Introduction

Since launching its operations as a mobile virtual network operator (MVNO) in November
1999, Virgin Mobile (VM) had proved to be one of the remarkable success stories of the UK
mobile phone industry. VM had achieved a number of significant milestones right from its
inception. With a steadfast focus on the 1835 year-old prepay segment, by June 2001 it
had captured more than one million customers, making VM the fastest (among the major
UK mobile communications providers) to have achieved that milestone.

Within five years of launch VM had an active customer base of over four million and its
customers were found to be among the most-satisfied in the pre-pay sector according to
surveys conducted by J.D. Power and Associates. VM had also been included in The
Sunday Times 100 Best Companies to Work For and was part of the FTSE4Good. The
company had been recognized as the most admired brand in the UK with a distinct
customer proposition and market positioning.a VM believed its strong growth had been
driven by its brand and differentiated approach to the market. The brand was consumer
rather than technology-oriented, and this strategic message had remained consistent with
the same core management team in place since inception in 1999.
But despite VM UKs success, the mobile telecommunications market in the UK was
undergoing profound transformation. Tom Alexander, CEO of Virgin Mobile in the UK
reflected on these changes and asked himself if Virgin Mobiles niche strategy could be
sustainable in the future, or would the company need to adopt a different strategy to survive
and thrive in the dynamic market environment?

a According to research conducted by HPI Research.

This case study was written by Jamie Anderson of TiasNimbas Business School and Martin
Kupp of ESMT European School of Management and Technology. Sole responsibility for
the content rests with the authors. It is intended to be used as the basis for class discussion
rather than to illustrate either effective or ineffective handling of a management situation.

Copyright 2009 by ESMT European School of Management and Technology, Berlin,

Germany, www.esmt.org.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any means - electronic,
mechanical, photocopying, recording, or otherwise - without the permission of ESMT.

The Virgin Group

The Virgin Group Ltd (VG) consisted of many separately run companies united by the Virgin
brand of British celebrity business tycoon Sir Richard Branson. VGs core businesses were
travel, entertainment and lifestyle. Virgin was one of the UKs best known consumer brands,
associated with excellent service and having the consumers interests at heart. In the words
of Richard Branson: I look for opportunities where we can offer something better, fresher
and more valuableI think one of the reasons for our success is the core values which
Virgin aspires to. This includes those that the general public thinks we should aspire to, like
providing quality service. However, we also promise value for money, and we try to do
things in an innovative way, in areas where consumers are often ripped-off, or not getting
the most for their money. I believe we should do what we do with a sense of fun and without
taking ourselves too seriously, too! If Virgin stands for anything, it should be for not being
afraid to try out new ideas in new areas.

Although Branson retained complete ownership and control of the Virgin Brand, each of the
companies operating under the Virgin brand was a separate entity, with some being wholly
or partly owned by Branson. Occasionally, Branson licensed the brand to a company that
had purchased a division from him, such as Virgin Radio (now part of SMG plc) and Virgin
Music (now part of EMI). With a few exceptions, all the companies began as wholly owned
Virgin subsidiaries. By end 2004, there were 42 Virgin-branded companies listed on the
group website. Virgin businesses numbered around 275 in all.

Virgin Mobile UK was floated as a joint venture between Virgin and T-Mobile in 1999. In
January 2004, in connection with the settlement of various disputes involving VM, T-Mobile
and certain Virgin Group companies, Virgin purchased out T-Mobiles stake in VM, and later
in the same year Virgin Group sold part of its stake in VM, offering 62,500,000 shares
through an Initial Public Offering (IPO) priced at 200p. VM's shares were listed on the
London Stock Exchange on 26th July 2004 and subsequently included in the FTSE 250
index.

Virgin Mobile UK was not Virgins only venture into mobile telecommunications. The
company made an attempt to launch Virgin Mobile in Singapore in 2001 in partnership with
Singapore Telecom, but the company was only able to acquire 30,000 customers before
shutting its doors. Although both partners had agreed that the Singapore market had been
too saturated too sustain a new entrant, some analysts believed that Virgins hip and trendy
positioning had failed to connect in the Singapore market. Virgin Mobile USA and Virgin
Mobile Australia had been altogether more successful ventures by late 2004, and Virgin
Group was preparing to enter South Africa.

The UK mobile communications market

The UK mobile industry had exploded since the turn of the millennium, and by mid 2005
growth in the UK mobile industry continued to exceed expectations, due to increased
consumer adoption

Virgin Mobile UK ESMT30900941

of multiple devices, the ongoing structural shift from fixed to wireless, and increasing
adoption of new services.

Penetration of mobile phones in the UK (measured in SIM connections) crossed 100% as

early as mid-2004. But favorable factors and ongoing technological advances were
expected to continue to deliver growth that outpaced average economic growth. While the
UK market was competitive, growth prospects remained promising. Total UK wireless
minutes increased by 16% in 2004, but only 29% of the UKs outbound voice traffic was
carried over wireless networks in 2004, up from 26% the previous year.

