Customer segmentation
The concept of segmentation has its roots in companies like Proctor & Gamble where consumer-marketing companies recognized the value of dividing customers into groups or segments. These packaged goods companies could effectively focus resources promoting specific products into specific customer groups where they would produce the highest possible revenue, at the lowest possible costs.
Initially, simple demographic segmentation was used as packaged goods companies promoted products such as perfumed soaps to women, while to men, they would promote a more sharp and spicy fragranced soap, smelling much like an aftershave. It was eventually discovered that not all men and women wanted the fragranced soaps. Some because they did not care for the smells the soaps imparted, and others for the simple fact that some needed to avoid the scented soaps so as to avoid an allergic reaction. These types of discoveries illustrate the value of segmentation to help provide a means to divide (and conquer) a market.
We experience segmentation today in virtually every facet of our lives, whether it is the commercials we see on TV, the advertisements we see in magazines and the customized ads we see online, the targeted mailings we get both online and offline, the packages that are offered from our phone and cable providers, and others. Virtually everywhere we turn we are being segmented and served advertisements and products that have been tailored to meet the needs of the segment we are a part of, sometimes, even if the segment is very, very small.
Simply defined, market segmentation is the division of customers into groups we can target for future products, research, or market messaging. According to Philp Kotler:
"Market segmentation is sub-dividing a market into distinct and homogeneous subgroups of customers, where any group can conceivably be selected as a target market to be met with distinct marketing mix."
What we are really trying to accomplish with segmentation is relatively simple and straightforward. We are working to divide a broad target market into subsets of customers, who have common needs and priorities, and then work to design and implement strategies and products to target them.
Segmentation is a key marketing tactic/strategy that has a large bearing on the organization both before a VoC analysis is undertaken, as well as after. Before we conduct a customer VoC initiative, we need to step back and figure out just who are our future and current customers? If I were an automobile manufacturer with a range of automobiles from an entry-level fuel efficient two-seater to a $100K luxury car, would it make sense to do a customer VoC for the high-end $100K luxury car with a middle-class recent graduate? Probably not. It is unlikely he will be in the market for this particular automobile so his wants and needs (and ability to pay) are not consistent with the target market. On the flip side, after a customer VoC is deployed, we may learn specific attributes or needs for a target segment that we can put into our new products, or deploy as part of our marketing campaign.
Organizations have a number of reasons to look at segmenting their markets. The main reason, as discussed earlier, is to develop a target market. Once this is accomplished, it is much easier for the marketing team to develop more in-depth understanding of customers within that segment, as it is a smaller group. By the same token, it also becomes easier to understand the competitive landscape within a more narrowly defined segment, it becomes more effective at developing marketing campaigns in a more defined segment, and opportunities for differentiation are more likely discovered in a narrower band. As we know, it is very difficult to have mass-market appeal for the majority of products in the market today, so segmentation allows companies to focus their resources where they will derive the most value.
This division into groups can be based on a number of factors, but usually, we like to see one or more of the selection criteria to be an important characteristic relevant to their purchase or usage behaviors. Some of the typical ways to segment a consumer market are as follows:
- Geographic segmentation: Marketers can segment a market according to country, region, states, locales, cities, neighborhoods, or postal codes. With respect to region, marketers would find willing customers for such things as snow blowers, gloves, and thick warm coats in the Northern part of the United States but would not find as much success or demand in the South and some Western states of the US.
- Demographic segmentation: Using such variables as age, gender, religion, ethnicity, income, family size, occupation, and social class marketers can divide a market to best target their likely customers. The US census bureau uses demographic segmentation when it conducts its census every ten years. This information is also available for the public and can be used to aid in your own demographic research.
- Psychographic segmentation: In this type of segmentation, buyers are divided into different groups based on lifestyle, personality, or personal values. Whether someone is outdoors oriented, sport oriented, or entertainment oriented are examples of psychographic segmentation.
- Behavioral segmentation: In this case, buyers are segmented on the basis of their knowledge of, attitude toward, use of, or response to a particular product. These can be classified as to whether a customer is a user of a product or not, what drives when the user needs a particular product, the benefits they achieve in using a product, the frequency of product use, user brand loyalty, attitudes toward the product, and how ready the user is to purchase the product.
Like consumer markets, business markets can also be segmented using similar variables like geography, benefits sought, and usage. The variables defining the segments vary somewhat from the consumer markets, but are very similar in concept and execution as the consumer segmentation. Some business segment variables could be considered as follows:
- Demographic: What geographical locations do they serve? How many locations do they have?
- Business: Which industries do the companies operate in? What is the company size and finances? What products do they sell and who do they sell to? Is the company private or public?
- Operating variables: What types of users should we target and what serves/functions do they require? What customer technologies are required?
- Purchasing approaches: Do we target companies that are quality oriented, price oriented, or service oriented? Should we target companies with centralized or decentralized purchasing and will we target companies who prefer to lease or buy? Do we target companies where we already have a strong relationship, or go after the most desirable companies?
- Situational factors: Should we focus on companies with large order requirements or smaller ones? Do we focus on companies requiring fast turn-around or long-lead times? Do we focus on certain applications of our product or the full suite of our offering?
- Personal characteristics: Do we focus on companies that show high amounts of loyalty to suppliers or focus on transaction-oriented companies? Do we serve risk-takers, or more cautious customers?
Once the preliminary market segmentation is complete, it is necessary to evaluate the segments against a set of criteria to insure the segments are properly defined. The following set of evaluation criteria should be followed to guarantee the segments are useable and businesses should only target the segments if it is:
- Homogeneous: Each of the customers/companies in the segment must be related to each other in some way and similar in terms of needs and/or characteristics.
