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RECALL No 1 Pricing

Welcome ...
to the first issue of Recall, a new publication for executives and board members that provides insights into marketing and sales for the telecommunications industry. Our industry is changing at an unprecedented pace. Market saturation, new technologies, regulatory pressures, and the emergence of new players are just a few of the issues among many. The way in which successful companies currently create marketing opportunities in this space is very different compared to just some years ago and will again be different in the years to come. Marketing and sales in telecommunications has never been more exciting and challenging. Recall aims to offer you a holistic view of the implications of these challenges and to recall how successful companies managed to take advantage of them and, how they have created positive recall with customers and consumers and hence, value. Recall will cover one marketing or sales topic at a time and is firstly published on the McKinsey Telecommunications Extranet (to register, see page 47). Topics will range from pricing via branding to channel management, striving to provide you with the latest thinking on telecommunications marketing and sales. The authors of Recall are members of McKinsey & Companys Global Telecommunications Practice, a group of more than 380 dedicated practitioners and some 60 research analysts. Together with leading academics, they aim to bring you an integrated perspective on key marketing and sales topics. We hope that you find Recall interesting and that it provides you with unique insights and ideas that are useful in your daily work. We look forward to your feedback and thoughts on relevant topics you would like to see covered in this publication.

Jrgen Meffert European Leader of McKinseys Telecommunications Practice

Pedro Mendona Leader of McKinseys Marketing in Telecommunications Practice

Boris Maurer Leader of McKinseys Telecommunications Extranet

Thomas Barta Leader of European Telecoms Branding / ROI, Editor Recall

About This Issue

Pricing is the focus of this first issue of Recall. It starts with Triple-play pricing. Like no other area, this topic combines many industry challenges into one: fixedto-mobile substitution, migration towards flat rates, the increasing commoditization of broadband, and the emergence of IPTV. If you can make it there, you can make it anywhere see what it takes to be successful in this arena. The next article is Value Pricing for Profitable Growth. Maturing mobile markets make sustaining profitable growth an increasing challenge for operators. Pricing creates a host of opportunities for those who know how to work with it, as examples show. Second Brands & Wholesale Plays: Pricing Strategies for a Changing Market is the next topic. A multi-brand and wholesale strategy can play a fundamental role in protecting the profitability of main brands. Part four explains McKinseys CHESS approach. This approach integrates pricing conjoint analysis, brand analysis, and product optimization in a single, comprehensive method that provides a way to increase a brands consumer preference share by in some cases 50 to 60 percent or more. The fifth part Best-Practice Multi-Play for Digital Convergence describes a market-research-based methodology for defining an optimal range of bundles. Digital convergence is quickly leading to the emergence of various telecoms and media services bundles, creating a new space of multi-market and product competition. Bundling is a way to differentiate offerings via complementary services and hence, reduce price competition. The first issue of Recall concludes with interviews with the CMO of T-Mobile Croatia and Telenors Head of Mobile. Get an inside viewpoint as T-Mobiles Hendrik Kasteel describes his companys success in defending itself against the market entrance of a new network operator and as Telenors Jon Erik Haug shares his perspective on pricing strategies and future developments in markets that have a heavy MVNO influence.

RECALL No 1 Pricing

01 02 03 04 05 06 Value Pricing for Profitable Growth Customer-Centric Success: Triple-Play Pricing Beyond Traditional Market Pricing: Second Brands and Wholesale Play CHESS Moves: Creating a Complete Customer Value Proposition Best-Practice Multi-Play for Digital Convergence Points of View 9 15 21 29 35 43 47


RECALL No 1 Pricing Value Pricing for Profitable Growth

01 Value Pricing for Profitable Growth

Europes maturing mobile markets and price-testing regulatory environment make sustained profitable growth a newly daunting challenge for operators, despite their significant brand-building investments. This value-killing shift has been an emergent reality in Europe since early in the decade, when revenue growth and earnings quality began to wane as markets became saturated. Regulation-driven cuts in interconnection rates are expected to cause up to 35 percent of the industry profit pool to evaporate over the next two to three years. Additionally, new regulations for mobile virtual network operators (MVNOs) are triggering price wars in basically all markets. To counter this downward spiral, operators should adopt a value-based pricing strategy, something that has, for the most part, been overlooked thus far. The typical marketing approach taken in the mobile industry has consisted of combining massive brand-building investments (with leading mobile operators emerging as top advertisers in each market) and more recently, a general shift towards viral marketing again, with significant investment into CRM systems and capability development. However, between these levers, little attention has been given to pursuing a consistent pricing and portfolio design, which proves crucial in effectively extracting the corresponding premium from such heavy brand investments and better focusing targeted promotional campaigns (Exhibit 1). A value-based pricing strategy involves better matching the natural segmentation of consumers reaction to each of the mobile price components. Such an optimized

pricing structure should allow operators to capture their brand premium from those who are less sensitive to price, while exploring profitable trade-offs with those who react to specific price components rather than to the price as a whole. A dual strategy is often required since, while on the one hand, a large majority of mobile customers are still willing to pay a brand premium or choose a price plan based upon a particular tariff component and on the other hand, a growing segment in each market is becoming increasingly sensitive to transparent, simple value propositions (Exhibit 2). Such a strategy, which takes advantage of the innate brand-building skills that operators have developed, consists of two complementary elements: 1. Leverage the inherent strength of the current main brand McKinsey & Company research conducted across different European markets reveals that a significant segment of customers (i.e., 30 to 40 percent, depending upon market) choose their mobile service based primarily upon brand appeal. Still, others react to specific price components rather than to the price as a whole. Operators should work to maintain and enhance the brand premiums captured from these customers by differentiating pricing according to a given groups willingness to pay, while exploring profitable trade-offs among the price components. 2. Launch a value-focused second brand and/or open own network to third parties Value-driven brands can enable operators to de-complicate pricing structures for price-driven customer groups. These new pricefocused brands allow operators to protect their premium



Value-based pricing (and product) design should be regarded as a crucial element to ensure marketing spend effectiveness

brands price position, while fighting for market share in other, more price-sensitive customer segments.

Leveraging current brand power

Europes mobile operators have worked hard to build power brands, having increased advertising spend over the past decade to the point where they outspend other traditionally brand-focused industries in many markets. The results of this spending have been impressive McKinseys analysis reveals that branddriven price premiums can represent 30 to 50 percent of a European operators margin pool (i.e., earnings before interest, taxes, depreciation, and amortization EBITDA). Unfortunately, these brand-based premiums are expected to decline by a range of between 9 to 32 percent, depending upon the country. To protect brand value, operators can explore a range of possible trade-offs among selected price factors. One key task involves clearly identifying price components that are fully visible to customers, as well as those that are less so (Exhibit 3). The former can include plans that leverage on-/off-net pricing differentials or the introduction of minimum consumption schemes. Such offers can have a big impact on churn and market share, but typically require a structured approach in order to fully

explore the profitability trade-offs that each plan brings with it. Less visible components, which can often be addressed on a stand-alone basis, could include roaming charges or fees associated with taxation periods. Acting upon visible price components requires an in-depth understanding of customer key buying factors (KBFs). For example, in segmenting a market in terms of price-sensitive buyers versus other types of customers (e.g., those driven by brand, network size, etc.), taking a closer look can help to clarify true customer needs. In one case, such an analysis revealed that fewer than 10 percent of price-sensitive customers were influenced by overall pricing schemes, but instead, were actually interested in specific aspects of their mobile pricing plans (e.g., on-/off-net pricing, no minimum usage requirements, etc.). Such an analysis can help operators to pinpoint value drivers for different customer groups and to maintain pricing levels (and associated profits) in areas of less interest. Price plans must be adjusted to exploit profitable tradeoffs that occur between different price components. For example, the pricing plans of one operator were not focused on delivering the value that customers in different KBF segments wanted. By realigning plans to better address true customer needs, the operator was

RECALL No 1 Pricing Value Pricing for Profitable Growth



To protect their revenues, MNOs should evolve towards a dual strategy, better matching of significant differences in consumer price sensitivity

able to meet the real requirements of specific customer segments and boost its ability to capture value. In a plan targeted towards on-net, price-driven customers, the operator discovered that by making a small decrease in the on-net tariff (which customers sought) it was also able to substantially increase off-net tariffs and thus, capture additional value. In addition, a brand price plan should be carefully designed to retain and extract appropriate premiums from brand-driven customers, but without destroying the portfolios consistency (Exhibit 4). Such a plan should be guided by two basic rules. First, no aggressive discounts should be offered in any of the key price components, which may include pricing for SMS (Europes dominant text messaging technology), off-peak calling, minimum consumption requirements, and on-/off-net plans. Second, the brand must be more competitive than other mobile network operator (MNO) brands in terms of at least one of these price components. By following these and other recommendations, one European mobile operator experienced a 33 percent increase in SMS ARPU (average revenue per user), with little or no churn impact. Additionally, the operator has already moved roughly 40 percent of its consumer

customer base onto the new price plans, which are generating an ARPU increase of 8.5 percent.

