What is Customer Segmentation?
Customer segmentation is the grouping of customers based on their commonalities.
Customer segmentation allows businesses to divide their target markets into specific groups. This is important for optimizing marketing spend and effective reach. Dividing a market into segments enables a more customized message.
Customers pay more attention when a marketing campaign is specific. Specificity sells.
A marketing campaign that pinpoints a consumer’s problem is more likely to convert.
For example, this is an advertisement I saw on a marketing blog I frequent:
Customer segmentation is more than just a way for businesses to optimize their marketing campaigns. Customer segmentation is a two-way street.
Both consumers and companies benefit.
Consumers benefit because:
- They feel like companies have their best interest in mind.
- Content and products address and fulfill their needs.
Companies benefit because they can:
- Optimize their marketing spend
- Increase customer lifetime value (CLV)
- Improve customer service and customer experience
- Implement optimal marketing channel selection for their each segment
- Improve product features and offerings
- Identify and cater to most profitable customers
This video from Steve Blank and Udacity discusses customer segmentation as it pertains to developing a product, but the points he makes cross-over to other fields as well.
So how does this differ from more traditional mass marketing strategies?
Mass marketing strategies cater to huge, ill-defined audiences. They aim for everyone and speak to no one.
The aim of mass marketing efforts is to create awareness for the product or service.
For a company as large as Coca-Cola, mass marketing works because the awareness they are attempting to generate isn’t specific to certain customer segments. They’ve turned Coke into a universally adorned and recognized product because of mass marketing.
But this isn’t always the case. For small and medium-sized companies, mass marketing is not only steeped in capital investment, but it’s also largely ineffective.
The point here is that mass marketing is ineffective and inefficient in most cases. This is why you need to understand customer segmentation and targeted marketing.
Note: If you’re looking for a more technical approach to Customer Segmentation read our article Applications and Methods in Data Science: Customer Segmentation. It’s full of code examples and technical and mathematical explanations for various segmentation elements and processes.
Outline
In case you’re like me and like to skip around, here’s an outline of this article. Click on the section titles to skip to that part of the article.
Types of Customer Segmentation
Customer segmentation is the grouping of customers based on similarities.
That’s GREAT, but how the heck do you segment customers into the targeted groups?
There are many ways to segment, but here are the most common:
Demographic Segmentation
Demographic segmentation refers to population statistics. This includes age, gender, religion, income, occupation, social class, or education level.
Demographic Segmentation: Income
A luxury brand can segment its customers based on income.
For example, Rolls Royce wants to target people with significant wealth. A Rolls Royce will cost $250,000 and up.
Marketing campaigns that speak to people making less than $100,000 per year don’t make sense.
Rolls Royce is likely targeting people with greater than $500,000 per year income.
Demographic Segmentation: Age
Age-based segmentation is another form fo demographic segmentation. It assumes that people in similar age brackets have similar needs, wants, desires etc.
LEGO is a good use case for age-based segmentation.
They can segment their customers into two groups. Those who want LEGOs (kids) and those who will buy LEGOs (adults).
In this situation, kids would be considered the users and the adults would be considered the customers. The customers buy the product for the users.
Customers can have many reasons for purchasing the product, but understanding the specifics allows for more targeted and effective marketing.
Customers, or parents, may buy LEGOs for their children to distract them. That way Mom or Dad can relax for 30 minutes after a long day of work while their child happily pieces together a LEGO spaceship.
If that’s the case, LEGO would be smart to highlight that kids never get bored with using the LEGO product.
Also, LEGO could include an educational element in their product marketing.
Something like, “LEGOs have been proven to improve children’s spatial reasoning by 75%.”
Or, as you can see, claim that LEGOs are “Pure Brainfood.”
The idea that LEGOs are good for children’s development makes it easier for parents to justify purchasing the product. On the other hand, this advertisement would likely do poorly with children.
LEGO could also target children with a campaign to entice them to ask for the LEGO product.
On this toy box, you see the advertisement geared toward children.
It’s busy.
It’s exciting.
The possibilities are endless.
But notice, there’s no mention of being “brainfood.”
