefore were not consistent users. Additionally, this

demographic routinely struggled to pass the credit checks that most cell phone carriers required in

order to sign a contract. Lastly, even if usage rates increased and credit checks were not required,

there is not currently an option on the market that would have a high level of appeal to this

demographic.

We agree with the marketing decision of Virgin Mobile to pursue this demographic because

there is a significant change coming. The quantity of users between the ages of 14 and 24 will rise

significantly over the next decade, ultimately resulting in that demographic making up the largest

portion of the cell phone market. Furthermore, we will provide a new and unique pricing structure

that allows Virgin Mobile to make a significant profit from this demographic without difficult
credit checks or contracts. Lastly, Virgin Mobiles strategic partnerships and unique product

design will increase consumers appetite for cell phones and grow the entire industry. Virgin Xtras,

faceplate options and custom ring tones are some points of differentiation that will create value for

the target customer.

Customer Dissatisfaction

Customers in the cell phone market are dissatisfied with the products and services

currently being offered, and a change to the landscape is long overdue. Hidden taxes and fees result

in nearly every customer paying more than he or she originally anticipated when entering the

contract. Customer service has been another prevalent issue the cell phone market, with customers

not being able to reach agents to understand billing, correct errors, or receive technology support

on their devices. Minutes used during peak hours have been another source of dissatisfaction for

customers in cell phone contracts. Customers are now using more minutes during peak hours while

off-peak hours continue to get later and later. Even if customers use the correct number of total

minutes allocated by their plans, they will be subject additional fees if they use the wrong mix of

minutes between on-peak and off-peak hours.

This is another way that the Virgin Mobile USA product will outperform its competition.

By applying Virgins renowned customer service, we look to reduce the churn rate of a typical cell

phone carrier. The monthly churn rate in the cell phone market is roughly 2% for customers in a

contract and roughly 6% for those on a prepaid plan without a contract. The 25% of customers that

defect each year to other cellular carriers provided the following reasons during customer surveys:

Unmet needs expectations, Poor product service quality, High complexity and billing errors.
 We will minimize the typical churn rate and subsequent profit loss by answering several of

these customer concerns in the current market. First, we recommend Virgin Mobile price monthly

charges exactly as prescribed, with no hidden taxes or fees. The price that customers see advertised

is the price they will actually pay. Not only with this reccomendation will reduce the churn rate, it

will eliminate the high complexity of customer billing and errors that come along with it. Second,

we recommend a highly trained and available staff of customer service representatives to answer

the needs and concerns of Virgin Mobile customers. Finally, we recommend that Virgin Mobile

eliminate the concept of on-peak and off-peak minutes. The majority of our target demographic

are students in high school, college, etc. Therefore, cell phone use will be limited during those

times. Nearly all users in our target demographic will begin high volume usage during the evening

hours, beginning around 6:00 PM. Therefore, if Virgin Mobile has a high price point during those

hours, customer acquisition and retention will be extremely difficult. By eliminating on-peak and

off-peak minutes, we will better meet customer expectations and reduce defection to other carriers.

Additionally, we believe Virgin should stay away from the pre-paid carrier market. In the United

States, the pre-paid market is not ready for a major provider due to low usage and customer loyalty.

For that reason, we are reccomending a flat rate, monthly subscription service with no contract,

credit checks or hidden fees. This pricing strategy fits in nicely with Virgin Mobiles brand and Commented [ACM1]: Are we recommending a Pre-paid?

overall strategy for entering the US cellular carrier market.

Pricing Model Recommendation

Due to the competitive market, typical carriers will wait approximately one and a half years

to get paid back. Therefore, we will utilize Customer Lifetime Value (CLTV) to compare our

pricing strategy with the competition. The CLTV is a prediction of the net profit attributed to the

entire future relationship with a customer. It is calculated by the expected retention rate (r),
discount rate (i, we assumed to be 5%), monthly revenue per a customer (R), monthly cost to serve

a customer (CTS), and acquisition costs (AC).

=
1+

Given our target market and the strategies that we recommend to Virgin Mobile, our pricing

strategy is dependent on one key variable: retention rate. We firmly believe that with this targeted

approach will reach an underserved market segment and increase focus on specific pain points in

the industry. By doing so, we can grow the current industry standard of retention rate annually. As

previously mentioned, the monthly churn rate for current customers on a pre-paid plan is roughly

6%. We believe Virgin Mobile can cut this estimate in half by excluding contracts and hidden fees.

In Appendix 1, we have the monthly retention rate at 94% for our proposed pricing plan as a

conservative estimate. We believe that the retention rate will be actually closer to 97% monthly.

While this is still lower than customers in a contract, it is a marked improvement on the current

estimate of customers without contracts.

