Customer Segmentation

Customer Segmentation

Definition:

Customer segmentation is the process of separating your customers into sub-groups that are homogeneous (similar) within and heterogeneous (different) between.

What it is: Customer segmentation creates sub-groups of customers that can be approached using similar strategies and tactics to attract, convert, and monetize them for your products and business.
What it does: Having unique customer segments (subgroups) allows a company to have different product offerings and four Ps strategies targeted at specific customer segments. It can target the development of new products and services for your customers. It can help you define where and how you will launch a new product, business, or company.

Uses:

How is it used: Being able to use a unique product offering, finely tuned to the needs, wants and desires of a homogeneous (similar) customer segment, will maximize market share penetration into the desired targeted segment. The same company can offer different products, specifications, services, pricing, complementary services, products, etc. to maximize market segment penetration to a different market segment.
Where: Customer segmentation can be used for many different purposes, in many different segmentation processes:

To create a unique product offering that best meets the needs of a specific group of customers and increase the market penetration into that customer segment.
When one customer segment can afford to pay more for a product or service because of the value that product or service creates for them, the selling company wants a unique product offering for that segment so they can charge a higher price.
When one customer segment needs a specific version of the product that is more costly to produce or deliver, then you want a unique product for that market to charge a higher price to cover your additional costs.
There may be a customer segment you choose to sell to only opportunistically, because they will not pay your full price. So you only sell to them when you have excess production. The rest of the time, you only sell to customer segments who will pay your full price.
A company might have a unique product and four marketing Ps strategy (Product, Place, Price, and Promotion) through a channel to serve a particular customer segment. In this case, the targeted customer segments are defined by the channels that serve them. Some examples might include products sold in a gas station, by an appliance repair shop, near the checkout stand in a store, at a carnival, etc.

Product specification differentiation: There are some customer segments that require different levels of purity or unique specification for a product. Identifying the customers who require different product specifications can help you create unique customer segments.
End-use applications: Customers who make different end-use products or use your products or services for a different application can be the source of segmentation.
Industry segments: There are times that industry expertise can be required to sell into a specific customer segment. Separating customers by industry can allow for targeted expertise to be applied to that industry-focused customer segment.
Customer needs segments: There are sometimes segments based on specific needs or purchasing approaches used by companies. Segments can be based on customer aggressiveness, risk avoidance, supplier loyalty, brand preference, channel preference, delivery needs, etc.
Brand preference: Customer segments can be made based on the willingness of customers to be loyal to a brand. Proctor and Gamble has several brands for each type of product (detergent, shampoo, skin cream, etc) based of price points, specialty uses, and brand preference.
Price preference segments: Segments can be based on low price buyers, value buyers, and customers to whom price is not the deciding factor. There are many customers who do not have a driving need to decide on suppliers based on price. Take brake fluid as an eample: What if Toyota saved $0.50 per car by finding a cheaper brake fluid, but the cheaper fluid increased the number of accidents their customer had (opening them up for lawsuits). Would Toyota use price to make their decision, or product quality and supplier assurance? The price difference between the brake fluid suppliers is not enough, compared to the risk, to impact the purchase decision.
There are many more factors that can affect segmentation, too many to list them all here. You decide the segmentation approach based on how your customer base segments their purchasing decisions.
Reasons why a company might use customer segmentation include the following:
Here are some customer segmentation processes and approaches:

Why: You segment customers so you can focus your product offering onto the issues that your targeted customer segment values. You can waste a lot of money trying to attract customers with an expensive product specification additon to all of your products, when only one segment of your customers values and will pay for the addition. You can focus your costs and price on how each customer segment makes their decisions.

Limitations:

Where it shouldn't be used: There are times you should not segment, such as in the following eamples:

When the segments are so small that you can not afford to have unique marketing strategies for them.
When you can not identify the unique customers within a segment or communicate the unique product offering to them.
When you do not have a mechanism to differentiate the price you charge to the different segments that will pay the price differences.
Any time that the cost of segmenting, creating unique products and services, communicating, or tracking and serving the customer segments is more than the revenues you can increase.

