Customer Segmentation

Customer Segmentation

Why Most Companies do it Wrong -- And How to do it the Right Way

So, you’ve wisely decided to focus on proper customer segmentation in creating, growing and evolving your business. Now, you’re facing one of the most important questions of all: ” Where do I start?”

Before we get into that, what does customer segmentation mean and why do we do it?

Overview of customer segmentation

Customer segmentation, sometimes referred to as market segmentation, is the process of dividing your customers (or prospective customers) into unique groups that share one or more common traits. However, customer segmentation is not simply grouping by obvious traits (e.g. age group). Rather, the goal is to group people based on their needs or purchasing pattern for your specific product.

Ultimately, the goal of customer segmentation is to learn about your customers wants and needs, allowing you to direct your marketing spend where it is most useful, refine the message, and develop products and services that meet each segment’s needs. It can also help you identify new opportunities by finding under-served segments.

The good news: there’s no shortage of great advice readily available from industry experts—real-life entrepreneurs from across a full spectrum of vertical industries who can speak from valuable, personal experience.

The challenge: not all of those experts agree on the best way to segment a market for best results.

For an overview on  customer segmentation strategies — as well as get a glimpse into the diverse range of opinions on the subject — let’s examine the views of two well-know authors on the topic: Brent R. Grover of Evergreen Consulting, LLC and Louis Stern of the Kellogg School of Management at Northwestern University.

How many groups?

Like the majority of customer-segmentation authorities, Grover agrees that it’s critical to focus on customers with the greatest potential for profit. The fastest way to identify them, he says, is to divide your customers into groups.

How many groups? “A meaningful segment,” Grover suggests, “is any group of customers that meets three criteria: they are identifiable by common characteristics, they are profitable, and they are growing.” For simplicity — and to retain focus — he observes, “it makes sense to keep the number of segments as small as possible.”

Often, customer segmentation can be as simple as identifying as few as two customer groups.

Grover offers an example from his study of distribution businesses. A distributor of foodservice items divided its customers into just two segments—hospitals and nursing homes.

“The two segments appeared, on the surface, to be one segment (healthcare),” Grover notes, “but the distributor quickly found that different types of salespeople were needed to serve the two segments better — and more profitably — than a single sales force serving only healthcare accounts.”

How could the two customer groups possibly be so different? After all, they were purchasing similar products and services from the same provider.

Simple answer: things change.

In this case, the rapidly growing hospital audience had become quite predictable. The entire industry was moving toward group purchasing, with exclusive, long-term contracts awarded to vendors based primarily on brand preferences and pricing. Nursing homes—on the other hand—tended to choose suppliers based entirely on relationships. Customer service was the key factor. Treating both groups the same in product planning, marketing and customer-service efforts would have been a huge waste of resources.

Leave no customer segment unturned

As for common, identifying characteristics, Grover suggests searching for as many clues as possible that a customer group might be profitable and growing: industry type, frequency of purchase, product mix purchased, order method, delivery method or just about anything else you can measure.

Use trial and error. Test different possibilities. Grover cites an example of a power transmission component distributor who gauged common customer characteristics—industry, geographic location, and frequency of purchase and product mix. Customer-profitability rankings revealed that product mix and purchase frequency were highly correlated with profitability. Customers who were more organized and consistent in purchasing patterns placed larger, more profitable orders.

One especially profitable customer segment emerged as a total surprise. They were redistribution customers, who purchased products for resale. Based on sub-standard profit margins, this group had been deemed “second class” customer citizens. Upon closer analysis, it was quickly determined that this profitable, fast-growing segment deserved special attention.

Look for these high-profitability characteristics:

  • Large orders
  • Fast payment
  • Lower service needs
  • Customers with inventory-management/order-entry tools

The bottom line, according to Grover, is that identifying your most profitable, fastest-growing customer segments is the roadmap to your company’s future. It lets you know precisely where best to concentrate your efforts and investments of time, money and human resources. It also helps you quickly zero in on those customer groups that should be protected at all costs, as well as those that need work in order to be worth your time in the long run.

“The way most companies segment customers and markets is just totally wrong.”

Louis Stern of the Kellogg School of Management at Northwestern University is a noted authority on customer channels. To him, ” major problems arise when suppliers want to reach heterogeneous customers with different service needs.” His answer: needs-based customer segmentation, followed by mapping out a series of channels that can provide appropriate levels of service to each customer group.

“This is not about training and rebates and pricing,” Stern says, “it is about saying, ‘I know this particular set of customers want a lot of product variety, small sizes and proximity and instantaneous delivery’ and setting up a channel which will meet their needs. Sure, sometimes customers will buy from a different channel — that is channel competition — and if they stray over, that’s OK from time to time. But if I plan it properly, they will not walk into my dealers expecting them to look like my sales force, and they will be willing to pay extra for services.”

Stern has serious disagreements with the way most companies approach segmentation:

“Most companies still cut up their markets by describing the external characteristics of the groups who make it up,” he says. “So they talk about consumers, small business and large accounts or the French or German markets. This is what I call the ‘demographics’ approach.”

So, what’s wrong with that?

“It doesn’t tell you anything about the real needs of your customers,” according to Stern, who notes that this isn’t just academic theory—it’s serious bottom-line business. “It is much better to analyze your customers by their needs and to develop products and services which meet those needs. People who do needs-based analysis are the ones who are going to make pots of money!”

Asked for an example, Stern proudly points to the non-traditional thinking successfully deployed by one of his former students (now a professor, as well).

The former student was consulting for a caterer who was designing bars and restaurants to be built in an airport. A typical demographic analysis might focus on four groups — business people, groups, airport employees and tourists — and build facilities for each.

But Stern’s student knew to do a needs analysis, as well. His research showed that what was really important was the amount of time customers had available. Those with more time typically valued increased service levels, while those with less time want faster food. His solution addressed the underlying needs of travelers in a way that a traditional demographic analysis would have overlooked.

Why listening to customer complaints is critical

According to Stern, many companies make the critical mistake of moving directly to focus groups to find out what customers want. “Customers cannot tell you what they want—they can only tell you what they don’t like about your products and services. They can’t tell you what they want, because they haven’t actually seen the new product.”

“Typically, companies are bad at listening to complaints and criticism from customers—the area where feedback is most useful and quite reliable. If they were better at this, they could quite easily make big improvements in what they do.”

Segmenting customers carefully can help you plan for the future, knowing where to deploy financial, customer-service and human resources. It can also help you maximize profitability by knowing which customer groups to protect at all costs, as well as those who require additional attention.

For more information about segmenting customers for maximum profitability, contact us today!

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