In my previous post on MetroPCS $10 price drop I overlooked a key aspect – increase in profits from customers staying longer because of the price cut. Thanks to Gerardo Dada for pointing out the scenario of increased customer retention. In my previous model I accounted only for new subscribers and said they needed an additional 1.65 million subscribers (to their current 6.6 million sbscribers). The correct model for break even profit should look like
Lost profit per month = Incremental % customers retained * 6.6 * $40 +
Incremental new customers * $40
units are $ million, and $40 is revenue per customer and marginal cost is $0.
The two extremes are
(1) No change in churn rate (currently 1.77%), which means MetroPCS must add 1.65 million new subscribers (add 25%)
(2)No new subscribers added, which means they must retain an additional 25% of customers. Since their current churn is 1.77% per month, this case is impossible.
The best churn rate in the industry is 1.1% (AT&T). That is for its subscribers under 2 year contract and driven by iPhone. Even if MetroPCS can reach this level, that is a savings ofonly $1.77 million, it still needs 1.6 million new subscribers to make up for the lost profit.
The net is, while price cuts help stop customer defection they resulting increased profits are not enough to make up for total profit lost. Brands need to find considerably large number of new customers to make up for lost profit from price cuts.
I stand by my previous claim, price wars lead to value destruction!