Our proposed margin was estimated using a monthly revenue. We will be priced

competitively, on a monthly basis, with the typical carriers at approximately $52 per user. This

will give us a buffer for operating without a safety net in a contract and help make up for not

utilizing a contract to remove non-profitable customers. (Note: We still see a marked advantage in

our pricing strategy if we use a competitive price of 12 cents per a minute. This is based on the

typical carriers pricing, but we believe that is leaving money on the table for Virgin profits.) We

also used an estimate of 45% of revenue for our monthly cost to serve due to our shrewdly

negotiated contract with Sprint. This allows us to purchase minutes on their network based on

usage and reduce monthly costs to operate. The table below gives us a comparison of other typical

carriers and shows where we can gain a competitive advantage.

 Monthly Cost to Serve
$35.00

$30.00

$25.00

$20.00

$15.00

$10.00

$5.00

$-
Typical Carriers/ Typical Carriers/ Virgin Without Virgin without Virgin without
Option 1 Option 1 (Minimum) Contracts hidden costs hidden costs or
(Maximum) contracts

Another area in our pricing strategy that we can see a competitive advantage is the

acquisition costs per customer. Our acquisition costs were broken into three categories:

advertising, distribution outlets and subsidies for handsets. We recommend reducing costs in all

three categories due to the fact that other aspects of the Virgin Mobile pricing model will be so

attractive. We will benefit from word of mouth and not require as high of expenditures on

advertising. Using retailers as a distribution outlet will only add an acquisition cost of $30 dollars

per customer. This is much better than the industry average at $100 per a customer. Virgin

Mobiles overall market strategy will also reduce the subsidized cost per customer for a new

headset. Typical carriers currently have an additional $90 to $210 acquisition cost for a subsidized

phone for each customer. Virgin Mobiles $30 subsidized headsets for their customers is another

improvement that will significantly reduce the acquisition costs per customer. These three

reductions bring Virgins acquisition costs to approximately $70 per customer, which is a marked

improvement to the industry estimates of $370 per a customer.

 Commented [ACM2]:
Acquistion Costs Commented [ACM3]: This seems out of the scope of our
$450.00 reccomendation
$400.00
$350.00
$300.00
$250.00
$200.00
$150.00
$100.00
$50.00
$-
Typical Carriers/ Typical Carriers/ Virgin Without Virgin without hidden Virgin without hidden
Option 1 (Maximum) Option 1 (Minimum) Contracts costs costs or contracts

Advertising Costs Distribution Costs Handset

With these figures in mind, we can calculate the CLTV for the margin, retention rates and

acquisition costs. These costs per customer provide Virgin with a significant competitive

advantage over their competitors. Even with a conservative churn rate of 6%, the overall CLTV is

still high. See the table below for a direct comparison and Appendix 1 for an overall break down

of the calculation for the CLTV.

CLTV
$300.00

$250.00

$200.00

$150.00

$100.00

$50.00

$-
Typical Carriers/ Typical Carriers/ Virgin Without Virgin without Virgin without
$(50.00) Option 1 (Maximum) Option 1 (Minimum) Contracts hidden costs hidden costs or
$(100.00) contracts

$(150.00)
 Finally, customers in our target demographic will use fewer minutes than the industry

average, so we will set a price per minute according to a new standard. While the typical user

spends 417 minutes per month on the phone, we will base our per minute price on a 200-minute

monthly average.

Conclusion

With all of these considerations in place, the monthly revenue per customer will be $52

and the monthly cost to serve each customer will be $27, setting the monthly margin per customer

at $23.40. The survival rate for the month will 94%. The interest rate is set at a fixed 5%. The

acquisition cost, consisting of advertising costs, distribution costs, and the handset subsidy, will

be $69.69. Finally, the CLTV will be $135.76 monthly, (Appendix 1). The recommended price

per minute is $0.30 accordingly. While we understand that this may not be the most profitable

option for the current average cell phone user, it is the most profitable option that is also viable for

the target demographic, and ultimately shows that you can, in fact, target young people and still

make money.

Appendix 1

Virgin Virgin
Typical Typical without without
Carriers/ Carriers/ Virgin Virgin hidden hidden costs
Option 1 Option 1 Without without costs or or contracts
(Maximum (Minimum Contract hidden contract competitivel
) ) s costs s y priced
Monthly
Revenue $52.00 $52.00 $52.00 $52.00 $52.00 $36.00
Monthly Cost to
Serve $30.00 $30.00 $23.40 $23.40 $23.40 $16.20
Hidden Fees $6.00 $6.00 $6.00 $6.00 $6.00 $6.00
Margin $22.00 $22.00 $28.60 $22.60 $22.60 $13.80
Retention Rate 0.98 0.98 0.94 0.98 0.94 0.94
Interest Rate 0.05 0.05 0.05 0.05 0.05 0.05
Acquisition
Costs $275.00 $405.00 $69.69 $69.69 $69.69 $69.69
Advertising
Costs $75.00 $105.00 $9.69 $9.69 $9.69 $9.69
Distribution
Costs $100.00 $100.00 $30.00 $30.00 $30.00 $30.00
Handset $100.00 $200.00 $30.00 $30.00 $30.00 $30.00

CLTV $39.29 $(90.71) $190.31 $253.16 $135.76 $55.76

Price per a
minute $0.12 $0.12 $0.17 $0.17 $0.17 $0.12