Virgin Mobile USA by sherinwilliam77

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									Virgin Mobile USA: Pricing for the Very
              First Time




                Amelia Cook
                Eddie Larison
                 MBA 532
                   2.6.07
Company Background

       Sir Richard Branson is the man behind the Virgin empire. Virgin is a U.K. based

corporation that has more than 200 corporate entities and is involved in everything from planes

and trains to beverages and cosmetics. Virgin is one of the top three most recognized brands in

Britain. Virgin is an innovative company that looks at industries that offer opportunities for

Virgin to enter. For example, Virgin prefers to enter industries in which the customer

traditionally receives a poor deal or where competition has become complacent.

       Branson, who is known for his wild and wacky antics, launched Virgin Mobile USA in

July 2002 after successfully launching Virgin Mobile U.K. in 1999 and attracting more than 2.5

million subscribers in less than three years. The U.S.-based communications venture hoped to

have 1 million subscribers by the end of the first year and 3 million subscribers by the end of the

third year. Branson knew that the cellular communications market was nearly saturated in the

US and Virgin would need to find a niche market within the industry and select a pricing strategy

that would attract and retain customers.

       Virgin Mobile U.K was innovative in that it was the first cell phone company to be a

mobile virtual network operator (MVNO) in the all of its markets. This meant that it did not own

its own network; instead, Virgin leased available network space from an existing cell phone

company. Branson planned to use this same business model in the launch of the U.S. firm. They

would partner with Sprint and purchase network space on the Sprint PCS network.
The Crowded Cellular Market: Identifying a Niche


                                                                                  Subscribers
                                                        AT&T                      Cingular                Verizon
       The US market for cellular service               VoiceStream               Alltel                  Sprint
                                                        US Cellular               Leap                    Other Carriers

was saturated and overcrowded. There were
                                                                           21,700,000
six national carriers and a number of                                                                  29,500,000
                                                          20,500,000

regional and local providers by the end of
                                                                                                          6,500,000
                                                                                                       6,700,000
                                                              26,100,000                        14,500,000
2001. Roughly half of the US population                                             3,500,000
                                                                           1,100,000

was cellular subscribers (130 million) in

2001 and the market was considered to be at its maturity stage in the product life cycle.

However, Branson and his team identified a niche market with 15-29 year olds. This group was

relatively untapped and had the potential for penetration.

       The reason that this was a largely ignored market segment was that most people in the

15-29 year old age group had poor or nonexistent credit. Most cellular carriers require credit

checks with their service agreements and for this reason, most people in this age group had a

difficult time acquiring a cell phone contract. Virgin thought that this segment had been

underserved by the existing carriers and that it represented the greatest opportunity.

       Consumers in the teenage to young adult market are inconsistent in their lifestyles. They

go to college, are just leaving home, or getting their first cell phone while still in high school.

The cell usage of these consumers is inconsistent and sparse. The calling patterns of this

demographic are different than that of a businessperson with the national average using 417

minuets per month. Teenagers and young adults embrace the new technologies of cell phones

such as text messaging, downloading ring tones or information, or upgrading to colorful and

exciting faceplates to better complement their personalities.
        Despite the disadvantages to targeting the teenage and young adult market, Virgin saw it

as potentially profitable and a way to differentiate its service in the U.S. First, penetration of the

15-29 age group in the U.S. was far lower than that in Finland, the U.K., and Japan (Exhibit 2).

In fact, in other countries, this age group had higher market penetration than the 30-59 age

group. Furthermore, teens were tech-savvy and would embrace new features (see VirginXtras)

as fast as they could be created. Teenagers in America had access to cash and regularly

purchased cutting edge technology, such as the Xbox and MP3 players. Finally, in 2002, parents

were beginning to view cellular phones as a great way to keep in contact with their children.

Teenagers could use phones to call for a ride or check in on the weekends. Parents were willing

to spend the money on a cell phone as a safety measure.



VirginXtras

        The revenue for nontraditional entertainment on cell phones was expected to increase

over the coming years; Virgin decided that it needed to be on the cutting edge of delivering

content, features, and entertainment to its consumers. Virgin called these features “VirginXtras.”