Any restrictions: None
Warnings: Not using customer segmentation can be a very expensive mistake. Consider the following example: The two largest customer segments for minivans are family minivans (bought by soccer moms) and delivery vans (bought by delivery companies and repairmen). Soccer moms want windows, soft seats, safety, dvd players, cup holders, and in-floor storage. Repair and delivery men want bare metal walls, no windows, shelves, no seats, and maximum room to carry things. I want to sell a minivan that would appeal to the entire market, so I will offer a minivan that has what both the soccer mom and delivery man wants. On the drivers side of the car will be the bare walls and no windows that the delivery man wants, and on the passenger side of the car will be what the soccer mom wants. It has something for everyone, I will sell millions. But in truth I will not sell any, because the soccer mom will buys minivans that have what she wants throughout the entire car, and the delivery man will do the same for what he wants. The companies that segement and provide minivans specifically to their target customer segment will make all of the sales. If you do not segment, you may be out of business soon.

Demonstrations:

Step-by-Step Process:

Establish the customer segmentation purpose and priority:

Why are you segmenting your customer base? What do you hope to accomplish?
Who will do the segmentation? Do you have the right mix of commercial, technical and functional people involved to understand the customer base well enough to succeed at the segmentation?
What is the customer base you will segment? Have you targeted the customers you will segment?
Hypothesize some likely segmentation criteria to consider.

Analyze available customer data: Utilize all sources of customer information to define who the customers are and how you might segment them.

Market structure: How do suppliers, customers, and industry organizations align in the market?
Current customer information within the company, including data for the following questions:

What are the key selling points that win an account?
Why do customers generally cancel?
Who is our marketing directed at and why?

Sources of information to utilize in hypothesized segments:

Market experts and their publications: How do they segment the market? How do they define your market and your competitors?
Competitive information: Review competitor websites for their marketing messaging, promotions, sales content, and product features. Who are they targeting? Do they segment their website content, messaging, and product lines? If so, why?
Structurally similar industries: Review industries with similar organizational characteristics to your own market. Doing so can provide clues that reveal special structural characteristics that define its segmentation.

Collect data: Collect and document all of the data.
Interpret the results: Utilize a variety of methods to try different hypothesized segmentation approaches. Plug in the data to see if the methods reach your desired outcomes:

The segment definitions are meaningful and intuitive. They make sense and do not require a lot of complex reasoning to define.
Measure customer quality by considering how highly the customers in the segment score on your factors of desirable customers
Measure segment size to see if the segment will be worth a unique market mix.
Forecast segment growth to see if the segment growth is attractive.
Cluster analysis: Try clustering customers with common factors using simple techniques like tables or sorted list and common factor grouping. Then try more complex approaches such as tree analysis, multi-factor regression analysis, and others (see customer segmentation guide for B2B in the example section for more information).
Composite segmentation: Once you have conisdered the different hypothesized segments, consider making hybrids or composites by combining some of the segmentation criteria or approaches.
Measure viability of segments: Not all segments are worth targeting. Consider the factors below for any suggested targeted customer segments (see the B2B link in Examples for more details):

The segments are well-defined and preferably demarcated by observable variables. It does not take a lot of effort to classify the customers by segments.
The segments are addressable using modern communication and marketing tools (this typically follows the previous requirement).
The segments are substantial enough (in terms of number of prospects or economic benefits) to be considered an integral part of strategy.
The segments are sustainable and will continue to be a meaningful part of the market, growing at least as fast as the overall market.

Evaluate the value of the potential segments:

Present the results: The purpose of the presentation is to explain the customer segments and why you selected them. It is also used to document the process and the information used in the anlysis. Most presentations will include these points:

A description of the original decision to complete the customer segmentation and its purpose
The people involved in the study and the stakeholders
A brief description of the methodology used (more extensive description in the appendix)
A listing and description of the segments selected and why
A review of the segments not selected and why
Insights gained in the process
Next steps going forward to implement the customer segmentation strategy