The four main established competitors (Vodafone, Orange, O2 and T-Mobile) had largely
avoided head-to-head price competition, competing more on dimensions such as coverage,
quality, service and value added services than on winning market share through price wars
(see Exhibit 1 for UK market share breakdown). Ofcom, the UK telecoms regulator, tracked
UK mobile price trends on a long term basis, and its research indicated that mobile pricing
in both the prepay and contract markets had remained remarkably stable over the period
19992004, despite the presence of five service providers. In terms of market share,
between 1999 and 2004 the UK market had been almost evenly divided amongst the four
major operators, with virgin representing a distant fifth place with approximately 8% market
share at the end of 2004. This competitive situation had provided Virgin the opportunity to
position itself as not only a strong brand experience, but as a value leader as well.

In the past operators had focused on new customer acquisition, with subscriber growth
typically translating into growth and profitability. But during 2004 the majority of new
customersup to 90%were coming from the prepaid segment, and the major operators
had turned their attention to managing customer contribution. The critical drivers were
average revenue per user (ARPU), subscriber customer acquisition costs (SAC) and churn
(the number of customers lost each month). For the year ended March 2005, the UK market
added only 7.3 million new net subscribers, but churn was 17.2 million, implying a 24.5
million pool of gross additions. As UK penetration reached maturity and new net additions
slowed, the incumbent operators were expected to look much harder at their own levels of
churn as a way of slowing subscriber losses. Many had indicated that this would be a key
focus during 2005, particularly O2.

As in other developed markets, the UK mobile market had traditionally been segmented into
prepaid users, postpaid customers and corporate/government and small and medium
enterprises (SME) customers. The prepaid segment continued to grow, but operators had
little knowledge of their prepaid customers compared with contract, and customer churn
remained high. On contract, the big four network operators, according to analysts, made at
least 65% of their total EBIT, off 34% of their customers, as the higher ARPU generated far
higher actual profit.

Despite lower ARPUs prepaid had several advantages compared to contract, such as:
higher average per minute charges; reduced credit risk; and lower administrative costs with
no itemised bills. As long as mobile phone subsidies were kept reasonable in the prepaid
segment (ie, about a

three-month paybacks versus three years for contract), prepaid could be very profitable for
operators. Vodafone and O2, with their large contract subscriber bases, derived 25% and
33% of their respective service revenue from the prepaid segment by the end of 2004. The
corporate segment was very attractive, but costly to serve. Voice and SMS had been very
profitable services for operators, and mobile data services were considered promising but
still at a relatively low level of adoption.

More broadly, the mobile industry was facing a significant technological and competitive
shift - industry analysts had long talked about the convergence of media, fixed and mobile
telecoms, and by early 2005 several telecom operators and media companies across
Europe were racing towards integrating media offerings with cable, fixed and mobile
networks. The primary goal of this service convergence was the concurrent delivery of all
media typesvoice, data, and video to an easy-to-use graphical user interface,
independent of location. The related goal of network convergence was to make all services
profitable and enable multiple business models. This fixed- mobile convergence (FMC)
involved a unified core network, multi-radio terminals as well as other terminal devices such
as PCs or digital televisions, access networks that complemented each other and common
multi-access service delivery platforms. Some UK mobile operators such as Vodafone were
rumoured to be in the market to acquire fixed-line assets to deliver FMC services, while
some media and cable companies such as NTL-Telewest (the UKs largest provider of
consumer broadband and second largest provider of consumer fixed-line and pay TV
services) had declared their interest in merging with or allying to mobile companies.

Virgin Mobile business model

Virgin Mobile UK operated as a mobile virtual network operator (MVNO) and provided
cellular services without owning spectrum access rights. To customers, Virgin looked like
any other cellular operator, giving the impression of a full-fledged mobile operator. But the
company did not own or operate base station infrastructure. Speaking about Virgins entry
to the UK mobile phone industry in 1999, Richard Branson declared: "If you can run one
business well you can run any business. There just needs to be a crying-out need for you to
enter the marketplace. The time to go into a business is when it's abysmally run by other
people... There is no reason we can't offer anything that a company like Vodafone canWe
will by no means be as big as them, but we will have a slice of the market.''

Being an MVNO, VM needed less capital. The company did not have to invest in network
hardware. Because of its partnership with T-Mobile, it already had access on long-term
contractual terms to billions of pounds worth of state-of-the-art mobile network assets. The
company enjoyed the scale benefits of the network operators, without the associated
investment and technology risk.

Although other incumbent operators could realise the benefits of scale once their large fixed
cost base was covered, VM had a very low fixed cost base compared to traditional MNOs
for

example, capital expenditure (CAPEX) as a percentage of earnings was just 2.1% for the
year ended March 2005. Therefore, assuming constant service gross margins, the key
factor to ensuring incremental value was acquisition costs. Even a prepaid subscriber
spending 10.5 per month could contribute value to VM.

Although VM and T-Mobile did not disclose their contractual agreement, it was believed that
VM paid 2.9p per minute for outbound voice traffic and one pence per SMS carried on the
T-Mobile network. Estimated gross margins for outbound Virgin mobile voice and SMS
traffic carried over the T-Mobile network were estimated at 57.1% and 73.3% respectively
for the year to March 2005. T-Mobile passed through all inbound interconnect charges
received from third parties in respect of inbound calls, or messages sent, to Virgin
customers.