Opening up to second brands: simplicity wins!

In most cases, boosting mobile plan simplicity and transparency levels in order to attract price-sensitive customers without damaging the primary brand can only be accomplished by launching an own second brand or opening up the network to MVNOs and SPs (service providers). Over the last couple of years, tens of new mobile brands were launched in European markets. Starting this new category of secondary brands, MNOs goals include protecting their main brands from aggressive price movements; addressing an important and growing consumer segment, estimated to represent more than 20 percent of most European markets; and, in some cases, launching a preemptive strike against the expected proliferation of MVNOs and SPs. Three common factors characterize the positioning of most of these second brands, either those belonging to MNOs or others developed by third parties:



Visible and less visible pricing factors may vary by market and require different approaches

Simplicity: All elements of the offer should convey ease of use and total transparency (i.e., no footnotes or tiny type). Low prices: Pricing should be competitive and based upon a single plan that essentially offers a 20 to 30 percent discount versus comparable MNO price plans (no hidden charges). Effectiveness: Although focused on the main service components, customer care should be distinctive (it works). Goals include problem resolution on first contact, innovative features that promote simplicity and cost control, and automatic interaction either online or through IVR (interactive voice response). Any of four models can be used to create a second brand (Exhibit 5), providing MNOs with a variety of options that can be tailored to specific needs and market conditions. Brand positioning should be delivered via a no frills value proposition. Pricing, for example, should be a single, flat-tariff plan, featuring the 20 to 30 percent discount versus comparable main-brand price plans. Products and services should be based upon a SIM card only offer, complemented by a limited portfolio

of low- to medium-range handsets. Distribution plans can include remote (e.g., the Internet) and direct (e.g., call centers) channels, complemented by nontraditional physical distribution channels. From the customer franchise perspective, the new brand should be designed to allow for smart and effective media choices. The above-mentioned elements must be supported by a low-cost operational model. For example, customer care should be very efficient, based upon Internet and IVR access, and augmented by a paid customer helpline. In terms of IT and systems, highly automated and integrated IT systems can enable end-to-end work flows and tariff flexibility. Human resources need to be optimized in a low fixed-cost structure featuring a singlelayer organization of 30 to 40 dedicated people. Support services could include formal service agreements supported by service level agreements for network access and shared services between MNOs and new operators. Overall governance issues include the need for the new brand to be managed in strict alignment with the MNOs main brand in order to prevent cannibalization. By Pedro Mendona, Duarte Begonha, and Ole Jrgen Vetvik

RECALL No 1 Pricing Value Pricing for Profitable Growth



A consistent portfolio should be composed of x+1 default price plan


Recent proliferation of asset-light mobile brands has been taking place in Europe illustrative examples/not exhaustive

RECALL No 1 Pricing Customer-Centric Success: Triple-Play Pricing


02 Customer-Centric Success:
Triple-Play Pricing

Across both developed and emerging markets, wireline operators are seeing substantial developments in the marketplace, driven by the acceleration of fixed-tomobile substitution, the continual migration towards flat rates, an increasing commoditization of broadband, and the emergence of IPTV. When combined, these trends are shifting the balance in the residential consumer demand profile, reducing the value of traditional voice, limiting the differentiation via broadband access, raising the importance of new service lines (such as TV), and above all, increasing the appetite for integrated home solutions with multiple services in bundled offerings. For incumbents, these trends clearly represent a threat, but also some positive aspects. On the negative side, they result (in most cases) in the ability of attackers to undercut their offers with dual- and triple-play bundles of 50 percent or higher price discounts, with a substantial impact on market share. However, and depending upon specific market conditions these changes also represent an opportunity to proactively accelerate fixedline market growth through broadband and in some cases, access uptake. Responding to these strategic shifts poses substantial, unseen challenges for incumbent operators: exploding complexity in product options and bundles; risky choices with substantial potential for cannibalization (e.g., flat voice, VoIP); complex trade-offs (e.g., regulatory concessions); the need to develop new skills in previously untested waters, which tend to be low-margin businesses for incumbents (e.g., TV); and most importantly, the need to deeply understand consumer demand and preferences.

The case for developing an integrated customer-centric approach

To effectively address the new paradigm, incumbent operators must follow a set of fundamental principles. These principles call for an integrated customer-centric approach and must guide the way in which operators develop and price their offer structure across the full product portfolio. 1. Product and pricing architectures that focus on segmented customer preferences can result in both gaining penetration/share and improving ARPU. Customer needs are not necessarily aligned with minimizing prices. Systematically, in all cases, McKinsey has identified sizeable segments of customers that are not driven by pure total price, but rather by specific price components or other elements of the offer. For instance, there are typically some segments that prefer lower-price entry TV packages and are willing to heavily consume a la carte channels and personalized on-demand content, resulting in higher penetration and ARPU. Others prefer an integrated, less flexible package. In a particular example, an optimized design of an IPTV offering yielded 75 percent higher penetration and 10 percent higher ARPU. In another example, for a particular customer segment, a lower monthly rental was a key buying factor in exchange for a higher per-minute price, thus allowing the capture of an important share of mobile-only households with limited cannibalization. In this context, designing suboptimal offer structures based only upon traditional intuition may yield



Principle 1 design integrated offers that match the KBFs in the market

substantial loss of penetration and more importantly, lower product margins due to increased cannibalization. On the contrary, by leveraging carefully designed market research, operators can understand the key buying factors (KBFs) behind the selection of individual products (and bundled offers) and structure an offer that is able to address the full range of customer segments, extracting the maximum value (ARPU and/or increased share/ penetration) from each segment (Exhibit 1). 2. There is substantial value to be gained from taking a comprehensive portfolio approach that goes beyond simple discounting. Matching underlying customer needs in a holistic manner by redesigning and optimizing a complete set/portfolio of integrated offerings in a single effort allows for compensating the likely cannibalization with increased up-selling and retention (namely, of broadband). Many operators still see bundling as a mechanism for delivering discounts. On the contrary, experience shows that well-designed bundles can, by far, compensate for the reduction of ARPU in some customer segments, with substantial gains in other segments. The key to success lies in being able to simultaneously understand preferences and trade-offs for multiple offerings, determining the net impact at the consumer level by using market research coupled with internal consumption data (Exhibit 2).

As an example of the benefits of applying these principles, one incumbent operator managed to carefully design a dual- and triple-play portfolio offering that resulted in having, in terms of ARPU, an up-selling, retention, and win-back potential six times higher than the cannibalization risk (40 to 50 percent of the customers acquiring any of the offers). This allowed the operator to achieve all-time record sales in broadband (multiplying by a factor of two) and a net ARPU increase in all segments, significantly contributing to total revenue growth. The key to the design of the offer was to develop a structure that was attractive to the segment at risk of churning, while at the same time, providing significant upselling potential to a large share of the segment at risk of cannibalization. 3. A consumer-integrated perspective should be taken into consideration, even when designing product/pricing architectures for individual products. A larger and increasing share of consumers make their consumption decisions in a comprehensive total spending manner. Hence, when redesigning individual products (e.g., ADSL structures), companies need to consider a fullspending perspective on the consumer (Exhibit 3). In fact, very often, new products derive more value from the side effects of other products than from their own self-standing business case (e.g., there has been a beneficial