By targeting either the users or customers, marketing campaigns are specific and personal. Marketing to both parents and kids with a generalized message, probably wouldn’t generate the same results.
Geographic Segmentation
Geographic segmentation is the process of dividing a market based on geographic location.
For example, In-N-Out is a company only in a few states. Many of their locations are in California.
Thus, their customer focus is on the lower west coast region of the United States. Not only does geographic segmentation increase In-N-Out’s exclusivity, but they consolidate business to maximize brand equity in an area where they are leading fast food chains.
More than just exclusivity, geographic segmentation is a powerful approach.
This is because people in a common location tend to share common needs.
For example, if you live in a city where it snows 360 days out of the year, you’re going to need warm clothing.
You’ll also likely need chains for your tires, defroster for your car, and a good heater for your home.
Unless it’s vacation season, it’s probably not smart to market to people in that area for swimwear.
There’s a reason we see the types of retailers like Patagonia, Columbia, and North Face in colder areas compared to O’Neil, Vans, and Billabong nearer to warmer, surfing areas.
As you can see, geographic segmentation is a simple yet effective method to divide a market.
Psychographic Segmentation
Also known as lifestyle segmentation, psychographic segmentation is more complex.
Psychographics takes into account the values, interests, and attitudes of a customer.
Going back to the luxury brand example, one choice could be to segment customers based on income.
OR, companies could segment their customers based on their lifestyle.
If most Rolls Royce’s customers are people who enjoy staying active and living healthy, then that is who Rolls Royce should focus on.
Segmenting customers on lifestyle preferences could potentially assume a greater validity than something as arbitrary as demographic classification. It’s hard to assume that everyone between the ages of 18 and 22 likes pop music, but it is easier to assume that all those who go to the gym would be interested in purchasing FitBit products to track their workouts.
This kind of customer segmentation is awesome for niche markets that focus on the authenticity and quality of brands.
Behavioral Segmentation
The last major type of customer segmentation is behavioral segmentation.
This includes data from consumer reports that capture buying patterns, brand loyalty, and price elasticity.
A good example of dividing a market based on behavior is by looking at customers who like to buy Pepsi and Coke.
These drinks are similar (depending on who you decide to ask) and could be the reason why customers will buy them interchangeably.
Some customers will be more loyal to a brand and thus will buy the said product no matter the price. You can coin these people as your “best friends”. They love your brand, and they’ll take the time, effort, and most importantly, money, to purchase your product.
Others will only buy a product because it is convenient. Let’s call these people the “butterflies.” They’ll keep your company on a pinwheel at top of mind, but they aren’t going out of their way to buy your stuff.
Price flexibility is important to note when using behavioral segmentation in a business strategy.
Less Common Types of Customer Segmentation
Other not so common methods of customer segmentation can be just as effective if not more so.
Distribution segmentation uses distribution channels as a way of reaching different groups.
This way, a high-end hair salon can use and sell an expensive hair product only found in their locations.
Occasion-based segmentation focuses on seasonal or event-based products.
This includes swimsuit sales during the summer or inflating airline prices over major holiday seasons.
Companies that have a good grasp on one channel of media like Instagram or Facebook can use media as a segmentation strategy.
They can focus most of their efforts on said channels and foster a relationship with their customers there.
A good customer segmentation strategy depends heavily on how a company uses their data to segment their customers.
Whatever the case, it’s always best to keep in mind how both the customer and company can profit from a well-structured marketing strategy.
Benefits of Customer Segmentation
So what’s the one way to get your customers to pay attention to you? You have to give them what they want.
And no it’s not money and free stuff of the travel sized variety, although that wouldn’t hurt either.
Authenticity has become paramount in the marketing and branding industry. Especially because this industry has garnered a reputation for playing on people’s desires.
It is at this point when humans crave a genuine entity that they can rely on. They need someone who is not going to deceive them into believing something that isn’t true.
Cue the segmentation strategies: one of the best ways to make a customer feel like their needs are met.
The following explains why customer segmentation is a big deal.
1. Increased Clarity
Customer segmentation allows companies to focus on the stuff that matters.