For T-Mobile, the main benefit of the partnership with Virgin was to tap into consumers with
whom it had a low brand affinity, therefore having a low risk of self cannibalization, and to
maximize utilization of its network capacity thereby achieving greater economies of scale.
Intriguingly, in 2000, T-Mobile UK was voted as having the worst network quality, and in the
same year Virgin Mobile was awarded best network quality. In January 2004, Virgin Mobile
secured access to T-Mobiles network for a further 10 years, including 3G network access.
The agreement not only covered existing voice and non-voice services using GSM, but also
future data services (with a three-month delay to T-Mobile launch) using GPRS (2.5G) and
UMTS (3G) including roaming on O2s 3G network. The agreement did not include other
services such as WiFi or access to T-Mobiles portal t-zones.

Unlike most other competitors, VMs business model was designed for a very specific group
of customersthe Virgin brand targeted the youthful or young-at-heart. Many surveys
and awards (OFCOM, J.D. Power, HPI Research, Mobile Choice magazine) highlighted the
attractiveness of the VM brand and services to these customers, and by 2005
approximately 50% of the VN customer base was aged 2834. Analysts believed that the
success of Virgins MVNO model depended on three core competencies:

The ability to leverage an existing customer base to acquire customers at a lower cost than
the competition. Virgin had acquired prepaid customers at significantly lower subscriber
acquisition cost than the four established mobile network operators during the period 1999
2001.

The ability to reduce churn rates through brand loyalty, excellent customer service and new
sticky services. VM reported the lowest industry churn at 17.5% for 2004 versus the
average contract churn of 25% and average prepay churn of 33% at the two listed
operators, O2 and Vodafone. These numbers showed the incumbents focus upon post- pay
retention over prepay, which had been positive for VM.

The ability to create new revenue streams by penetrating its niche segment, leveraging new
distribution channels with innovative and more targeted value propositions.

VM firmy believed that the key to delivering a truly unique customer experience was
customer service, and the companys management believed that superior customer care
was the most important aspect of VMs operations. In the words of Tom Alexander:

Theres no great mystery to Virgin Mobiles approach. We are a marketing and service
business: we focus on customers, not engineering; we focus on the brand experience, not
technology. We give our customers what they wantnot whats easiest for us to provide.
And what our customers want is exactly what we stand for: value for money, outstanding
service, great products and a sense of funBecause were not a network operator, were
free to focus on people, not hardware. We focus on our own people, through our singular
Virgin Mobile culture; and we focus on our customers, by providing them the best customer
service in the businessAttention to the needs of our customersin our role as the
Consumer Championis at the heart of everything we do.

Alexander believed that there were five key areas that best illustrated how Virgins business
philosophy set it apart from the competition. In his own words:

At our company, as well as in our marketplace, we focus on people, not just numbers. We
have a singular company culture, fuelled by excitement and passionate commitment. We
believe our people should always come first: happy staff treat customers well, which helps
to grow the business, creating shareholder returns. Simple.

The Virgin brand gives us a prominent profile in a crowded marketplace. The strong
heritage and reputation of our brand is a powerful competitive advantage, and our
distinctive approach to advertising, packaging, point-of-sale marketing and sponsorship has
won many fans.

Our products are innovative and industry-defining. We give our customers exactly the
features and functionality they want, because we listen to what they have to say and tailor
our offer accordingly. Weve worked hard to make our service easy to sell, easy to buy, and
easy to use.

And we back everything up with market-leading, award winning customer service.

We have a different business model, which provides scalability and high cash returns in an
industry traditionally characterised by accelerating capital investment. Our low-cost
business model gives us a solid foundation of consistent profitability from our existing base,
while being flexible enough to accommodate new and exciting areas of growth with minimal
investment.

Product

VMs saw itself as the Consumer Champion. In the words of Virgin Mobile UK CEO Tom
Alexander: We believe in putting consumers first by making our offer as clear and
straightforward as we can. We believe that offering exceptional value isnt just a question of
money; its also about making life simpler. Virgin prided itself as having no-hidden costs as
part of any of its offers.

Virgin was the first operator in the UK to abolish peak rates, the first to offer free voicemail,
as well as the first to offer prepay airtime bundles where unused minutes rolled over to the
next month. The other mobile companies had followed later. VMs standard pay-as-you-go
tariff, Flex, let customers top up when they needed to with vouchers that never expired
(while connected to the network)or they could use e-top ups, credit or debit cards.
Customers were also offered the option of paying by direct debit each month. Customers
were provided with many ways to run and pay for their account with Virginbut all options
provided the same core tariff structure.

Customers could join network via a SIM card only starter kit starting at 10, including 5 of
airtime. VM also offered an extensive range of stylish mobile phonesmany included
cameras and music playersat reasonable prices. In October 2004 Virgin revamped its
handset portfolio and strengthened its high-end handset range in an effort to attract high-
usage customers. The company offered nineteen different phones, giving it the widest
handset portfolio amongst UK mobile service providersin comparison Vodafone offered
just eight handsets.