RECALL No 1 Pricing Customer-Centric Success: Triple-Play Pricing



Principle 2 focus bundling not on discounts but on up-selling

effect of IPTV on increased broadband uptake). Also, adequate bundling can minimize cannibalization within a specific product (e.g., bundling of flat voice with DSL). All of these are effects that can only be accounted for if tackled from an integrated consumer perspective. In one particular case, the optimized design of an IPTV offer allowed for a significant impact on ADSL cross-selling, which added nearly 35 percent more higher-margin ARPU to the initial business case. These principles will be critical for incumbent operators in addressing individual and bundling product development decisions in an effective manner: In voice, flat-rate pricing requires a holistic approach. In order to develop an aggressive offer that adds significant value, operators need to move away from launching offers on a product-by-product basis towards the design of a full offer structure that covers the needs of all segments from infrequent users (that for the most part, will not buy flats) to more frequent users (that will require premium voice offers to avoid the reduction in ARPU from the unlimited flat), e.g., the new voice offer from Telecom Italia. In broadband, offer structuring will become more sophisticated. To further stimulate growth, operators

will have to explore the remaining opportunities in order to adjust the existing offers (driven by speed and price structure) to better match the existing structure of customer needs. At the same time, they will need to develop bundled offers with content and value-added services, contributing to differentiation and unlocking new broadband segments that are currently dormant (e.g., the Comcast approach). In IPTV, maximum value extraction for telcos requires effective matching of consumers underlying needs. Although new in the pay-TV markets, telcos must leverage a higher degree of offer flexibility than established competitors (e.g., mini-basic entry packs or a la carte channels, such as the PCCW offer). Telcos must also provide a higher degree of interactivity (e.g., personal/ shift TV) with new creative pricing structures (e.g., flat rates for on-demand catalog movies, bundles of channels with PPV/on-demand content). For optimum design of their IPTV offer, operators need to use a systematic approach based upon a deep understanding of consumers underlying preferences. Dual- and triple-play bundling requires sophisticated pricing. As markets evolve into integrated home solutions, operators will face the difficult choice of pricing their bundles to compete with aggressive attacker offerings,



Principle 3 take an integrated perspective even when designing individual products

while avoiding the risk of cannibalization. To avoid this deadlock, operators need a new way of thinking about bundles, based upon launching all new bundled products not necessarily developing individual products that are then bundled at a discount, but rather thinking about full offerings from the start (e.g., Fastweb triple-play entry offer) that truly promote up-selling and retention. Shifting from product-oriented to customer-centric pricing will be a key differentiating element between best and worst performers in the sector, particularly as the market gets more competitive and complex. Players that manage to develop the necessary capabilities and processes will be able to sustain a higher premium and take advantage of opportunities and threats that lie ahead.

(consumer- and competitor-based) market tool that can be used for both tactical as well as for more strategic pricing and product development. Operators will be able to thoroughly understand consumer preferences and potential decisions in each competitive scenario. In fact, the approach includes the development of an optimized product and pricing market segmentation based upon key buying factors, which is instrumental for the purpose of offer design and allows for the structuring of the full triple-play offer or specific components of it. The model will simulate the likely customer adoption rates given different price points and competitor reactions, and will support the development of migration paths from the current situation. This first phase is required for in the complex design of new products (i.e., identifying what to offer), but could be avoided if a clear idea of a desired offer structure already exists. The second phase will simulate up-selling, downselling, retention, etc., based upon a usage-oriented segmentation and identified consumer preferences in order to refine pricing and optimal structure of the offer. Consumer preferences can be performed with the conjoint simulator (if Phase 1 were conducted) or with

The proposed customer-centric approach

While the challenges may be very specific, the approach that operators should follow in order to develop their offer structure is very similar. This approach can be set up in two phases (Exhibit 4). The first phase is based upon sophisticated consumer market research, conjoint analysis, and will lead to the identification and design of the ideal offer structure. This would allow for the development of an integrated

RECALL No 1 Pricing Customer-Centric Success: Triple-Play Pricing



Product and pricing approach based on an end-to-end customer-centric integrated methodology

simplified price-testing research. This phase, which will be required in all cases, will result in the offer road map, including key implications of implementation and net impact on overall economics. This overall approach would also allow for understanding the impact of multiple critical decisions that take place during product development, including technical, operational, regulatory, and even those related to media content acquisition, which are absolutely key to successful net value creation.

Wireline operators are facing new unforeseen challenges in the marketplace, which will require a much more sophisticated approach to product portfolio and pricing design. Recent examples demonstrate that, by adopting a systematic methodology to understand customer needs and match the offer structure to satisfy these needs, operators can extract substantial benefits (in volume and/or ARPU) and significantly improve their competitive positioning. By Armando Cabral and Pedro Mendona

RECALL No 1 Pricing Beyond Traditional Market Pricing: Second Brands and Wholesale Play


03 Beyond Traditional Market Pricing:

Second Brands and Wholesale Play

Can mobile operators develop a successful multi-brand strategy? Many apparently think so, judging by the exploding number of virtual players entering the market. In fact, over the past five years, players launched nearly 300 mobile brands worldwide (two-thirds of them in Europe), significantly changing the traditional three-to-four-player competitive market landscape in many countries. Within the flood of new offerings, most mobile virtual network operators (MVNOs) and mobile network operators (MNOs) second and sometimes even third brands seem quite similar, as they typically feature asset light low-cost operational structures that are 20 to 50 percent below those of MNO primary brands. However, upon closer examination, significant differences emerge. These new operators tend to assume different business models, depending upon whether they possess their own network code, interconnection agreements, customer relationship management programs, or pricing schemes. The different players align as follows: MVNOs tend to control all four of the above elements, thus ensuring full separation from the MNO. ESPs (enhanced service providers) lack network code (and may or may not have interconnection agreements). MNO second brands are generally similar to ESPs, but are MNO owned. Brand partnerships (between an MNO and retailers) feature separate pricing plans.

SPs (service providers) act as pure resellers of MNO tariff plans. Furthermore, the positioning of MVNOs and second brands tend to vary across regions, since the competitive challenges faced by players are significantly different (Exhibit 1): In Europe, where national regulatory agencies strive to enforce the creation of wholesale offers in mature markets with excess-installed capacity, MNOs must decide whether to open their networks to MVNOs and/ or launch their own second brands. In either case, such brands can address a growing market segment that is sensitive to low prices and transparency (i.e., no frills), but less demanding in terms of service or the need for interaction. In the United States, where there still remain important penetration pockets, MNOs aggressively attempt to gain market share through the development of wholesale offers that allow different MVNOs to target and penetrate specific sizeable groups, such as the youth and Hispanic segments, as well as develop premium-based offerings. In developing markets, where the most profitable segments have already been skimmed, MNOs have been launching second brands in order to profitably penetrate low-income customer segments. Focused on affordable positioning (e.g., low consumption, low denomination vouchers, inexpensive intra-group/zone prices, and basic handsets), emerging operators seek to ensure differentiation in terms of brand, product/



MVNOs/second brands dominant purpose and positioning have been different across regions

service, and channels to avoid cannibalization of the existing customer base.

How MNOs can address the multi-brand issue

Clearly, questions surrounding MVNOs and second brands will continue to make their way to the top of the mobile CEOs agenda either as major opportunities to conquer additional market share (i.e., attracting new customers via a differentiated positioning) or to preempt third-party competitive moves driven by regulatory action. Because the premature launch of a second brand or aggressive pursuit of a wholesale strategy can jeopardize the profitability of the current and potential new customers, MNOs should consider two central dimensions in order to determine the best time to act. First, they need to evaluate their prospects for profitable growth in terms of EBITDA, which hinge largely on market competitiveness. Second, MNOs must assess the inherent risk of these initiatives starting a price war, which depends upon both the potential for price reductions (measured by comparing the lowest flat fee versus interconnection rate) and other specific market conditions, including perceived price elasticity, current brand positioning of different players, and current existence of other MVNOs or second brands (Exhibit 2). Overall,

MNOs should develop a multi-brand strategy only when it either presents a limited risk of triggering (or fueling) a price war (having a negative impact on the current client base) or when the actual market context indicates poor future profitable growth prospects. However, if the high risk of a price war exists and there are still interesting growth prospects in the market, MNOs should maintain a wait and see posture and evaluate trade-offs in cases in which at least one of these elements may jeopardize MNOs future performance. If the case for action is clear, MNOs need to decide between launching a second brand or pursuing a leading wholesale market strategy, taking into account their actual market position, the strength of existing no frills players already operating in the market, and the level of regulatory pressure focused on opening up networks. A critical aspect of this decision centers on the MNOs current market position. Market leaders are able to offer lower flat tariffs (due to a relatively higher portion of on-net minutes at marginal costs), thus they typically should pursue a second brand strategy instead of the less attractive option of selling wholesale minutes to MVNOs. Conversely, a mobile attacker will likely develop a wholesale strategy because of its ability to offer lower wholesale prices without the fear of cannibalizing its (relatively smaller) customer base (Exhibit 3).

RECALL No 1 Pricing Beyond Traditional Market Pricing: Second Brands and Wholesale Play



To understand if it is time to act, MNOs need to consider 2 key factors

The prevalence or lack of no frills operations in the market should also influence MNO strategies. Experience shows that a first mover in this category clearly benefits from a winner takes all dynamic, easily capturing a 10 percent overall market share, which usually equates to a 50 to 60 percent share of the no frills category. If no/a few strong no frills competitors currently exist, launching a second brand may seem like an obvious move. However, if many planning-stage MVNO candidates may soon emerge, using a wholesale strategy to lock in potential winners without losing control of prices or customers may constitute a better approach. Finally, regulatory pressure to accommodate MVNOs also drives MNO strategies towards wholesale, since launching a second brand while negotiating with MVNO candidates can reduce an operators degrees of freedom and drive down wholesale prices. As an alternative to launching a second brand or opening its network to a wholesale play, MNOs can consider collaborating with strong customer franchisees or distributor networks in order to leverage their retail brands, while maintaining some degree of control over potential competitors. Partnership models can be structured like second brands (e.g., simple brandlicensing agreements) or like real MVNO wholesale deals (e.g., selling large minute bundles to a jointly owned new MVNO).