- Heterogeneous: Each segment of consumers/companies should be relatively unique as compared to the other segments. This results in different customers grouped by differing need.
- Measurable: There should be some form of measurement available as to the size of the segment so the overall number of customers and attractiveness of the segment can be considered.
- Substantial: The segment should be large enough to warrant the organizations attention to return a benefit to the organization by investing in the segment. Often, organizations may conclude that a segment is desirable, but not large enough to invest into.
- Accessible: The organization must have the ability to reach the segment through distribution and communication.
- Practical: The organization must have the capabilities to develop products and services to address the needs of the segment.
The following is an example segment analysis done for a hypothetical automobile manufacturer:
First timer: Young person recently passed drivers license test with nominal income. Looking for low-priced transportation solution with excellent gas mileage. |
All about Luxury: Customers focused on having the best, most luxurious automobile with all the latest bells and whistles while taking a Sunday drive in the country. |
Family First: Family with two or more children needing safe effective transport for children to school and activities. |
Getting it Done: Consumers who use their automobile in the work environment and need to haul equipment to and from a job site. |
In this example, you see that each segment has been grouped according to a shared need, each segment is significantly different in what their purpose is for the vehicle, using demographic data we should be able to measure each segment, each of the segments are substantial enough to be targeted, the company likely has dealers that can address the needs of each segment, and we would assume the manufacturer has the capabilities to develop the vehicle to meet the needs of the various segments.
How to segment a market
A step-by-step process for segmenting your market is mentioned as follows. Depending on your segmentation goals you may only need to complete the first three steps, or may need to complete all six:
- Define the market: The first step is to define the market of interest. It is unlikely your market is the entire world, so as a first step, you must define who that would be. Looking at our previous example, we may define the market as the US automobile market.
- Create market segments: Now that we have defined the overall market, we need to determine which types of different consumers form that overall market. To do this, we need to review the list of segmentation variable we discussed previously (demographic, geographic, or others) and choose the ones that we think are influencing the purchasing behaviors of the market. As a starting point in segmentation, it is preferable to try and split the market using the largest criteria at first to divide the market, and then continue to further divide the market based on the other criteria. In the case of the consumer market, this would often be based on age, gender, or income as the first step. An approach which helps marketers to visualize and explain market segmentation is through a segmentation tree, as shown as follows:
Figure 3.8: Market segmentation for US auto market
- Evaluate the market segments: Assess each of the market segments based on the evaluation criteria discussed previously in terms of Homogeneous, Heterogeneous, Measurable, Substantial, Accessible, and Practical. If, for some reason, your market segments do not meet one of more of the evaluation criteria, revisit this step to and change the segment variables you have selected.
- Construct segment profiles: In this step, we want to take a deeper dive into the segments to try and understand them a little more. A segment profile is a detailed description of the market segment across a range of factors and is designed to provide the organization with a good understanding of customers within each segment for comparison and strategy purposes. A segment profile would likely outline important aspects of demographic and psychographic descriptions; segment size, share, and growth rate; segment needs; customer behavior; brand preferences, usage rates, price sensitivity, and others.
- Evaluate the attractiveness of each segment: Next, we will evaluate the relative attractiveness of each segment in comparison to the organizations goals and resources. We also evaluate whether this particular segment fits with our strategic direction, whether it is the best use of our resources, and to whether or not we are able to compete in this segment:
The following factors should be considered as part of this step:
- Financial: Is the segment the correct size for us, is the growth rate attractive, and what are the profit margins?
- Attractiveness: What is the competitive landscape and do we have the right channels to market? Consider incorporating variables uncovered during the Porter Five forces exercise and use this for additional consideration.
- Strategic: Does this segment fit with our organizations strategy and goals?
- Expertise: Do we have the right resources, technology, and capabilities to serve this market? Do we have, or can we develop, a brand in the segment?
- Opportunity costs: What is the range of other opportunities for the organization and is this the best use of available resources?
Entry and exit barriers: When entry barriers are high and exit barriers are low, few new firms can enter the industry and poor performing ones can easily exit. When both entry and exit barriers are high, profit potential is high but firms face more risk competition because incumbent firms stay in and fight it out, even when performing poorly. When both entry and exit barriers are low, entrants enter and leave the industry and the returns are stable, but low. The worst situation is where entry barriers are low but exit barriers are high. In this case, firms enter during good times, but find it hard to leave in lean times resulting in overcapacity and reduced profitability.
- Select target markets: Using the analysis you just completed, you can select the most appropriate target, or targets, for the organization. While you may not be able to address each point in step 5, at a minimum, you should consider the organizational strategy, the attractiveness of the segment, the competitive landscape in the segment, and the organization's ability to compete.
It should be noted that often, organizations that are performing segmentation analysis will give a descriptive nickname to the market segments. The purpose of the nickname is to create a moniker to quickly identify and understand the segment inside the organization during meetings and presentations. Ideally, these nicknames should be memorable and descriptive of the needs of the segment they are identifying. We have all seen examples of segment nicknames with the description of a generation of people born between the years of 1946 and 1964 as Baby Boomers, those born from the early 1960s to the early 1980s as Generation X, and the generation to follow, from the early 1980s to the early 2000s as the Millennial Generation.
Segmentation is typically part of the Segmentation, Targeting, and Positioning (STP) process within a company. After the segmentation is complete, this information can be leveraged to develop new products to meet the needs of the target segments, target those segments with this new product by position the company for success by managing the customer's perception, and understanding of key benefits of your new product. More details of the STP process and how to use it to position your product in the market will be discussed in Chapter 9, Completing the Circle – Using the Customers Voice in Your Organization.