Virgin did not require customers to take out a contract to get a mobile phone, and it was the
first operator in the industry to offer monthly installment plans to pay off a handsetmore
like consumer financing than a subsidy. If consumers chose to leave the Virgin network
before paying of their mobile phone, they only needed to pay-out the remaining amount
owingthere was no contractual lock-in. For every 100 spent on calls and messages
Virgin offered 10 off a new phone. Customers could earn up to 100 off any new phone in
the companys range. Recognizing that theft of handsets was a problem, particularly
amongst its teen consumers, Virgin offered theft insurance as part of its mobile phone
offers.
Virgin packaged its products in simple but brightly colored boxes and consumer-electronics
type packaging, and instead of being locked away behind a counter product bundles were
stacked in position ready to be taken away by customers without needing a salesperson to
help them. Everything was provided in the starter-pack boxes to allow the customer to
register their SIM card, without the need for in-store paperwork.

In addition to voice, text and handsets, virgin also offered value added information services.
Virgin Mobile Bites, launched in August 2004 gave customers a completely new form of
entertainmentbite-sized boredom busters delivered straight to their phones, any time, day
or night. Virgin Mobile Bites helped customers keep abreast of all the hottest celebrity
gossip and the latest stories and opinions from the worlds of music, entertainment and
sport.

During late 2004 Virgin launched various customer-retention initiatives, such as:

Big Bonus, whereby a customer spending more than 30 received a 10% discount in the
subsequent month;

Flash it!, whereby for every 10 spent in a Virgin Megastore, customers received a 1 free
airtime voucher, as long as they showed a Virgin mobile phone at the till;

Pricing

Compared to the tariff plans of the established operators which were complex and
confusing to many consumers, Virgin took a very simple and transparent approach to
pricing. According to one analyst: The main operators in the UK seem to have the objective
of confusing consumers at the top of their agenda when designing their tariff plans. It is
virtually impossible to compare prices and plans across networks due to the dizzying
number of plans on offer. Compared to these tactics, the simplicity of Virgins tariffs come
as a breath of fresh air.

VM believed in giving its customers value for money in a transparent way. VM used
common sense pricing structures such as its daily declining call rates, having the only
prepay bundles that allowed unused minutes to be utilized the next month. VMs basic
prepay tariff plan was as follows:

First five minutes of calls each day: 15p per minute

Each minute after that: 5p per minute

Text messages to Virgin Mobile phones: three pence per message

Voicemail retrieval (provided airtime left): Free

Calls to other UK networks: 35 p per minute

Text messages to other UK networks and BT landlines: 10p per message

Picture messages to all UK networks: 30 p per message

Virgin Mobile Bites - free to explore for 30 days. After that, a flat rate of 30p per day. If not
used, no charge applied. WAP chat and downloads costs extra -0.5p per Kb

Virgin Prepay Bundles were launched in October 2004 and started at 7.50 for 40 minutes
airtime or 100 texts (or 20 minutes and 30 texts off-net), up to 24 for 200 minutes or 800
texts (or 100 minutes and 200 texts off-net). Prepay bundles targeted customers who made
a high number of calls to other mobile networks, and were up to 70% cheaper than Virgins
standard prepay tariff if customers used up a 400 minute bundle on off-network calls. If
customers mainly called friends or family on the Virgin network they were still better-off with
Virgins standard tariff package (see Exhibit 3 for a summary of the Virgin Bundles).

By March 2005 VM was cheaper by a significant margin than the four established
operators, for both standard prepay and bundled prepay offers. Vodafone was
approximately 19.6% more expensive than VMs standard prepay tariffs, and O2, 14.4%.

Place

Effective and targeted distribution played a key role in VMs success. In just 5 years, VM
had built a distribution network of around 6,000 sales outlets, with another 50,000 outlets
selling airtime.

VM capitalized on the value of the Virgin brand by putting dedicated Virgin Mobile stores
within stores inside 96 Virgin Megastores nationally, many staffed by dedicated, expert VM
people. Each store stocked the entire range of products. The store within a store concept
proved very successful, and VM introduced Virgin Mobile Stores into several WH Smith
outlets.

There were a total of 104 Virgin Mobile Stores throughout the UK in 2005 where only
Virgins services were soldthis represented about one-third of some other operators.
However, VM had plans to increase the number of direct outlets in line with growth in the
Virgin Megastores. Virgin Mobile Stores were designed to offer customers a unique
experienceas the perfect environment to showcase VMs products and services.
Customers were made to feel relaxed and staff made a point of being friendly but not
salesy. VMs in-store experts were trained to be open, honest and knowledgeable, and to
help bring Virgin Mobile to life. Customers could try before they bought a phone to see if the
phone was right for them; they could set up Bites or Bundles, and self-service interactive
kiosks showed customers the range of VM products and services on offer. According to
Tom Alexander: We hand-pick our Virgin Mobile Stores staff. Theyre warm and friendly,
they always give their best, they like talking to people and were proud of them! In the
words of Rebecca James a VM customer from London: This is the first time I have been so
impressed by a companys shop that Ive had to write and tell them about it. Fantastic!
(See Exhibits 4 and 5 for images of Virgin Stores).