Companies are not going to want to advertise their parkas and ski equipment in desert areas. Unless they want to waste money.
Customer segmentation allows for more personalized engagement with their intended audience.
It allows them to gain a better understanding of their customers’ interests. It also allows them to maximize the use of relevant information in their ads and content.
2. Competitive Advantages
Resource Allocation
By focusing on a few market segments, this allows you to better adapt to changing market trends.
Know who your customers are, be better able to adapt to trends, thus be better able to allocate resources.
Say, for example, more of the market was turning into health nuts and tree huggers. A company will want to know how to keep their product relevant. Thus it would benefit them to allocate more time and resources in their R & D department.
Beyond that, you will likely find that most of your profit is generated from a small part of your customer base. Leveraging customer segmentation will allow you to identify your Primary Customers, those most valuable to your business, as well as your least valuable customers.
By focusing on your Primary Customers and decreasing your focus on your least valuable customers, you will grow your profit margin.
If you haven’t heard of The Pareto Principle or the 80/20 principle, here’s a quick video for you:
Value Chain Optimization
It’s all about knowing where and how to increase value that will best match the targeted segment.
Let’s go back to the example above. If a market consists of converted environmentalists, it’s beneficial to associate with like-minded companies.
Partnering with other companies that support environmental practices would increase perceived value.
3. Opportunity for Expansion
There are two ways that a company can expand: geographic and internal expansion. Strategic marketing is possible with customer segmentation. It enables expansion into other geographic locations with like-minded populations.
Product and service growth is also more likely with segmentation.
Innovative ways of solving customers needs through products or services is a valuable growth tactic. As a customer comes to trust a company then the more likely they will invest in new ideas.
4. Increased Customer Loyalty
You’re more likely to grab a consumer’s attention if they feel a message is relevant to them.
This increases the likelihood of that consumer becoming a paying customer. That customer is then more likely to become a repeat customer, and finally a loyal customer.
5. Make the Most of Big Events
Understanding what your target segments want, when they want it, and why they want it is key to profit.
As is the case with occasion-based segmentation, there is a time and place for product or service demand.
Take Peeps marshmallows. Is there ever a time when Peeps are in higher demand than during Easter? Not likely.
Through segmentation, companies know the right time to ramp up efforts, who to target, where, and why.
6. Maximize Pricing Options
Once you gain a loyal customer base, then you will be able to use a value-based pricing technique.
This means offering customers a reasonable price depending on perceived value.
Determining the value of your segment is critical in pricing strategies.
Start by determining the percentage of the market that generates the most revenue. This will offer an idea about what segments to focus on based on perceived loyalty to the product or service.
7. Better Product Development
There are many reasons why new products fail.
Here is what Pawel Grabowski had to say about AT&T’s Picturephone failure:
“Blinded by their own vision the company ignored negative user feedback right from trials and developed a product that failed to meet customers needs and wants.”
Customer segmentation can remedy this by offering a better idea of what your most valuable customers want to see. Companies can then use this focus info to improve product features and benefits for the people who are the lifeblood of the company.
Another reason why products fail is that companies target the wrong market.
And why does this occur? Because companies underestimate the value of proper segmentation.
Conducting interviews or even concept testing can prevent such a mistake from occurring.
Mistakes to Avoid When Using Customer Segmentation
When done right, segmentation can help in achieving even the most daunting of tasks.
Nobody’s perfect, mistakes are bound to occur. When it comes to segmentation though, it’s best to avoid those mistakes altogether.
Here’s a list of 6 mistakes to avoid (and how to avoid them) if you want to save yourself the trouble later.
Mistake #1: Not Using Clean Data
This also applies to outdated data.
The marketing and growth industry is dynamic. Also, companies tend to make significant changes every couple of years.
If you’re trying to appeal to your customers today, STOP using yesterday’s data.
It’s fundamental to create a good foundation of data before using it for customer segmentation. The data you use for segmentation is the basis of the results.
Bad Data = Poor Results
Otherwise, you will be making misguided decisions on irrelevant data.
