Maximising ARPU Price Elasticity

Coleago Consulting Ltd Martin Duckworth, Director 14 March 2005

Contents

W hy is elasticity important?

W hat is elasticity?

How can we measure elasticity?

Summary

2

Why is elasticity important

3

Pricing is clearly one of the key determinants of ARPU Pricing feeds through directly into ARPU Creative pricing can stimulate demand Pricing is one of the key tools in any marketing strategy for customer acquisition and retention 4 .

Pricing is driven be a range of factors Competitor Behaviour Customer Behaviour Pricing Costs Regulation 5 .

Each time we change prices we need a to go through a check list Is the new price profitable   Is price above incremental cost? Is it above incremental cost + mark up W hat will be the competitive response? W hat is the revenue (ARPU) impact of a price change?  What volume change can I expect? Is the price consistent with regulation? 6 .

We need a set of tools to address these questions Profitability Cost Model Competition Competitor analysis/ Game Theory Revenue Impact Elasticity estimates Regulation Compliance 7 .

What is elasticity? 8 .

Elasticity definition Demand price elasticity is the responsiveness to demand to a change in prices: percentage change in demand Ed   percentage change in price 9 .

consumption will also change  A reduction in price will result in more calls with value > cost Elasticity is an expression of the reaction of a customers to an incremental change in price 10 .Elasticity is a model of customer behaviour Customers behaviour is the result of a large number of purchasing decisions Customers purchase when the value of the product to the consumer. for example a call. exceeds the price If the price changes.

Consumer behaviour in mobile telephony is complicated Customers understand the value of calls  A repeat purchase However customers awareness of the price of calls is limited    Customers have limited awareness of prices Tariff plans hide the price of an individual call Feedback on the cost is delayed For innovative services both the pricing and the value of the service may be unclear 11 .

... or on an aggregate basis  “Is my current usage worth more to me than my monthly bill?” “Budget” Aggregate Elasticity 12 ..For many consumers the overall bill is more important than individual prices Customer may see value on a individual decision basis.  “Is this call worth more to me than its cost?” “Value” Service Elasticity .

Setting prices according to elasticity can increase revenues without an overall increase in prices Increase prices for the most inelastic customers and services  Little impact on volume so that the price increase flows through to revenues Reduce prices for the most elastic customers and services  The effect of price reductions is offset by increases in volume “Ramsey pricing” states what the theoretically optimal pricing is 13 .

Elasticity may be in conflict with other objectives The most inelastic customers tend to be the most valuable (e.g. business users)  There is often a desire to reduce prices for customer acquisition and retention Inelastic customers may be less valuable (e.g. low spending residential users)  There may be a desire to raise prices to increase profitability Prices changes may provoke a competitive response   Price reductions can spark a price war Price increases can lead to increased churn if not matched by competitors 14 .

Aside : Elasticity in regulation Regulators are starting to question price discrimination  Different prices for services which appear to have similar costs A number of services are being investigated    Mobile call termination On net calls Roaming calls Elasticity provides an argument for price discrimination  Theoretically efficient “Ramsey” prices 15 .

Measuring Elasticity 16 .

Measuring elasticity approaches Traditional “macro” approach  Model the relationship between demand and prices for the market as a whole over a period of time A “micro” approach  Response of individual customer segments to a given price change Other approaches   Customer surveys “Cross sectional” approach to analyse differences in demand between different groups of customers who have different prices 17 .

.2 0.000 10.000 40.3 0.15 0.000 50..45 0.25 0.The first step is finding a consistent time series for volumes and prices.4 0.000 60. UK Mobile Retail Minutes and Revenues 70.000 30.05 0 Minutes (millions) Revenue/minute Mmitts £/minute Year Source : OFCOM (excludes ‘3’) 18 .000 0 19 96 19 /97 97 19 /98 98 19 /99 99 20 /00 00 20 /01 01 20 /02 02 20 /03 03 /0 4 0.1 0.35 0.000 20.

.Volume changes do appear to mirror price changes.. UM Mobile Retail Minutes and Revenues 80% Annual Change 60% 40% 20% 0% -20% -40% /9 8 /9 9 /0 0 /0 1 /0 2 /0 3 19 97 19 98 19 99 20 00 20 01 20 02 20 03 /0 4 Volume change Price Change Year to: 19 .

And there appears to be a clear correlation between changes in price and change in demand UK Mobile Retail Minutes and Revenue 100% Volume change 80% 60% 40% 20% 0% -30% -20% -10% Price change 20 Volume change Expon. (Volume change) 0% 10% ....

results cannot necessarily be applied to an individual segment   There is a significant amount of price discrimination Elasticity is likely to vary between customer segments Historic relationships may no longer be relevant 21 .However the traditional “macro” approach is of limited value Correlation does not imply causality   Price may not be the key determinant of changes in demand Price changes may be the result of an increase in demand and hence reduction in costs As neither pricing nor customers are homogeneous.

Similarly for fixed to mobile calls volume changes do appear to mirror price changes.. UK Fixed to Mobile Retail Minutes and Revenues 80% 60% 40% 20% 0% -20% -40% /9 8 /9 9 /0 0 /0 1 /0 2 /0 3 19 97 19 98 19 99 20 00 20 01 20 02 20 03 /0 4 Annual Change Volume change Price Change Year to: 22 ..

.. (Volume change) .. Although the correlation is far less clear UK Fixed to Mobile Retail Minutes and Revenue 100% Volume change 80% 60% 40% 20% 0% -40% -30% -20% -10% 0% 10% Price change 23 Volume change Expon.

02 0 Revenue/SMS Messages £/SMS Year Source : OFCOM (excludes ‘3’) 24 .08 0.04 0.1 0.For SMS there is little evidence of elasticity UK Mobile SMS and Revenues 2000 SMS (millions) 1500 1000 500 0 19 99 /0 0 20 00 /0 1 20 01 /0 2 20 02 /0 3 20 03 /0 4 0.06 0.

any underlying trend and to filter out noise 25 .Micro approach Identify relevant price changes  May be temporary promotions or permanent changes Extract information on usage for data warehouse for a period covering the price change Time series analysis to remove the impact of seasonality.

The results of price changes may be masked by other sources of volatility Price Demand Time ----> 26 .

Time Series Analysis must be used to “decompose” demand in order to extract the elasticity effect Trend Seasonality Noise Elasticity Demand Time ---> 27 .

“micro” approach The micro approach provides targeted and timely elasticity estimates  We can use segmentation consistent with the marketing strategy W e need to identify appropriate price changes Also need a long enough time series to enable us to extract the effect of the price change from other sources of volatility 28 .

Summary and Conclusions 29 .

Summary : How do we use elasticity? Efficiently price to maximise ARPU and profitability   Reduce prices for elastic services to stimulate demand Increase prices for the most “inelastic” services to increase revenues Effectively compete  Understand the revenue impact of competitive price cutting Financial forecasting Justify prices to regulator  Argue that price discrimination is “efficient” 30 .

Summary : How can we measure elasticity? Traditional approach based on the whole market may provide a first estimate  Results may be too general for targeted pricing actions The increasing availability of detailed data allows us to carry out more relevant analysis   For individual segments For individual price changes 31 .

Conclusions Elasticity estimates are an important part of the marketing toolkit Adjusting prices to reflect elasticity can boost ARPUs W hile estimating elasticity is difficult. it is worthwhile 32 .

com +34 679 472760 .duckworth@coleago.com Martin Duckworth. Director martin.coleago.www.

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