VM services were also available in specialist mobile retailers such as Carphone

Warehouse, Phones 4U and The Link. Virgin also innovated by being the first mobile
company to offer its products through such well-known high street stores as Woolworths,
Comet, Argos, Sainburys, Tesco, and Asda. The high street channel was particularly
attractive for Virgin as these retailers typically charged lower commissions than traditional
industry channels. Encouraged by the success of the Internet-based marketing initiatives,
VM had also invested to grow this cost- effective distribution channel. Virgin was also
planning concession outlets within specialty retail stores to further strengthen Virgins High
Street presence.

VMs extensive use of retailers was an important difference between its distribution
approach and the approach of the established mobile network operators. For example, O2
reported 4050% of its sales were attributable to its owned retail channels, while for VM
this number was only 22%. Mobile retail specialists (Carphone Warehouse, Link and
Phones 4U) accounted for approximately 42% of new VM customers.

In 20042005, VM continued to expand its distribution network.

The total distribution network was expanded by 20%, adding products to approximately
1,000 new outlets. VM products were made available from approximately 6,000 outlets
throughout the UK.

Total number of VM Stores had gone up to 104, from 85. This phase of the VM Store rollout
was complete, with ongoing opportunities for further expansion as the Virgin

Megastores network grew. VMs Stores continued to be a very effective distribution channel
for VM, attracting high value customers.

The VM Store concept was expanded in October 2004 with a pilot at eight WH Smith
locations. VM would continue to explore opportunities to further expand the VM Stores on
the high street.

VM established an independent dealer network of 600 outlets, supplied through a number

of distributors and began to distribute products to dealers directly. This new channel had
made a significant contribution to connections.

The Internet formed a very effective distribution point for VM. Various Internet-based
marketing initiatives during 200405 were very successful, and VM intended to continue to
develop this cost-effective distribution channel. Customers could recharge, but and activate
online.

An essential component of VMs brand strategy was to provide superior customer service.
VM consistently received the highest ratings in the UK mobile market for its customer care.

VM achieved the highest customer satisfaction rating in the prepay market in the JD Power
& Associates survey for 2004 and 2005, the first two years of inclusion. Customer service
rating in the survey was substantially ahead of all of its competitors. VM also won Best
Customer Service for the fourth year in a row at the Mobile Choice Consumer Awards
2004.

Promotion

The Virgin brand was widely perceived to be stylish, provocative and irreverenta true
original. But it was also well established, and had an aura of strength and credibility. It had
a tremendous market heritage. People of all ages responded to it. VM spent only 23
million (4.4% of sales) on advertising and marketing during FY2004. Whereas, Vodafone
spent 990 million during the same period.

VM won a number of marketing awards, demonstrating its brands effectiveness:

The top Gold Award at the IPA Advertising Effectiveness Awards 2004

Best Ad Campaign for Idle Thumbs at the Mobile Choice Consumer Awards in October
2004.

VM used high-profile sponsorship to remain in the public eye. It focused on music and
sports in line with the Virgin brand: dynamic and exciting, and which created opportunities
for bright new talent. VM was also supporting a British Superbike team and the R6 cup,
which was designed to find and promote young, up-and-coming talent to the main
Superbikes circuit.

VM Louder was the name used for all music sponsorship activities. Every summer,
hundreds of thousands of music fans flocked to the VFestival, for which VM sponsored.
During that time, VM

had brought VFestivalgoers innovations such as Text the Fest on the main stage screens,
and free beer for VM customers. Virgin Mobile customers were given preference for V
Festival tickets before they officially went on sale, and received exclusive invitations and
free tickets to one off gigs, shows and events (See Exhibits 6 and 7 for images from
VFestival events). The company also sponsored a UK-based motorbike racing team.

According to VMs brand and marketing director, Andy Mallinson: Salt and pepper, cheese
and tomato, ham and eggssome things are just meant to go together. Our sponsorships
focus on activities that ideally complement our dynamic and exciting brand. From
Superbikes to music festivals we strive to connect with people with plenty of get-up-and-go.
Our sponsorships focus on music and sportson activities which are entirely at home with
the Virgin brand: dynamic and exciting, and which create opportunities for bright new
talent.b

VMs TV advertising had been recognized as amongst the most entertaining in the UK, and
unlike the frequently broad-brush advertising of its competitors was completely targeted at
the companys chosen segment. Virgins The Devil Makes Work For Idle Thumbs
television campaign won the 2004 Mobile News award for Best National PR/Advertising
Campaignan award also won by VM in 2000 and 2001.

Organization and culture

VM employed talented, motivated people, irrespective of their age, sex, sexual orientation,
physical abilities or religious beliefs. An important recruitment channel for the company was
its own website, and many of its employees had become aware of the company by being
Virgin Mobile customers.

Virgin Mobile believed in clear communication and consultation with employees on matters
that affected themfrom the working environment to the companys performance. An
Employee Forum that consisted of elected employees represented the concerns and
interests of staff to management. Employee satisfaction surveys were conducted twice a
year, with over three- quarters of employees regularly reporting that they found the work
atmosphere upbeat or pretty good. VM regularly featured among the top places to work in
the UK, and in 2005 was included in The Sunday Times Top 100 Best Places to Work in
Britain.