Typical positioning of a second brand in Europe

European operators position most second brands (e.g., Uzo, YESSS!, M-Budget, Tchibo, simyo) based upon three fundamental factors simplicity, low prices, and effectiveness. These factors differentiate virtual operators from both the complexity inherent in main brand pricing schemes and the need for massive communication of low penetration services. Such positioning targets a growing segment that according to extensive market research in various European countries and five years experience in Scandinavian countries can represent from 20 to 25 percent of all current users, making it much larger than any other market niche built upon sociodemographic factors (Exhibit 4). A no-frills value proposition relies upon four key attributes. First, most no-frills players focus on a SIM card only offer, complemented by a limited portfolio of low- to medium-range handsets and a very simple and reduced range of services. Second, from a pricing standpoint, they offer single plans with flat tariffs and no minimum consumption obligations at a discount of approximately 50 percent compared to similar plans from main brands. Third, no-frills operations usually offer a combination of remote and direct channels (e.g.,



Second brands seem to be more attractive for market leaders, while wholesale seems to be more favorable for attackers

the Internet and call centers), complemented by nontraditional physical distribution channels at half the cost of telecoms retailers (e.g., post office branches, kiosks). Fourth, no-frills players brand design and positioning typically favor innovative and cost-efficient marketing campaigns focused on younger customer segments, but with universal reach. In order to be able to systematically offer low prices, MVNOs and second brands rely upon low-cost operational models. The key elements of these low-cost models include efficient Internet and IVR (interactive voice response) customer care, complemented by a paid customer helpline, and highly automated and integrated IT systems that enable end-to-end work flows and billing/customer care flexibility. Other features include a reduced fixed-cost structure with a single-layer organization of about 30 to 40 dedicated people and the outsourcing of all shared services (e.g., accounting, human resources) supported with pre-negotiated service level agreements (SLAs) with the MNOs.

that wholesale will have on the operators market share and ARPM (average revenue per minute). In this context, designing a winning wholesale strategy requires the answers to three fundamental questions: What wholesale pricing conditions should operators push for? While the maximum wholesale price per transit for MVNO breakeven typically runs at about half the interconnection level, MNOs must avoid very low wholesale tariffs, since they will lead to MNO retail price cuts and thus, destroy value across the industry. Therefore, MNOs should attempt to maintain as much control as possible over wholesale pricing and avoid indexing them to interconnection rates (that are doomed to be cut in the future). Furthermore, leading MNOs should resist engaging in wholesale price wars in order to retain a fair market share, since in most situations they are economically better off with a lower wholesale market share than with lower retail prices (induced by the wholesale price war). Which services should be provided? Restricting an MVNO to a basic offer limits its ability to compete in high-end customer segments. However, enabling a wholesale offer of data connectivity and content can drive upscale MVNO business models focused on valueadded services that prevent pure voice price competition.

Best practice in designing a winning mobile wholesale strategy

When pursuing a leading wholesale market strategy, MNOs must simultaneously take into account the effect

RECALL No 1 Pricing Beyond Traditional Market Pricing: Second Brands and Wholesale Play



In Europe, most operators second brands have been targeting a market segment (20 25% of mobile consumers) more sensitive to low price and simplicity of mobile service

Which partners should be engaged? Selecting wholesale partners forces MNOs to make important trade-offs between locking in potential winners in order to gain share in the wholesale business and minimizing the negative effects on retail prices by, for example, filling the market space with non-voice-focused business models. To clear these significant hurdles while creating a wholesale business model, MNOs should follow three basic principles. They should establish a retail minus wholesale pricing scheme that ensures better control over the wholesale price and avoids setting prices that are oriented to cost. Next, they should offer a standard closed list of services and maintain the ability to negotiate ad hoc services according to the profile and objectives of each MVNO. Finally, MNOs should provide a balanced offer for different types of virtual operators (such as pure MVNOs, enhanced service providers, and pure service providers). At the same time, they need to ensure a pricing scheme that allows for appropriate profitability to different types of MVNOs one that doesnt feature conditions that can be used by the NRA (national regulatory authority) to impose special benefits to pure MVNOs under the non-discrimination principle umbrella.

Adjusting the organization to a multi-brand reality

As MNOs evolve into more customer-centric organizations, selecting the right organizational framing for second brands and/or wholesale businesses can help ensure the appropriate coordination and development of valuecreating solutions going forward. To manage a second brand, early evidence suggests that the most appropriate framing is to position the new brand as an independent consumer unit within the MNO organizational structure, ensuring coordination through a unified command (e.g., both reporting to the same COO). This model fosters the independent and flexible development of a second brand, enables accountability, and ensures basic coordination between the main and second brands, while preventing regulatory action. In short, an MNOs second brand should be seen by consumers as a new operator, by other departments in the MNO structure as an autonomous but articulated marketing unit, and by NRAs as just another tariff plan (Exhibit 5). MNOs should avoid organizational solutions that either make the second brand little more than a simple tariff plan within the MNO consumer market division or create a full-fledged independent operation with transfer prices for network usage.



There are 3 alternative organizational framings for an MNOs second brand


There are 3 alternative organizational framings for the wholesale business

RECALL No 1 Pricing Beyond Traditional Market Pricing: Second Brands and Wholesale Play


To manage the wholesale business, MNOs should adopt different organizational models depending upon the nature of the contract and the relationship established with the virtual operator (Exhibit 6): Pure service providers should be managed by the MNOs consumer business unit, which simplifies the close articulation required between retail and wholesale, and facilitates the contracting process. Pure MVNOs should be managed by the interconnection area or by the area that manages the MNOs business with other operators. This makes for a less complicated interface with the other areas, such as network and IT, and increases transparency for the regulator and contracting entities. All enhanced service providers are best managed by an independent business unit. This unit assumes responsibility for the overall development and management of the no-frills and other niche segments (including potential MNO second brands).

Actual experience across markets shows that, in most cases, few MNOs strictly follow these rules. Some attackers opened wholesale access too early, jeopardizing profitable growth. Market leaders often chose to open their networks to third parties rather than launching second brands. Several operators have launched their second brands with no clear differentiating positioning or, even worse, as simple price plans. Given these missteps, the mobile brand explosion under way legitimately generates mixed feelings. However, McKinsey & Company believes that when appropriately managed and positioned, the multi-brand strategy can play a fundamental role in protecting the profitability of main brands by addressing the needs of a growing price-sensitive segment in all markets and avoiding the quick commoditization of mobile offers. By Duarte Begonha, Pedro Mendona, and Hugo Espirito Santo

RECALL No 1 Pricing CHESS Moves: Creating a Complete Customer Value Proposition


04 CHESS Moves: Creating a Complete

Customer Value Proposition

Believe it or not, the maelstrom that appears poised to consume much of the telecoms industry isnt unique. In fact, many consumer and industrial sectors face the seemingly endless proliferation of products, services, channels, segments, and media. The only constant that most of these industries share is the tirelessly searching consumers, who are actively trading up or down to capture the best deals on the best products and services at the best prices. These maturing industries face the paradox of sinking prices and rising customer acquisition costs. In the telecoms industry, for example, prices dropped by 6 to 16 percent in Europe and the United States from 2003 to 2005, while the costs to acquire a new customer rose significantly in some markets by nearly 60 percent. In such an environment, firms seeking to surprise and delight customers confront the need to provide the best (and most profitable) value proposition in terms of product/service, price, and other benefits. Due to attendant complexities, most telcos trying to deliver on this promise tend to manage things along a single dimension, focusing entirely on the product (e.g., prepaid, data, voice), the price, or the emotional benefit being offered (e.g., fun, functional, etc.). Instead, McKinsey & Company research shows that two or more dimensions must really be pursued in order to deeply understand a category. Further complicating things, two key dimensions benefits and price usually dont correlate very well with each other. Staying on top of so many issues can challenge even the savviest marketers.