The company signed agreements with MTV networks to deliver music, games, and other content

to the Virgin Mobile consumer. In addition, Virgin would also include other extras in their plans

to appeal to the teen and young adult market, such as text messaging (a feature popular in Europe

by 2002, but slow to catch on in the U.S.), online real-time billing, ring tones, wake-up calls, and

more.
Purchasing the Service

         Virgin Mobile examined the typical methods for providing cell phone service used by the

U.S. carriers and saw that dramatic decreases in selling costs could be made by the creation of a

radically different channel strategy. Instead of leasing mall space for kiosks, hiring expensive

sales staff, and paying costly commissions, Virgin decided to make its service accessible for its

target market—they would contract with retailers like Target, Best Buy, and Sam Goody to sell

Virgin phones and plans off the shelf. No expensive sales staff would be employed,

commissions to the stores would be lower than the industry average, and the phones would be

stocked in the places where the youth market shopped. Additionally, Virgin opted to contract

with a virtually unknown phone manufacturer to produce less-expensive phones with trendy

names like “Party Animal.”

Advertising

         Cellular advertising in the U.S. was a bloated beast when Virgin entered the market in

2002—the industry as a whole was expected to spend $1.8 billion that year to retain and attract

customers in a mature market. Virgin Mobile, on the other hand, aimed to spend a mere $60

million on extremely targeted advertising and quirky stunts to get teens and twenty-somethings

talking about Virgin Mobile. Virgin wanted to target the youth market in such a way that it felt

exclusive for that market. Virgin did not want the parents to “understand” what all the hype was

about.

The Pricing Decision

         Once Virgin Mobile had identified its target market and deemed it substantial enough to

pursue, the question became, how to structure pricing? As Virgin saw it, the company had three

pricing options.
       1. Clone the existing industry pricing structure. Over 90 percent of cell phone

subscribers in the U.S. had contractual agreements with their providers whereby they agreed to a

“bucket” of minutes to use per month. If the customer used more than their allotted minutes, he

or she would be charged extremely high rates for the overages. If they did not use all of their

minutes, they still paid the same monthly fee and did not get to recapture the unused minutes the

next month. When the customer got his or her bill for the month, there were also substantial

taxes and service charges added to the fixed fee and overage charges. A typical monthly bill

frequently amounted to 120 percent or more of the agreed service charge.

       If Virgin Mobile copied the industry prices in the U.S., they would benefit from the fact

that Americans had accepted and were used to the strange and often confusing pricing policies

and monthly billing in arrears for cell phone service. However, the advantage of working within

an established framework for pricing was outweighed by the disadvantages of this pricing

strategy. First, there would be little Virgin could do to differentiate itself from other cell phone

providers, short of the easily copied practice of dropping prices or offering better off-peak hours.

Second, by pricing with contractual agreements and billing in arrears, Virgin would essentially

have to abandon its preferred target market of teenagers, since children under the age of 18 could

not enter into contractual agreements in the U.S. Third, Virgin saw a way to create an advantage

in the industry by making pricing for cell phone service more straightforward and easy to

understand. However, the current pricing structure in the U.S. was complicated and not

transparent to the customer. Virgin did not want to force “hidden” fees and overages onto their

customers.

       2. Price below the competition. Virgin could adopt a similar pricing structure as the rest

of the U.S. cellular industry, but set prices well below the competition to attract younger cell
phone users. There were several problems with this idea. In addition to the aforementioned

disadvantages to adopting a pricing structure similar to the rest of the U.S. providers, Virgin

could easily engage its competition in a price war. While consumers might like to see lower cell

service prices throughout the industry, none of the service providers would ultimately benefit

from lower prices and Virgin, being the new entrant, might be quickly priced out of the market.

       3. A new, prepaid service plan. Upon examination of its target market, Virgin

recognized that a new cell phone service plan might be necessary to meet that market’s needs.

Virgin wanted to find a plan that would eliminate contracts, hidden fees, and even monthly

billing while still being profitable. The plan Virgin conceived was a prepaid plan in which

customers would buy minutes in advance and then, once the minutes were used, “recharge”

minutes onto their phones with their debit cards.