VM emphasized a jeans and T-shirt culture. There was a rack by the elevator banks
where visitors were asked to deposit their ties. VM had a roughly 50:50 male to female split
and ages ranged from early 20s to over40s. Staff was allowed to wear casual clothes and
music could often be heard playing in the office. There was a great sense of respect for the
workers.
In July 2004, when VM was floated, the company gave all eligible Virgin Mobile employees
shares in the company. The company ran a scheme that made it easy for any new Virgin
Mobile

b Empower staff, leave them alone, and get results, B&T, June 25, 2004.

employee to become a shareholder in the company. Save As You Earn enabled

employees to make regular savings with an option to buy shares at the end of a three year
plan.

All employees received a free Virgin Mobile phone as a matter of course; and all are
members of the Virgin Group Tribe scheme, which offered a range of discounts on products
and services from across the Virgin Group, as well as other organisations. Virgin offered
three additional days holiday after three years service and after one year, people were
entitled to take a three month (unpaid) break. Virgin encouraged its staff to get involved in
charity and community work, and provided an additional five sabbatical days each year for
employees to take at their discretion.

VM kept employees updated regarding its operational and financial performance. The CEO
wrote a letter to employees about the companys results. Employees were encouraged to
discuss company strategy, results and goals at staff conferences and through other
communications. The annual staff conference was part work, part fun, and included a
strategy briefing and Q&A with top management, where staff had the chance to quiz the
executive team on anything and everything. This was followed by a weekend-long party
where VM people could celebrate with each other, their family and friends.

Its the little things that make it worthwhile working here, like receiving a Christmas card
from Richard Bransonit makes me feel valued by the whole company. Laura Coggins,
Team Manager & Customer Service Specialist.

VM did not have a layered management system and so had quite low staffing levels. Hence
people had greater responsibility and accountability, and put in longer hours. According to
Andy Mallinson: The most important thing is that we empower people to do the job, we
give them the tools to do the job properly and just let them do it.were not looking over
their shoulders all the time.c VM operated a thank you scheme called SHOUT!, which
lets its people nominate colleagues who had done a particularly good job. These
exceptional employees were eligible to

win a European weekend city break every month.

Mallinson remarked: The first step was to make sure employees were provided with a good
package and a decent wage. But beyond that what makes a great employer is what you
add on top of that. We have a great culture in our company where we have huge respect for
the individual. We have fun and we dont work in a culture of blame. Branson had always
maintained that if the staff were looked after, they would do a good job, leading to satisfied
customers and happy shareholders. In his own words: Convention dictates that a company
should look after its shareholders first, its customers next and last of all worry about its
employeesVirgin does the opposite. For us employees matter most. It just seems
common sense to me that if you start with a happy, well-motivated workforce, you're much
more likely to have happy customers. In due course the resulting profits will make your
shareholders happy.

The competitive environment

Virgin Mobile had carved out a highly differentiated niche in the UK mobile market during
the first five years of its existence. While its main rivals had attempted to serve a wide range
of customer segments with broad product and service portfolios, Virgin had remained highly
focused on its target customer segment. But by early 2005 some analysts were questioning
the sustainability of Virgins strategy in the face of a number of new developments.

EasyMobile

The most tangible example of higher competition in the UK had been the launch of
EasyMobile, a 50:50 JV between EasyGroup and TDC, a Danish network operator that had
been challenged by low-cost MVNOs in its home market. VMs share price fell 15% within
days of the EasyGroup announcement of its intention to launch a mobile offer.

EasyMobile was based on a concept pioneered by no-frills MVNO Telmore in Denmark.

Since its inception in November 2000, Telmore had captured 9% of the total mobile
telephony market in Denmark through a simple, transparent and low-cost internet-only
model that had proved a big hit with customers. It had led a massive price decline in mobile
prices, with charges for voice calls dropping 54% in 2003 alone. By early 2004 Telmore had
reached 500,000 customers to become the fourth largest mobile operator in Denmark. The
basic elements of Telmores approach that were to be replicated by EasyMobile were as
follows:

Uniform product for all

no handsets, only SIM-card provided

no subscription fee

one tariff all the time

no portal or complex multimedia services

All interaction via the Internet or over the mobile phone via SMS

adding on/canceling services

recharging account/call specifications/balances via text messages

self service FAQ/trouble shooting

minimal telephone service

Low cost operation

no network infrastructure

no high-street shops

flat organization with few employees

minimal marketing budget

all subscribers pre-pay

EasyMobile launched in March 2005 with aggressive headline tariffs for the first three
months, offering customers six pence per minute (ppm) for all calls (to fixed or any mobile),
and two pence for SMS (again both on or off-net). From June, EasyMobile indicated that
calls would move back to the original levels of 15ppm for all mobile and fixed calls and 6p
per SMS.

Carphone Wharehouse Fresh

Following EasyMobiles launch one of the UKs biggest mobile retailers Carphone
Wharehouse reduced tariffs on its own MVNO Fresh to make them mildly cheaper than
those offered by EasyMobile. The highlights of the new tariff included: Off-net mobile calls
5p per minute (compared to 35p per minute on VM standard prepay tariff). This was
expected to move back to 15p per minute in mid-June. All SMS 1.7p per text (compared to
off-net SMS 10p on VM, on-net 3p). This was expected to move back to 5p from mid-June.
Fresh had acquired approximately 150,000 customers by March 2005. Like Virgin Mobile,
Fresh utilised the T-Mobile network.