Rather than following conventional approaches, McKinsey has developed a way in which to understand a category and define the best product/service, price, and value proposition all in a single pass. The CHESS approach integrates pricing conjoint analysis, brand analysis, and product optimization in one comprehensive method that provides a way to increase a brands consumer preference share (i.e., the percentage of customers preferring a given brands products or services) by, in some cases, 50 to 60 percent or more. CHESS enables marketers to see a category through the customers eyes and identify the right segments. With it, marketers can locate the ideal (and most financially attractive) product and price by segment, understand which benefits to communicate, and finally, simulate the impact. There are three primary CHESS pieces that together can provide an unassailable marketing strategy (Exhibit 1): Pricing conjoint analysis determines which product attributes customers prefer. The representative customer taking the conjoint survey must choose one product out of several with different attributes, and the process is repeated multiple times to determine the persons (i.e., segments) product preferences. BrandMatics is a quantitative analysis that assesses customer behavior and attitudes towards brands. It enables marketers to precisely define real consumer needs using a derived needs analysis technique.



CHESS integrates pricing conjoint analysis, brand analysis, and product optimization in one comprehensive approach

The Product Optimizer allows marketers to quantify how many customers would choose a given product. Through multiple simulations, the optimal product configurations can be determined, and the calibration of the optimizer allows teams to convert preference shares into gross adds shares (i.e., the proportion of subscriber additions that an operator can expect from a given product/service offering).

handset, bundles of minutes, or voice prices. From among these attributes, different product/price packages are then assembled and shown to the survey respondents, who must choose a favorite bundle from a group of perhaps three bundles in a 30-minute conjoint survey. Create preference clusters: Once the basic factors are established, distinct customer preference clusters can be identified, based upon the relative weight of purchasing factors. For mobile operators, first-cut purchasing factors may be the brand and the price, with subsequent cuts refining these factors further (e.g., price may be broken down into those seeking the lowest possible price per minute and others seeking the lowest monthly recurring costs). In terms of process based upon results of the conjoint survey utility profiles are generated for each respondent and individual profiles are grouped into logical clusters. The right number of clusters is achieved when each is distinct and can be described in a unique way. Typically, a mobile market has from four to seven clusters each for pre- and postpaid segments. Fill in relevant details: Additional research data will help marketers to gain a deeper understanding of the initial conjoint clusters. Examples of such data might include customer commitment levels, sociodemographic insights, or brand market shares. Ultimately, the conjoint

Opening gambit: pricing conjoint analysis

Consumers often perform a sophisticated calculus when shopping for products and services, trading off tangible and intangible benefits against prices within an array of possible choices, until they narrow down the selection to a single product and buy it. Pricing conjoint analysis replicates this highly efficient process by surveying representative test consumers, who are forced to make a series of trade-off decisions among various products at different price points. A three-step process is used: establish basic factors, create preference clusters, and fill in relevant details. Establish basic factors: This first critical step defines the possible key buying factors that will be tested via the conjoint analysis. Attributes considered by a mobile operator, for example, might include the brand, the

RECALL No 1 Pricing CHESS Moves: Creating a Complete Customer Value Proposition



The CHESS board helps to identify market potential

process results in the creation of the basic CHESS board, which identifies customer segments by size. The CHESS board can also be overlaid with an operators own market share per cluster (Exhibit 2). From this data, its possible to establish where the company is leaving money on the board because it has low market shares in attractive customer segments.

Emotional benefits, which can include how the brand interacts with the ways in which respondents view themselves (e.g., this brand makes me feel special, connects me to friends and family, allows me not to worry, etc.) Rational benefits can include product or functional attributes (e.g., the handset has a good keypad, allows for connection everywhere, etc.), or values that are related to the process or relationship that surrounds the branded product. Emotional attributes consist of the aura surrounding the brand (e.g., has a good reputation, is an innovative company, etc.) Tangible attributes might include elements of things that the company does, such as good design, many product promotions, or offering a helpful Web site. Attributes and values representing all four of the above dimensions should be included in the quantitative BrandMatics survey in order to ensure the holistic coverage of all relevant brand drivers. To determine the brand drivers for each customer cluster, marketers must assess the relative importance of the drivers in reaching specific customer segments and

Middle game: BrandMatics

Brands can be powerful marketing tools that help companies elevate their ability to capture value or anchors that drag down competitive products and services. To better understand these enigmatic assets, McKinseys proprietary BrandMatics approach helps marketers identify customer preferences that extend beyond the product to the brand itself. The BrandMatics approach typically includes three steps: the completion of the BrandMatics survey, identification of the brand drivers for each customer cluster, and the development of product positioning by cluster. The BrandMatics survey is used to compile the relevant set of brand drivers. The survey itself should be part of the conjoint analysis survey discussed above. To be effective, the survey must address all four dimensions of the brand, which comprise:


identify which drivers differentiate best among the clusters. For example, in the telecoms industry, the purchase drivers tend to be rather rational and emotional (depending upon customer segment), with core brand drivers often including trust, network quality, affordability, etc. Determining which brand drivers are most important to a given customer cluster requires marketers to fully understand the purchasing process. When customers shop for mobile service, the process they go through in some ways resembles a funnel. It begins wide open, with the shoppers awareness of the many brands in the marketplace. From here, the consumer zeros-in on the group of familiar brands perhaps a family member uses one of them and maybe another had been purchased in the past. Consideration is next: Does the brand make it onto the shoppers favorites list? After this comes purchase and in the future repurchase (loyalty). As shoppers go through this process, they typically reduce the number of brands in which they are interested until they choose the one they will buy. The key drivers for each stage will differ by cluster. For example, one group of customers may see excellent customer service as a key driver during the favorites funnel stage, while the fact that a given brand is the leading provider might attract customers during the loyalty stage. In the final step of the BrandMatics process, marketers develop product positioning by cluster, based upon the insights developed thus far. All of the information is collected in a customer cluster profile summary that lists the brand drivers, price preferences, the brand purchasing funnel performance against competitors, and a summary of what it all means. Overlaying the BrandMatics analysis on the earlier conjoint work creates the smart CHESS board, which includes customer benefits that are required in order to attract specific customer clusters. For example, a cluster defined by a low commitment level to the brand and a high interest in getting the best deal can be lured by the offer of low monthly recurring costs accompanied by an attractive incentive. Another cluster that has medium commitment and seeks no worry service can be attracted by an offer designed to reduce risks perhaps even including an automatic payment plan.

End game: the Product Optimizer

As the final CHESS piece, the Product Optimizer dynamically simulates the impact that different product configurations can have, enabling managers to incorporate the best into their CHESS strategies. The Product Optimizer allows teams to quantify how many shoppers would choose a given product. By running multiple simulations, they can determine the optimal product configurations for a given customer cluster. Furthermore, the calibration of the optimizer allows teams to convert brand preference shares into actual gross adds shares, which provides a more meaningful proxy for the revenue potential of a product portfolio. The Product Optimizer approach involves three steps: analyze the current situation, simulate the product portfolio optimization, and then incorporate the findings into the CHESS strategy. Teams first analyze the current product portfolio with an eye towards understanding the risks and opportunities the company currently faces. They determine the brands preference shares for each price/preference cluster and then quantify the risk and potential for each. Next, marketers can simulate the preference share for a new, optimized product portfolio. Finally, they combine the gathered insights into a distinctive marketing strategy focused on product, price, and promotion. McKinseys experience with the Product Optimizer has been dramatic, increasing the preference share for one companys brand by over 50 to 60 percent and effectively enabling the recovery of nearly all revenues at risk in the companys prior portfolio. McKinseys CHESS approach provides a comprehensive method for developing a complete value proposition for service markets all in one go. CHESS enables marketers to see a category through the customers eyes and identify the right segments. With it, marketers can locate the ideal (and most profitable) product and price by segment, understand which benefits to communicate, and finally, simulate the impact. By Thomas Barta, Boris Maurer, and Steffen Ruppert

RECALL No 1 Pricing Best-Practice Multi-Play for Digital Convergence


05 Best-Practice Multi-Play for

Digital Convergence

With the advent of convergence, many players in the telecommunications and media industries are quickly marketing a set of multi-play offerings in a combination of products and services, including the Internet (broadband), television services (mostly digital), and telephony (moving to VoIP and wireless). Todays examples are many from the early VoIP and digital service bundles from Cox in the United States, to the multi-play services of Free in France via its Free box, to the quadruple-play offering being put into place by NTL-Telewest-Virgin in the United Kingdom. In fact, given the current number of bundle launches, not offering them is more the exception than the rule in the digital convergence services industry. There have been various business reports showing the strategic relevance of bundling for the convergence industry. Likewise, many economists (e.g., Economides, 1993; Bakos and Brynjolfsson, 1999; Stremersch and Tellis, 2002; Whinston, 1990) have looked at the effects bundling might have in terms of competition dynamics especially those motivated by a) the need to define the underlying variables determining optimal bundling and b) the need to determine how those factors could lead to anti-competitive behavior, which would need to be closely monitored via antitrust regulation. From a static economic perspective, bundling can be seen as a way to differentiate offerings via complementary services and hence, elude price competition. However, today, the most used bundling strategies in digital convergence have instead been very competitive, i.e., large discounts to motivate quick uptake.