       Virgin Mobile had a cost structure that was more amenable to this type of plan than any

of the other service providers. Because Virgin “rented” space on the Sprint PCS network, it did

not have the high fixed costs associated with network infrastructure. Furthermore, Virgin did not

plan to lease space for mall kiosks or employ commissioned salespeople to sell its phones and

plans. Instead, Virgin placed its phones in mass merchandisers and major retailers as an off-the-

shelf item. This distribution system was less expensive than the competition’s, and it would

likely work well with a prepaid plan. Finally, Virgin planned to spend much less on advertising

than its competitors, meaning that it could afford to take lower margins on its plans. For these

reasons, Virgin could price prepaid minutes at around 18 cents/minute, as opposed to the

industry average for prepaid plans of 35 cents/minute. (See Appendix 1 for breakeven and

customer lifetime value analysis.)
       There were plenty of other advantages to a prepaid plan. Virgin would appeal to both

teenagers and their parents by creating a prepaid plan; kids would not be able to run up a large

cell phone bill by creating overages, and parents could monitor how much money was spent to

“recharge” the phone each month. Additionally, customers both young and old would not be

faced with hidden fees and taxes in a confusing bill each month. Virgin hoped that by making its

billing more transparent it would create value for its customers.

       There were also some disadvantages to a prepaid plan, most notably the monthly churn

rate expected from a prepaid plan. The lack of contracts might keep customers from being loyal

to Virgin Mobile—as soon as customers were old enough to enter into a contract with another

service provider, they could, with no penalty. In addition, customers had the option to not

recharge their minutes after they had used them all. Higher churn could eat into Virgin’s

profitability. (See Appendix 1.)

       Virgin Mobile also faced a challenge in lowering acquisition costs so that a prepaid plan

could be more profitable. Typically, service providers subsidized the cost of the phone, which

usually ran from $150 to $300. Virgin’s phones would be less expensive on average, $60 to

$100 plus the $30 store fee, but it would be difficult to price phones and plans in the stores to

recoup all of these costs. Teenagers might not have that much cash and young adults might see

the “free phone” offered with two-year contract from other service providers as a better deal.

Thus, Virgin Mobile would likely have to subsidize some of its phone cost.

Conclusion

       Given the market Virgin Mobile chose to target as it entered the U.S. market for cell

phone service, the pricing option it should pursue is #3, a prepaid service plan. Unfortunately,

it would be difficult for Virgin to create barriers to its competitors to create their own prepaid
plans and also target the teenage and young adult market. However, if Virgin creates a positive

brand image with the youth market, they should be able to engender customer loyalty among that

market. Teenagers and young adults will want a service provider who understands them and is

in touch with their culture. Virgin’s image has the potential to make a connection with

consumers in this age group, and Sir Richard Branson’s antics have the potential to capture the

imaginations of that market.
                                             Appendix 1



Industry average customers acquisition cost: $370

Industry average monthly cell phone bill: $52

Industry average monthly hidden fees (plan price markup): 21%

Industry average monthly cost: $30

Retention rate at 2% churn: 1- (0.02 * 12) = 0.76

Retention rate at 6% churn: 1- (0.06 * 12) = 0.28

Average minutes used by the 15-29 age group: 100-300 minutes

Virgin prepaid price/minute: $0.18

Interest rate: 5%

Break-even Analysis

Regular Plan

Average monthly bill – average monthly cost = $52 - $30 = $22

Plan price markup = monthly interest rate = 21%

$22/1.21 = $18.18

Breakeven: $370/$18.18 per month = 20.35 months



Prepaid plan

Average monthly charge for 200 minutes = $36

Assume monthly costs = 30%

$36/1.30 = $27.7

Breakeven (assuming half industry acquisition costs): $185/$27.7 per month = 6.7 months
Customer Lifetime Value

Regular plan at 2% churn

[($22 * 12)/(1 – 0.76 + 0.05)] - $370 = $540



Regular plan at 6% churn

[($22 * 12)/(1 – 0.28 + 0.05)] - $370 = -$27

								
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