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Maximising ARPUMaximising ARPU
Price ElasticityPrice Elasticity
Coleago Consulting Ltd
Martin Duckworth, Director
14 March 2005
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Contents
Why is elasticity important?
What is elasticity?
How can we measure elasticity?
Summary
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Why is elasticity important
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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
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Pricing is driven be a range of factors
PricingCustomer
BehaviourCosts
Regulation
Competitor
Behaviour
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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
What will be the competitive response?
What is the revenue (ARPU) impact of a price change?
What volume change can I expect?
Is the price consistent with regulation?
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We need a set of tools to address these questions
Profitability Cost Model
Competition
Competitor analysis/
Game Theory
Revenue ImpactElasticity
estimates
Regulation Compliance
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What is elasticity?
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Elasticity definition
Demand price elasticity is the responsiveness to demand to a
change in prices:
priceinchangepercentage
demandinchangepercentageEd
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Elasticity is a model of customer behaviour
Customers behaviour is the result of a large number ofpurchasing decisions
Customers purchase when the value of the product to the
consumer, for example a call, exceeds the price
If the price changes, 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 anincremental change in price
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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
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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?
... or on an aggregate basis
Is my current usage worth more to me than my monthly bill?Budget
Aggregate
Elasticity
Value
ServiceElasticity
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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
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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
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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
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Measuring Elasticity
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Measuring elasticity approaches
Traditional macro approach
Model the relationship between demand and prices for the marketas 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 demandbetween different groups of customers who have different prices
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The first step is finding a consistent time series for volumes and
prices...
UK Mobile Retail Minutes and Revenues
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
1996
/97
1997
/98
1998
/99
1999
/00
2000
/01
2001
/02
2002
/03
2003
/04
Year
Minutes(mil
lions)
00.050.10.150.20.250.3
0.350.40.45
Revenue/minute
Mmitts
/minute
Source : OFCOM (excludes 3)
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Volume changes do appear to mirror price changes...
UM Mobile Retail Minutes and Revenues
-40%
-20%
0%
20%40%
60%
80%
1997
/98
1998
/99
1999
/00
2000
/01
2001
/02
2002
/03
2003
/04
Year to:
AnnualCha
nge
Volume change
Price Change
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... And there appears to be a clear correlation between changes in
price and change in demand
UK Mobile Retail Minutes and Revenue
0%
20%
40%
60%
80%
100%
-30% -20% -10% 0% 10%
Price change
Volumechang
e
Volume change
Expon. (Volumechange)
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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 andhence reduction in costs
As neither pricing nor customers are homogeneous, resultscannot 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
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Similarly for fixed to mobile calls volume changes do appear to
mirror price changes...
UK Fixed to Mobile Retail Minutes and
Revenues
-40%
-20%
0%
20%
40%60%
80%
1997
/98
1998
/99
1999
/00
2000
/01
2001
/02
2002
/03
2003
/04
Year to:
AnnualChan
ge
Volume change
Price Change
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... Although the correlation is far less clear
UK Fixed to Mobile Retail Minutes and
Revenue
0%
20%
40%
60%
80%
100%
-40% -30% -20% -10% 0% 10%
Price change
V
olumechange
Volume change
Expon. (Volumechange)
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For SMS there is little evidence of elasticity
UK Mobile SMS and Revenues
0
500
1000
1500
2000
1999
/00
2000
/01
2001
/02
2002
/03
2003
/04
Year
SMS(millions)
0
0.02
0.04
0.06
0.08
0.1
Revenue/S
MS
Messages
/SMS
Source : OFCOM (excludes 3)
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Micro approach
Identify relevant price changes
May be temporary promotions or permanent changes
Extract information on usage for data warehouse for a periodcovering the price change
Time series analysis to remove the impact of seasonality, any
underlying trend and to filter out noise
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The results of price changes may be masked by other sources of
volatility
Time ---->
Price
Demand
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Time Series Analysis must be used to decompose demand in order
to extract the elasticity effect
Time --->
Trend
Seasonality
Noise
Elasticity
Demand
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micro approach
The micro approach provides targeted and timely elasticity
estimates
We can use segmentation consistent with the marketing strategy
We 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
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Summary and Conclusions
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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
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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
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Conclusions
Elasticity estimates are an important part of the marketing
toolkit
Adjusting prices to reflect elasticity can boost ARPUs
While estimating elasticity is difficult, it is worthwhile
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www.coleago.comwww.coleago.com
Martin Duckworth, Director
+34 679 472760