The are many simple solutions to this problem. Perform regular audits of company resources. Spreadsheets are your best friend here.
Make a list of all your data sources. Update current sources, find new ones, and decide on what kind of info you need to create proper segments.
Mistake #2: Not Aligning Segments With Business Goals
Without a clear goal in mind then everything is liable to fall to pieces. Including your segmentation strategy.
A well-defined business goal offers a sense of direction. It’s a way to keep departments in line and on the same page.
Keep the following things in mind when thinking about how to create clear objectives:
- Be specific. Make sure that it’s easy to understand by everyone in the department.
- Make it measurable. Define the criteria for each goal and stick to it.
- Make it achievable. It’s good to be optimistic but also realistic. Create a goal that is do-able and within the limits of the company.
- Keep it relevant. Make sure it follows stakeholder wishes and anyone affected by these decisions.
- Make a schedule. Give your goal a certain amount of time to reach fruition.
Mistake #3: Not Identifying the Correct Market Segment
You know you’ve targeted the wrong segment when you’re not generating enough interest.
Say you’re trying to reach out to all food lovers by marketing a fancy new crock pot. It comes with added features to make cooking that much more complicated.
If someone doesn’t even know how to boil pasta, then they probably don’t need a fancy crock pot. This is a classic case of mistaken identity: “food lovers” does not equate to “food experts.”
Make sure you target a segment that can afford your product or service. Make sure they have an interest and that they have intentions to buy whatever it is being offered.
Targeting the wrong segment can waste crippling amounts of time and money if not done right. Therefore, it’s critical to perform smart business experiments to limit losses and increase the likelihood of success.
Mistake #4: Identifying Customer Segments too Broadly
Defining a segment too broadly defeats the purpose of segmentation, to begin with.
The purpose of customer segmentation is to narrow down a market into smaller groups as a better way to cater to their needs.
Targeting a broad segment is akin to not targeting a segment at all. You miss out on opportunities to increase engagement with better-suited segments.
Mistake #5: Segmenting Without a Clear Strategy
Not having a strategy in mind is like not having a purpose: there’s no guideline for finding the best segment.
Having a strategy in mind provides criteria for evaluating the best fit for a target segment.
Think about what the company’s goals. What kind of profit is the company trying to reach? How do they want to go about defining their target segment?
If you don’t properly plan, you’re at risk of producing poor results. Having a plan in place offers some clarity and can save time best used for future endeavors.
Mistake #6: Ignoring Future or Potential Segments
Segments with future potential are also known as ghost segments.
A company shouldn’t set aside segments because they don’t conform to current plans. If there is a chance to convert segments into loyal customers then it would be worth thinking about it.
Look back at that food lover example. It might not benefit the company to advertise a fancy crock pot to a group of beginners.
Although, people could find interest in learning how to cook. Companies can start generating interest by creating the proper message to incorporate beginners.
This could then convert beginners into master chefs that would use a fancy crock pot one day soon.
The takeaway message here: think about the value that potential segments can create in 2 or 3 years time.
The Path to Follow and the Road to Avoid: Examples of Customer Segmentation
Creating a segmentation strategy can be difficult.
Do yourself a favor, and don’t cut corners where it matters. Take the time to do your research, create a plan, and know your company objectives so you can know your customers.
Here are 2 examples of companies that have managed to get it right. Read on to find out how to learn from others mistakes and make an effective segmentation strategy.
Segmentation Done Right
CVS Pharmacy
There’s a good reason CVS Pharmacy is on this list and why they’re such a successful drugstore chain in the US.
The secret sauce? Data.
Through data analysis, CVS manages to segment their customers according to location.
They discovered that people’s buying habits differed in urban and suburban areas. People in urban cities treated CVS as a general store to do some one-stop shopping, but people in suburbia did not.
CVS also uses data to track customer buying habits and segment them based on behavior.
This way they’re able to decide on in-store item location and what offers their customers want to see.
Patagonia
Patagonia not only segments by demographics but also by lifestyle. As a result, they have maintained large profit margins and continuous annual growth.
They aim to target the mid to high-income sector and those who fall follows their do-good mentality.