These aggressive, possibly pro-competitive strategies can, however, have large perverse effects if the customers signing up are only motivated by price discounts, thus leading to persistent lower margins for the industrys marginal suppliers of digital services. This, in itself, compensates by delivering poorly correlated services to those bundled customers. There are ways to believe that the best answer is the middle to gain a welfare perspective with sufficient room left for profitably offering bundling in order to achieve quicker new product intake. This article aims to demonstrate how convergence services players can leverage the demand functions of triple-play services to create versioning strategies and deliver the best offering of service bundles and prices in the context of acquisition. The methodology is based on systematic market research and a conjoint analysis. We will explain the methods and results applied to a set of disguised European convergence clients, outline the different types of optimal bundles and compare them to current practices, and finally, we will describe the managerial and strategic implications of the approach.

A research-based approach to optimal bundling

Before explaining the approach in detail, it is important to understand three underlying principles to be considered when designing optimal bundling strategies. The first principle deals with matching the natural structure of consumer preferences. Beyond the different weighting consumers place on key buying factors (KBFs) for each service, there are also differences in the way



A comprehensive 1+3 steps methodological approach

consumers value the various services. Better understanding and matching these natural market segments should, therefore, be regarded as the basis for an optimized design of the commercial offer. Given the significant differences across markets, the most typical clusters range from discount driven individuals to product oriented consumers those receptive to packaged offers when the highest standard of a particular service is included to brand lovers with a clear preference for a specific provider to piece buyers who seek the best solution in each service category and dont react much to bundled offers. The next principle consists of taking an integrated perspective towards the optimal structure of the offer, rather than the simple optimization of individual service price points. As a matter of fact, cross effects of individual service pricing can be much more relevant. The most classic example in the battle for the home is that of cable operators discounting telephony services as a fundamental lever for displacing telecoms incumbents from the home and thus, increasing cables share of the broadband access market. This same practice is also evident in the way that some telecoms incumbents have been positioning their newly created IPTV offers.

The third principle focuses on pursuing bold pricing moves rather than incremental change. Experience shows that up-selling opportunities are related to a step-change in consumer purchasing behavior, thus requiring a significant packaged price discount in order to trigger large-scale adherence to additional services and offset margin cannibalization among those already paying for several services. On the other hand, downselling and margin cannibalization risks follow more of a logarithmic distribution, i.e., most of the potentially negative effect comes with incremental price reduction since the customers decision is not about changing their consumption patterns, but simply moving to a packaged offer of the services to which they already subscribe. Application of these principles can be enforced through a tested 1+3 steps approach (Exhibit 1) that starts with (1) a research-based understanding of the natural structure of consumer preferences as the fundamental basis for: (1+1) structuring what should be the ideal offer and price positioning to match potential demand; (1+2) adjusting that offer to the specific competitive context; and (1+3) defining a migration path from the existing offer to the new offer through simulation of the market dynamics.

RECALL No 1 Pricing Best-Practice Multi-Play for Digital Convergence



A non-hierarchical clustering provides a natural market segmentation

Understanding the natural structure of potential demand

At a preliminary stage, a comprehensive piece of market research should be designed and executed in order to assess the natural structure of consumer preferences. With a non-proportional sample that should be structured to include a minimum number of interviewees with different consumption patterns (from non-users of each service to subscribers with different providers), a multi-step adaptive conjoint analysis is typically required to encompass all the relevant factors that emulate consumers choices among alternate suppliers, key service characteristics, and possible structures of the offers (packages) at different price points. The results of this research will show the relative importance of key buying factors (e.g., supplier, standard of the different services, and price) and the utility of the alternative attributes within each factor (e.g., utility of each brand/supplier; of different levels in each service; and utility of each price level). Based on these results (the relative importance of KBFs and the specific utility of each attribute), a nonhierarchical clustering of the sample will provide the natural market segmentation in terms of what different consumers look for (Exhibit 2):

At an integrated level 2-play (2P), 3-play (3P), or 4-play (4P) this will allow for understanding the natural clustering of consumer reactions to bundled offers of different services provided by different suppliers. As mentioned, beyond the natural brand versus price trade-offs, consumers also differ in the relative importance they place upon each service attribute. At a specific product/service level (e.g., TV service), that same exercise will help identify the natural clusters of people in terms of the relative value of different service components. In the case of TV services, for example, we typically find a natural segment of people that equally value multiple types of content and the diversity of channels (natural candidates for a basic TV package) and others who are fundamentally focused on specific channels and content genres (natural candidates for vertical packages and/or premium channels). Overall, the natural segmentation of preferences should reflect the ultimate drivers of choice in the marketplace. For some people, a specific provider may have a natural advantage with an integrated offer; for others, price discount will be the driver in penetration of 2P or 3P standard solutions. For specific groups, access to some type of killer content or service can be used as a fundamental lever to foster integrated offers.



Different market structures can be identified and influence consumer reaction patterns

The opportunity to address and serve these natural segments as such will, however, depend on: Their willingness to pay according to their relative preferences. In many cases, the greater preference and importance placed upon a certain element of the offer by a specific group of people is not enough to make it exclusive to that segment. This is either because such a segment is not big enough or because it is not willing to pay a sufficient premium over the value that the average consumer places on the given item. Therefore, deriving the ideal offer to match the natural structure of demand requires the analytical assessment of service components value for a target segment and for the total market. The degree to which the structure and design of existing competitive offers already match (or dont match) those preferences. Operators have the fundamental option to go head-to-head with existing players or to look for an alternative and complementary positioning of the offer. Market simulation can be built upon the research results, allowing for an estimate of potential reach (penetration and market share) and profitability of alternative configurations and price positioning of the operators own offer vis--vis competitors current offering and possible reaction.

The dynamic effects, in terms of up-selling, competitive churn, and margin cannibalization, of launching new single and packaged offers in the marketplace. Rather than greenfield developments, most cases are about complementing and partially replacing the existing offer, with natural concerns over expected migration of own customers and competitive reaction. Market simulation should also be used to define the migration path from the current offer to the new offer. With the described systematic approach, convergence services players can leverage the demand functions of triple-play services to deliver the best offering of service bundles and prices in order to maximize the value captured.

Overview of optimal bundles and current practices

As previously mentioned, significant differences have been identified regarding the nature and size of customer segments across different markets. These differences are fundamentally explained by the specific competitive structure and existing offers in each market, reflecting consumers experience and influencing the dominant patterns of consumer reaction. For example, in a market with only two strong players, the brand lovers segment will be much larger than in a market with a strong proliferation of discount players.

RECALL No 1 Pricing Best-Practice Multi-Play for Digital Convergence



Serious challenges ahead, beyond analytical complexity

Of the many different types of markets, one could generally describe three typical ones (Exhibit 3): (1) markets with a strong telecoms incumbent presence and a strong media player (e.g., Portugal and Belgium), (2) markets with strong competition in the telecoms field, but one dominant media player (e.g., the UK), and (3) markets with very strong competition from both the telecoms and media fields (e.g., France). Markets with a strong telecoms incumbent presence and a strong media player. These markets are generally characterized by strong brands competing in a duopoly and a polarization of customers with interest in different premium products. For example, in Flanders, both Telenet and Belgacom have a strong brand with different attributes, and both players could develop a portfolio strategy to extract the most value out of the market. Markets with strong competition in the telecoms field, but one media giant. In markets such as the UK, there is generally a customer preference for specific products in the media and telecoms arenas (e.g., Sky won against cable 3P; BT has survived without its mobile arm) and, in the other extreme, preferences for telecoms bundles are essentially based on good price offers (e.g., basically, all players in the UK have added 3P and 4P discounted offers to their portfolios). This represents both an

opportunity and a challenge to capture 3P and 4P customers and, at the same time, sustain product differentiation. Markets with strong competition in both the telecoms and media fields. France is an example of a market that has generated large discount driven segments based on the development of highly competitive offers that have forced all players to lower prices. To illustrate this approach, the following example describes a specific market with a typical segmentation and the types of bundles that better cover the needs of the segments in order to generate an optimal portfolio. Lets picture a market with four segments: (1) discount driven individuals, for whom discounted price is their key driver and who have no special request for product specifications, (2) the product oriented, who generally have one or two core product needs and are receptive to packages that include other services, (3) the brand lovers, with a clear preference for a specific provider and who are generally interested in one or two core products from that company, and (4) the piece buyers, who want the best solution for each service and rarely react to bundled offers. In this market, the optimal portfolios aim would be to maximize the value extracted from each segment,