Hutchison 3

In addition to the new pricing pressure from EasyMobiles arrival and aggressive tariffs from
Fresh, the UK market was being impacted by the aggression of new entrant 3 and the
emergence of Tesco Mobile. 3s marketing campaign began in January 2003, with an initial
launch plan to set brand credentials. Coverage was 4045% at launch, rising to 6070% by
the end of the year. Outside of 3G coverage areas 3 had 22.5G national roaming in place
with O2. The company focused on lead services such as Video Telephony and Football
clips in the run-up to network launch on March 3. Industry commentators believed that the
initial campaign provided poor positioning, and unclear brand values. Much of 3s initial
advertising was mixed in terms of look and feel and key messages, and consumer uptake
was slow. But perhaps the biggest hindrance to adoption was pricefew customers
required more than the 200 to 500 minutes offered by the top-end packages of competing
carriers, and these deals were offered at a price that was 3040% cheaper than the initial
3 base package. Customers also appeared to be unwilling to pay extra for added services
that were perceived to be not much different (perhaps with the exception of video
messaging) to services offered by competitors such as Vodafone live!

In an effort to boost 3 UKs poor performance the company executed a strategy review and
turn-around plan. The company slashed its tariffs to levels that were significantly below
Virgin, traditionally the lowest in the UK market. The company launched a new advertising
campaign that focused heavily on the new 3 value propositionvoice calls at only 15p per
minute, and no minimum contract. From late 2003 3 also began offering free phones with
some offers, and

launched an offer of 100 voice minutes per month for only 15. It appeared to industry
observers that the new tariffs represented cuts beyond the break-even level, and were
clearly designed to deliver a user base as rapidly possible, in the hope that use of its
services would grow rapidly and compensate. It seemed that 3 UK was betting everything
on growth over a 1218 month horizon.
Combined with improvements in network coverage, 3s realigned strategy had an
immediate effect. The company started to see its market share grow rapidly, although from
a small base. Given that the company was able to offer customers larger and larger
bundles of minutes at very low marginal cost, it aimed to compete head-on with the
incumbent providers on price. By mid 2004 3 was adding over 60,000 new customers per
week, and by mid 2005 reported a customer base of 3.2 million. 3 believed that it would hit
the 4 million customer mark by the end of the year.

Interestingly the company had been able to rebuild its brand as a technology innovator, and
was seeing increasing uptake of its value added services by subscribers. There had been a
clear change in the skew of the companys UK growth towards prepay, with 68% of the net
growth in the UK base in the year to March 2005 coming from prepay subscribers. The
company was continuing to target high-end prepay users with big yield discountsmore
than 50% depending upon the bundle.

Tesco Mobile

Tesco Mobile, a 50:50 JV with O2 had shown significant customer momentum since launch
in late 2004, with an estimated 750,000 customers signed up by mid 2005. Tesco had used
its distribution power to target the family segment of prepay, with the main value proposition
being one of simplicity with flat rates per minute and no differentiation between peak and
off-peak usage. Since Christmas, Tesco had doubled the space given to its MVNO offering
(though retaining the space given to rival offerings). Together with an improved range of
handsets and a new pricing offer, Tesco had seen sustained growth and boasted of a target
of up to 2 million customers longer-term. The main features of its tariff offer were:

All mobile calls 20p per minute

All calls to fixed line 20p per minute

All SMS 10p each

Scheme to allow half price (at 10p per minute) calls to three favourite phone numbers (fixed
or mobile).

Family and Friends number offering.

A proven non-food retailer with growing share of the Electronics market, Tescos mobile
growth was being closely monitored by industry analysts, particularly with O2s 50% share
and continued Chairmanship of the venture.

Reactions of existing competitors

The established operators had not sat still in the face of actions by companies such as 3
and Tesco. O2 had won significant prepay market share in 200405 with new bundled
offersadding

1.1 million new customers (785,000 prepay and 335,000 contract) over a twelve month
period. Orange also launched a series of special promotions in 2004 based around tailor-
made monthly programs, while Vodafone had launched a concerted marketing campaign to
target what it described as the young, active, fun segment via its Vodafone Live! Portal,
new prepay packages and a marketing campaign with British footballer David Beckham. T-
Mobile UK had been working to increase its store base, build brand and grow customer
acquisition through a more aggressive approach to the market. All of the established
operators had focused on reducing prepaid subscriber acquisition costs, and by 20042005
Orange and O2 had achieved SACs that were significantly lower than Virgin (see Exhibit 8),
whereas Vodafone and T-Mobile were roughly on- par.

Impact of intensified competition upon Virgin Mobile

In the face of intensified competition, VMs percentage share of prepay net adds had
slowed since the highs of 2003/04, and had become far more erratic (see Exhibit 9). By
March 2005 VMs voice pricing was still cheaper by a significant margin than for the four
established operators. Vodafone was approximately 19.6% more expensive than VM, and
O2, 14.4%. But Fresh, EasyMobile and Tesco were all significantly cheaper using the same
usage assumptions. For instance, both Fresh and EasyMobile were 62.6% cheaper than
VM, whilst Tesco was 20.1% cheaper. 3 was 27.9% cheaper than VM for usage alone. The
level of competition for SMS traffic had also become much more intense. While VMs
pricing for on-network SMS at 3p per text had been industry-leading up until mid 2004, its
off network charge of 10p per text was relatively expensive. During late 2004 other
operators launched SMS buckets that, assuming full usage, offered texts on and off network
for about 34p per text.