Their ideal consumer tends to be young males with a steady income and are well educated. Above all, their ideal customers care about improving the future.
This means they care about, philanthropy, environmentalism, and living responsibly. A mentality that Patagonia strives to achieve and represent.
Patagonia is one company that has a good grasp on their objectives and what they aim to achieve in society.
They make it a point to match their values with those of their target segment which is how they’ve managed to do so well and become such a staple of the outdoor market.
Segmentation Done Wrong
BIC
This is a perfect example of what NOT to do.
BIC came out with a line of pens, “Bic ‘for Her'”. The purpose of the pen was to appeal to women with it’s sleek, elegant design and pastel colors.
The public was not happy about it. It received outrageous reviews on Amazon and even from Ellen DeGeneres herself.
The issue here is that BIC was trying to fix a problem that did not exist. There was no benefit in dividing the market based on gender and thus, they failed to meet customer needs.
Microsoft Zune
It was a mix of not having a clear strategy and having too narrow of a target segment that set this product on a path to failure.
Marketed as a portable music player, Zune did not appeal to customers, resulting in a poor outcome.
Robbie Bach, former president of Entertainment & Devices at Microsoft this to say about Zune:
“…we ended up chasing Apple with a product that actually wasn’t a bad product, but it was still a chasing product, and there wasn’t a reason for somebody to say, oh, I have to go out and get that thing.”
He goes on to say that their marketing focus was too narrow. Their ads focused on a small area of the market when it should have appealed to the most music listeners.
Their goal was to compete with Apple’s iPod when their goal should have focused on giving customers a reason to trust the company.
Tips to Build Your Best Segmentation Strategy
Creating a customer segmentation plan is not always simple.
You’re likely going to hit a few bumps in the road before you reach your destination.
Keep the following tips in mind to help you and your business stay on track.
1. Understand Your Company and What it’s Offering
Take another look at your company’s values and mission statement. If that’s not good enough, try to assess and take a deeper look at what you are trying to achieve.
What is it that the company is trying to achieve? What needs is the company trying to fulfill? Where do you see the company in 2-3 years time?
Remember, this is one of the reasons why companies fail to succeed in the market.
Take a look at Microsoft Zune for example. The company lost focus on their objectives because of heavy competition with Apple.
Now you’re in the right state of mind to think about who you want your customers to be.
2. Estimate Value of Segments
Once you determine all potential segments, now you have to place a value on them.
Which is most profitable or worth spending time and effort on?
This is when you find where most of your customers are versus your valuable customers.
Think back to the 80/20 rule that states 80% of sales come from 20% of customers.
If most of your customers are in urban areas but most of the sales come from suburban areas, what does this tell you?
This tells you that your most valuable customers are in suburban areas. They are more likely to convert to loyal customers and worth focusing on in the future.
3. Find Relationships Between Segments
Cross-correlate commonalities between segments to find what works best.
Again, the more you know your customers the easier it will be to develop a relevant message they care about.
Say you managed to identify a demographic segment of women in their early twenties. You could stop there and call it a day.
OR, you can segment them further according to behavior or hobbies.
If you find that some segments are not as responsive as others, then try other combinations. Take some time to experiment with what works and what doesn’t.
4. Don’t Make Segmentation a One-time Thing
Test eligible customers regularly to better predict needs.
If you’ve managed to segment your customers and are now thinking, “Great! I’m done, I can relax now,” then you’re mistaken.
Customers are always changing which is why it’s important to keep up in a dynamic market. What might be of interest to them today might not even elicit a second thought the following year.
Conduct audits of the company’s intellectual resources on a regular basis to stay up so far.
Also, do regular audits on current segments to make sure they’re getting something valuable.
Final Thoughts
It’s crucial to find relevant data on segments whether it comes from a database or not. It’s also crucial to know how to interpret this data to make strategic decisions.
Know which segments will maximize the value of the company and vice versa. Think of how the company can maximize value for their intended segment.
Follow these tips, do your research, and get organized!
There is no ‘drink me’ tonic or magic mushrooms to help your business grow, that requires work all on its own.
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