adjusting the offer to the needs of each segment. The optimal portfolio for this market could be structured as follows: Individual premium products to cover the needs of the piece buyers with the high-end products of the portfolio range. Prices for these products should be maintained while offering product enhancements, since discounts on premium combinations dont drive up customer penetration and would imply a reduction of value. 2P/3P bundles combining design-to-margin products and high-end solutions at a discount. These packages attract product oriented individuals to the offer with a better solution for their core needs. The optimal price for these bundles will be defined based on the price sensitivity of this segment in order to foster up-selling. 2P/3P bundles combining standard and low-end solutions at a discount to attract discount driven individuals. The price sensitivity of this segment forces the offer to be quite price attractive, and a combination of pay-per-use products with standard services achieves this requirement while avoiding cannibalization of other segments. Along with these bundles, a differentiated offer should be designed for the brand lovers segment. In markets where this segment is strong, a great opportunity exists for capturing the brand premium that these individuals are willing to pay. However, the solution is not as simple as increasing prices across the entire portfolio, since there will be a strong impact on customer loss from other segments. In this case, the optimal strategy would consist of a combination of the standard product version, with over-allocation of the advertising budget and optimal channel distribution. Knowing the most common service level valued by this segment allows for enhancement of the standard product (either individual products or 2P/3P offers), thus developing an exclusive offer that captures this segments surplus. Achieving success in this context underscores the importance of understanding the specific needs for each market, given the fundamental differences observed, which are explained as we have seen by the specific competitive structure and existing offers.

Underestimating market elasticity has inhibited established players from making bold pricing moves that could result in significant market share growth and preemptively fill the natural room for new attackers. In many cases, the unstructured response to new offers in the marketplace is also inducing margin cannibalization of traditional business. To profit from proliferation and succeed in the transition to a multi-play landscape, operators still face serious challenges that go far beyond the analytical skills and capabilities needed to deal with the increased complexity of pricing and offering design (Exhibit 4): First, top management has to be involved and willing to take risks. Bold pricing moves typically encompass some downside risk (e.g., cannibalization of the existing offer and margins) and therefore, should not be relegated to marketing managers who will always choose an incremental path. Second, it often calls for a significant shift in operators posture towards regulation. To ensure the required degrees of freedom to develop new bundled offers (deregulation of retailing conditions), operators may have to make wholesale conditions more transparent. Finally, operators will also need to learn how to navigate uncharted waters. In a number of circumstances, telecoms operators lack consideration for what it takes to design a TV offer that will drive subscription and high usage. The same happens to other media-based players that are extending their reach into the telecoms services realm, such as with broadband access and VoIP. Although recognizing that the convergence of these services brings significant differences back into the competitive landscape from one market to another (often requiring local regulatory frameworks), we believe this transformation process and the corresponding challenges that lie ahead should play a fundamental role in the telecoms and media CEOs agenda in the coming years. By Jacques Bughin, Armando Cabral, Patricia Ferruz, Pedro Mendona, and Steven Spittaels

Managerial and strategic implications

Overall, most operators have not yet found the way to optimize development of their offering or to deal with the increased complexity of a multi-play world.

RECALL No 1 Pricing Points of View


06 Points of View
Interviews with Hendrik Kasteel, CMO of T-Mobile Croatia, and Jon Erik Haug, head of mobile, Telenor

To better understand the challenges facing mobile players in Europe, McKinsey & Companys RECALL magazine had the opportunity to talk with T-Mobiles chief marketing officer (CMO) in Croatia and the head of Telenors consumer mobile business in Norway. T-Mobiles Hendrik Kasteel spoke about his companys success in defending itself against the market entrance of a new network operator, while Telenors Jon Erik Haug shared his perspective on pricing strategies and future developments in markets that have a heavy MVNO influence.

enter the market and make the first move; we proactively rebalanced our prices prior to the new operators entry. The principle underpinning our pricing adjustment was to establish a few price plans that all had one really attractive price point. We launched an aggressive on-net price plan one price plan with low prices for calls to fixed services and so on. This made it difficult for the new player to undercut our portfolio on all the important dimensions. The on-net dimension was absolutely essential. On-net is key for Croatian subscribers and by leveraging it, we gained a market share greater than 50 percent, making this a huge advantage relative to the new operator. In fact, many subscribers compared our on-net price to the new entrants off-net price. This dynamic really hurt them, since our on-net price was set close to interconnect rates. The real beauty of our new portfolio was the opportunity that it gave us to respond to the new players marketing strategy. Whatever they communicate, we can always communicate one price element from one of our price plans that is better or is at least perceived to be better than their offerings. We can now adjust one price plan if we need to change prices, rather than having to cut prices across the board. McKINSEY: By how much did you actually reduce the price level? HENDRIK KASTEEL: We reduced prices by about 20 percent. However, the price elasticity effect has proven to be much larger than we expected. In fact, the elasticity has far outweighed the price reduction. Blended ARPUs (average revenue per user) and revenues have increased a lot, despite the price reduction.

Hendrik Kasteel
Hendrik Kasteel, T-Mobiles CMO in Croatia, has spearheaded a remarkable achievement, namely, growing the market leaders revenue market share and profits at a time when a third network operator entered the Croatian market. McKINSEY: When you heard that a new player was about to enter the market, what were your thoughts? HENDRIK KASTEEL: A mix. On the one hand, the new operator has a certain reputation, and I realized we (T-Mobile Croatia) were facing a substantial challenge. On the other hand, I was inspired by the challenge. This challenge injected energy into the entire organization. McKINSEY: Established operators have used different strategies when encountering new entrants. What was T-Mobiles strategy? HENDRIK KASTEEL: Our ambition was to stop the new player at the beach. We didnt wait for them to


McKINSEY: How did T-Mobiles position change after the new player entered and you introduced the new price plans? HENDRIK KASTEEL: Our revenue market share is around 55 percent (up from 52 percent) and margins have increased somewhat. The new entrant has gained about a 4 percent share, mostly coming from the other network operator in the market, Vipnet. The market has also changed. Marketing intensity has increased and communication is much more aggressive. Vipnet has also launched a no frills brand in order to strike back at the new player. The total minutes of usage have increased significantly by about 30 percent and interestingly enough, SMS (short message service) usage is down by 20 percent or so. The SMS reduction is probably due to subscribers getting dual SIMs (subscriber identity modules, which are smart chip cards used in handsets) and thus, replacing off-net SMS with on-net calls. The MoU (minutes of usage) increase is partly due to lower minute prices and is partly a sign of emerging fixed-to-mobile substitution. McKINSEY: Going forward, what are your priorities? Are you considering launching a second brand? HENDRIK KASTEEL: We are very satisfied with our brand position. Despite being an incumbent, our brand is dynamic and stronger today than before the new player entered. A part of the brand success is our ability to shape the market. We are usually the first-to-market with innovative price plans and new products. For instance, we were the first operator within the T-Mobile group to launch the value bundle or Flext concept in the postpaid segment. The ability to shape the market is a core reason for our strong brand and the successful fight against the new entrant. However, our experience doesnt necessarily mean that other operators shouldnt have more than one brand. Generally, the mobile category is maturing and consumer preferences are becoming more diverse and sophisticated. I would, therefore, expect to see more future brand proliferation in the mobile industry. Whether to have more than one brand must be a case-bycase decision, based upon the merits of the respective markets. I do not believe there is a general rule about if operators should or shouldnt have more than one brand. Im surprised that many firms seem to be launching no-frills brands. The mobile industry should introduce brands that move the consumer focus away from price.

Just look at retail banking: We all know we could get better deals somewhere else, so why do consumers not move? I believe it is due to comfort. Customers are comfortable with the bank they have, although it may be neither the cheapest nor the best in terms of service. The mobile industry should build brands that move consumers into the comfort zone.