Perhaps not surprising given this intense competition, VM stated in early 2005 that
advertising and customer acquisition and retention costs would rise in 2005, and guided
EBIT margins downwards. But Tom Alexander was bullish about the future:

While new entrants continue to come into the marketplace, Virgin Mobiles performance
goes from strength to strength. Success in the UK mobile market is based on a combination
of factors, rather than on price alone. As markets mature, our key strengthsgreat
customer service, deep consumer insight and a strong brand imageare increasingly
powerful differentiators.d

Virgin Mobiles profitability

VMs financial and operating performance to March 2005 represented the fifth successive
year of double-digit revenue and EBITDA growth for the business. While revenues had
grown from 76.2 million to 521.3 million over the previous five years, profit margins had
also expanded, with EBITDA margin reaching 19.2% in 2005, and operating free cash flow
margin reaching 16.2%. In the 2005 financial year ended March 31, Virgin grew its active
customer base to over four million Meanwhile service revenues grew by 16.2% for the year.
These gains reflected an increase in market share in both customers and revenuesall
with a minimum of investment. As Virgin had grown it had been able to keep its operating
costs flat, driving down average cost per customer by 23% while maintaining the best
customer service in the industry. The companys ability to grow with minimal investment
resulted in operating free cash flow of 84.5 million, or a margin of 16.2%.

But despite these results, Virgin Mobiles share price fell 7% on the announcement of its
results as the company indicated it saw competition in the UK mobile market continuing and
a further flattening of service revenue growth. Active subscriber additions were lower than
forecast, with the company adding 417,000 net additions in the Christmas quarter.
However, taking into account higher churn and a falling active subscriber proportion to
77.2%, Virgin Mobile only added 276,000 active net subscriber additions. This was around
half the number of active net adds that Virgin Mobile added in the December 2003 quarter.
Interestingly, Virgin also seemed to be drifting from its traditional positioningby March
2005 more than 50% of the companies subscribers were over the age of 35.

In addition to reduced additions, margins had been negatively impacted by two key
developments in the market:

Termination rate cuts: Termination rates were cut by 30% by the UK regulator in
September 2004. This resulted in gross margin for inbound voice declining to 61.4% in the
year to March 2005 from 68.5% in the year to March 2004.
Decreases in outbound voice and SMS yields: The trend of increasing bundling of
minutes and SMS by mobile operators negatively impacted Virgins per minute and per
message yields. Given that Virgin Mobiles incremental cost of capacity was broadly fixed
(rate payable to T- Mobile), gross margin suffered as yields declined. Analysts forecast that
outbound voice and SMS gross margins would decline to 56.0% and 72.8% in the year to
March 2006 from 57.1% and 73.3%in the year to March 2005, but that this scenario could
be worse in the case of a more extreme competitive situation.
Due to its variable cost base, Virgin Mobile was much more exposed to a decrease in yields
than traditional network operators, and was also highly geared to a change in churn and
SAC levels. A change in competitive activity in the UK had the potential to significantly
impact margins in Virgin Mobile, as demonstrated in Exhibit 10. According to analyst Bear
Stearns International:

We currently forecast an EBITDA margin of 19.6% in the year to March 2006, churn of
25%, and SACs of 27 (25 in year to March 2004). If SACs were to increase by 4 to 31,
and churn from 25% to 30%, we estimate that margins would compress by 290 basis points
to 16.7%.

Despite the concerns of the analyst community regarding Virgins exposure to increasing
competition, VMs Chairman Charles Curassa remarked: Turning to the future, VM is very
well- positioned to continue to grow revenues and earnings. We expect further growth in the
prepay segment, through the development of new products, services and innovative
distribution. Weve also broadened our offer to encompass new areas of the marketin
particular the consumer contract sector. These new areas offer exciting potential future
growth prospects for the Company.

Moving forward

Without the concerns of network constraints, rollout and investment, Virgin mobile had
experienced success over the period 19992004 by leveraging its understanding of the
consumer and targeting the burgeoning prepay market. And CEO Tom Alexander believed
that Virgin was in a good position to continue its track-record of success:

We have enjoyed great success in the prepay marketand well continue to do so. It
remains a constant focus. There is still plenty of growth to come, as we continue to
introduce innovative products that challenge market norms. Our superior customer service,
an essential part of our strategy, differentiates us from our competitors. Were confident
these advantages will continue to attract customers away from our competitors, while new
services and technologies will help to increase the value of our existing profitable base. We
have a solid base on which to build. We know we can count on our products, our proven
commitment to customer service, and most of all, our talented, passionate, dedicated
people, to ensure that we continue to capitalise on the many exciting opportunities the
market offers.

But would Virgin Mobile be able to sustain growth and profitability given the changes
underway in the UK market by early 2005, or was it about to be overtaken by aggressive
new rivals such as 3 and Tesco?