Free Lunch: The Power of Segmentation

Free Lunch: The Power of Segmentation

I remember a business school professor proclaiming, “diversification is the only free lunch.” He meant that diversification is the only technique in finance that simultaneously lowers risk and increases returns (click here if you don’t believe me).

I say there is another free lunch in the business world: segmentation. Segmentation allows companies simultaneously to lower marketing costs and increase sales.

When I’ve led formal segmentation projects, I saw results across firms such as:

  • 50% increase in email conversion rates
  • 10 point increase in profit margins
  • 15% increase in sales in a competitive, commodity market
  • $300,000 reduction in marketing spend without affecting sales

What is segmentation? defines segmentation as: “The process of defining and subdividing a large homogenous market into clearly identifiable segments having similar needswants, or demand characteristics. Its objective is to design a marketing mix that precisely matches the expectations of customers in the targeted segment. Few companies are big enough to supply the needs of an entire market; most must break down the total demand into segments and choose those that the company is best equipped to handle.”

In other words, find groups of similar people so you can target them in the way they want to be targeted.

But doesn’t focusing on a narrow piece of the market limit my sales?

No! This is a common concern. Many are afraid to zoom in on a subset of the market for fear that it will damage their chances of success.

Think about this in your personal life: for example, looking for a job. A common, but flawed, approach to job seeking is to blast the marketplace. Why not send dozens or even hundreds of cover letters and resumes? The data show this strategy yields less than a 3% success rate. According to Pam Lassiter, author of The New Job Securityfocus is the best way to find a new job. Target the segment of employers that you can help given your skill set. If you communicate an understanding of their needs and wants, you will be much more successful in landing your next job. You’ll also save yourself time.

The same principle applies to marketing. Don’t believe me? What about mass market companies like McDonald’s – they target everyone all at once, right? Actually, no. McDonald’s relies on segmentation. Three example segments are travelers, teenagers, and busy moms. This make sense once you look at their marketing activities:

  • Travelers: placing locations in key travel spots like the side of highways and airports
  • Teenagers: high quantity, low quality “Dollar Menu” offerings
  • Busy moms: Playland and Happy Meal toys to entertain the kids and give mom a break

So if you are afraid that focusing on a segment will stunt growth, think of it this way: you can always narrow in on many segments to grow your business. But trying to be everything to everyone is costly, and it doesn’t work.

Why does it work?

In short, segmentation helps companies in two ways. First, is increases empathy with customers. Second, segmentation helps leaders make better tradeoffs in a world of limited resources.

By focusing on a niche, firms can precisely dial in on the needs and wants of their target audience. Marketers can more accurately allocate research dollars and time.

Once you develop an understanding of the target market, you can do a better job at making tradeoffs. For example, let’s say you are building a new website aimed at Millennials. You only have resources to implement five out of the ten conceptualized features. If you have a good grasp on your target segment, then you can evaluate the options based on Millennials’ prioritization.

The four primary ways to segment your customer base are: behavioral, demographic, psychographic, and geographic.

behavioral segmentation clusters together consumers who behave similarly: when they buy, what they buy, how they buy, how they browse, what else they buy, etc. Modern predictive analytics focuses on this type of segmentation. Think about the Amazon recommendation engine. Many research projects have shown this is the most effective type of segmentation. In my professional career, I have also seen the best results with behavioral segmentation.

Demographic segmentation divides your audience based on observable traits about the customers: age, gender, ethnicity, etc. Demographic segmentation is popular because it’s easy to measure these attributes. Most beauty care product companies segment based on gender, for example.

psychographic segmentation groups people into categories based on their attitudes and beliefs. Underlying this type of segmentation is the belief that consumers are interested in the technical attributes of a product or service as well as the ensuing emotional benefits. Psychographic segmentation goes deeper than simple demographics, but, understandably, is more challenging to measure. Typically, firms need to conduct expensive market research and surveys to develop this type of segmentation. Car companies are known for using this type of segmentation. For example, Volkswagen targets different types of lifestyles through its line of cars (Beetle, Passat, Toureg, etc.). Another example is food companies targeting health-conscious consumers through “organic” or “free-range” lines.

geographic segmentation helps companies regionalize their offerings to local tastes, preferences, and needs. For example, clothing companies may differentiate offerings by region given variations in climate.

OK, you’ve sold me, how do I segment my customer base?

So on what basis do I segment?

If you don’t have a budget, the easiest way to get started is to take an educated guess! When I led business development and product management at the sports media and technology company TrackMan, we divided the golf market into behavioral segments. That is, we looked at how each type of consumer would use the product: PGA professionals for self-practice, club pros/coaches for training hobbyists, universities for training competitive athletes, and retailers for fitting clubs. This segmentation allowed us to deliver the right message and right product to the right audience. We prioritized our development roadmap accordingly and refined our segmentation once we got a better understanding of the markets.

You might guess wrong about a segment, but at least it instills a discipline around focus. You can always course correct as you get smarter about the marketplace

The “right” way to do a segmentation, if you can afford it, is to perform what is called a cluster analysis on your customer database or market research survey results. A cluster analysis is an advanced analytical technique that Wikipedia defines as the task of grouping a set of objects in such a way that objects in the same group (called a cluster) are more similar (in some sense or another) to each other than to those in other groups (clusters).”

You need data and a data scientist to crunch the numbers. Experts in the field widely understand this technique, so it’s relatively straightforward to implement. Costs depend heavily on the state of your data and how much new market research is needed. I would say a proper segmentation project is at least a five-figure investment, but you could end up in the six-figure range if you don’t have the right data on hand.

We’re all busy and have too many balls in the air. By using customer segmentation, you can narrow your focus. Yow can do a better job at developing products and marketing campaigns that appeal more strongly to your target market.

So, are you ready to make reservations for your free lunch?

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