Jon Erik Haug

Norways Telenor enjoys a strong position in its domestic market, with a subscriber market share close to 60 percent and healthy margins. Last summer, Telenor introduced new postpaid price plans in the consumer market that resulted in a 7 percentage point increase in EBITDA (earnings before interest, taxes, depreciation, and amortization) margins and a small market share increase. However, the head of Telenors Norwegian mobile business, Jon Erik Haug, is far from complacent. He sees several threats on the horizon, including the current challenges from aggressive MVNOs (mobile virtual network operators). In McKinseys conversation, Jon Erik Haug expands on this point and discusses future threats such as VoIP (voice over Internet protocol). McKINSEY: How price-sensitive are Norwegian mobile subscribers and how has this developed over the last few years? JON ERIK HAUG: When MVNOs entered the market around 2003, they focused on price and claimed this position in the minds of the consumers. This clearly increased subscriber price awareness, and we now find price hunters in all classic sociodemographic and needs-based segments. The established operators, for example, Telenor and TeliaSonera, responded to the price competition by differentiating in terms of simplicity, coverage, network quality, and innovation. This was only partly successful, and as long as established operators such as Telenor struggle to successfully differentiate on parameters other than price, price sensitivity will probably continue to increase in most segments. In the marketplace, we see our brand premium diminish year-on-year. McKINSEY: Telenor and other mobile operators have, in the last few years, invested significantly into their brands. To what extent have they been able to capitalize on this investment? JON ERIK HAUG: In Scandinavia, incumbents have had limited success with brand investments due to

RECALL No 1 Pricing Points of View


a lack of consistency. Telenor and others have shifted focus between several differentiators for example, coverage, innovation, service, and simplicity. In a European context, numerous attempts have been made at building brands, but in my opinion, few if any established operators or incumbents have succeeded in doing this. The most successful cases actually seem to be attackers that have a clear price-focused value proposition. Overall, I would be surprised if the mobile industry as a whole has had positive returns on brand investments. McKINSEY: Your main competitor has at least had some success focusing on simplicity; and the MVNOs focus on simplicity in addition to price. Is simplicity a must in your opinion? JON ERIK HAUG: Ideally, price plans should be simple and straightforward for consumers to understand. Transparent price structures do, however, stimulate price competition and reduce industry margins although attackers sometimes benefit profitwise from price reductions. I believe operators should try to appear simple on the elements that are most important for different customer groups, while maintaining complexity in price elements not considered important by subscribers. In Norway, subscribers focus on elements such as minute prices and subscription fees. Therefore, Telenor must be competitive on these elements. There is, on the other hand, less focus on call setup fees and thus, were not so keen on reducing them. Unfortunately, it seems to be the case that complexity is especially important for incumbents such as Telenor, since market transparency appears to dilute our brand premium. McKINSEY: MVNOs have been around for several years in Norway and they have clearly influenced the market. How large do you think they can become? JON ERIK HAUG: MVNOs will remain focused on price in the foreseeable future. There is, however, a limit to how many MVNOs can exist in any market, given the need for scale. In Norway, MVNOs have typically captured around 20 percent of the market. I believe this is relatively high in a European context. I would not be surprised if several European countries experience MVNOs capturing 25 percent of the market in the longer term. This will, however, vary significantly. We see, from our research within the Telenor group, that the segment focusing on no-frills offerings varies significantly across markets.

McKINSEY: Do you consider VoIP a mobile threat, given that more than 18 percent of all fixed lines in Norway are now VoIP? JON ERIK HAUG: The largest danger for incumbents is to underestimate the threat from VoIP, since it is an uncomfortable issue to address. Drawing upon the experience of fixed-line businesses, I would expect the impact to be larger and materialize more quickly than we expected at the outset. It is, unfortunately, difficult to be precise as to the size and timing of the impact. McKINSEY: Should mobile operators launch flat-rate schemes to head off the VoIP threat? JON ERIK HAUG: Ideally, operators should try to avoid flat rates as long as fixed-to-mobile convergence continues. Operators should, however, be ready to launch hybrid plans, that is to say, price plans with flat-rate elements, in areas where the threat from alternative technology is imminent such as, for example, in the home.

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McKinseys Telecommunications Extranet

McKinseys Telecommunications Extranet is the gateway to some of the best information and most influential people in the telecommunications industry. The Extranet offers selected McKinsey-generated information that is not available in the general Internet. Extranet users have access to selected McKinsey articles on subjects ranging from Industry & Regulation, Growth & Innovation, Sales & Marketing, Services & Operations, IT & Technology, Corporate Finance, Organization & HR, Corporate & Enterprise, and Equipment & Devices. Direct communication channels ensure that your questions and requests will be addressed swiftly. The site is updated weekly with new articles on current issues in the industry. Through McKinseys Telecoms Extranet you can: Obtain exclusive information free of charge and take advantage of an Internet portal specifically designed for the industry. Access cutting-edge business know-how, interact with other experts to gain new perspectives, and contact leading industry professionals. Stay well-informed with daily industry news from factiva that you can tailor to your needs and interests. General information about the site is available at: http://telecoms.mckinsey.com Contact: telecoms@mckinsey.com

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The Telecommunications Practice

McKinseys Telecommunications Practice serves clients around the world in virtually all areas of the telecommunications industry. Our staff consists of individuals who combine professional experience in telecommunications and related disciplines with broad training in business management. Industry areas served include network operators and service providers, equipment and device manufacturers, infrastructure and content providers, integrated wireline/wireless players, and other telecommunications-related businesses. As in its work in every industry, the goal is to help McKinseys industry clients make positive, lasting, and substantial improvements in their performance. The practice has achieved deep functional expertise in nearly every aspect of the value chain, e.g., in capability building and transformation, product development, operations, network technology, and IT (both in strong collaboration with our Business Technology Office BTO), purchasing and supply chain, as well as in customer lifetime management, pricing, branding, distribution, and sales. Furthermore, we have developed perspectives on how new business models and disruptive technologies may influence these industries.

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About the authors

Dr. Jacques Bughin is a Director in McKinseys Brussels office. He is a core leader of both the Media & Entertainment Practice and the Telecommunications Practice. Since joining McKinsey in 1992, Jacques has worked on many media-, telecoms-, and mobile-related studies, including mobile media. Jacques holds a PhD in Economics and in Operational Research. jacques_bughin@mckinsey.com Hugo Espirito Santo is a Manager in McKinseys Lisbon office. He joined McKinsey in 2000 and has worked mostly in telecommunications, particularly in marketing, overall strategy, and regulation. hugo_espirito_santo@mckinsey.com

Thomas Barta is an Associate Principal located in McKinseys Cologne office and a core member of the European Marketing Practice, where he focuses on marketing in the telecommunications industry, especially branding and pricing. Since joining McKinsey in 2001, he has primarily served clients in the areas of telecommunications and consumer goods/services across Europe. Prior to joining McKinsey, Thomas worked seven years in Consumer Goods Marketing. thomas_barta@mckinsey.com

Patricia Ferruz is a Manager located in McKinseys Madrid office. She joined McKinsey in 1999 and has mainly worked on marketing topics in telecommunications and consumer goods. patricia_ferruz@mckinsey.com

Duarte Begonha is a Principal in the McKinsey Business Technology Office (BTO). Since joining McKinsey in 1996, he has a strong focus on the telecommunications and media industries. Geographically, he has been serving mobile clients in Southern Europe and South America, as well as helping various teams on pricing, data services, and technology-related issues around the globe. duarte_begonha@mckinsey.com

Dr. Boris Maurer is a Principal located in McKinseys Berlin office. He joined McKinsey in 1996 and has served automotive, telecoms, and public sector clients since. Boris has extensive knowledge on a wide range of topics embracing innovation, product development, strategy, marketing and sales, as well as on performance management issues. He holds a PhD and Masters in Economics. boris_maurer@mckinsey.com

Pedro Mendona is a Principal in McKinseys Lisbon office. He leads the Marketing & Sales group of McKinseys Telecommunications Practice. He joined McKinsey in 1995 and has worked primarily within the media and telecoms industries since. Pedro is an expert in pricing topics. pedro_mendonca@mckinsey.com

Armando Cabral is a Principal located in McKinseys Madrid office. He joined McKinsey in 1996. armando_cabral@mckinsey.com

Steffen Ruppert is an Associate Principal in McKinseys Dsseldorf office and a core member of McKinseys High Tech Marketing & Sales Practice. Since joining McKinsey in 1999, Steffen has worked primarily with multinational high-tech and telecommunications companies on marketing- and sales-related topics but also supported medium-sized technology companies in turnaround situations. steffen_ruppert@mckinsey.com

Steven Spittaels is an Associate Principal located in McKinseys Brussels office. He joined McKinsey in 2001. steven_spittaels@mckinsey.com

Ole Jrgen Vetvik is a Principal in McKinseys Oslo office. Since joining McKinsey in 1998, he has been primarily active within the Media and Telecoms Practice. Ole Jrgen has worked extensively on mobile pricing, the integration of fixed and mobile, and go-to-market strategies in the consumer and corporate market. ole_jorgen_vetvik@mckinsey.com

Telecommunications Practice 2007 Copyright McKinsey & Company, Inc.