What is customer segmentation?

attrition, direct marketing, marketing communication, retention, segmentation, target market

Like so many buzz words in marketing, “segmentation” is one of those that is interpreted by folks to mean many different things. If the word “segmentation” were blurted out in a room of 20 business people, chances are it would conger up 20 different images of all colors, shapes & sizes.

So what is segmentation and how can it propel your business?

Segmentation defined
Customer segmentation is simply the grouping together of customers based on similarities they share with respect to any dimensions you deem relevant to your business.  Dimensions could include customer needs, channel preferences, interest in specific product features, customer profitability – the list goes on.

The key is for you to determine how to segment (or group) your customers in a way that will have the biggest impact on your business.  You *could* decide to segment your customers by hair color – brunettes here, blondes there, red heads over there… but to what end?  How would segmenting your customers by hair color help your business? (Hair salons notwithstanding)  Goal-directed segmentation is the only segmentation worth pursuing.  It’s purely a means for achieving your business ends.  

What are the business goals of my segmentation?
The only way to answer the question of how to best segment your customers is to first define what your objective is for the segmentation. In other words, you must first define what you want the segmentation to “do for your business”.  Examples of common segmentation objectives include:

  • Develop new products
  • Create segmented ads & marketing communications
  • Develop differentiated customer servicing & retention strategies
  • Target prospects with the greatest profit potential
  • Optimize your sales-channel mix

A brief example: segmenting for customer win-backs

Let’s say you manage Toade-ALL, the fee-based music subscription service for Toade, a new Pandora competitor. One day your boss asks you to optimize Toade-ALL’s win-back strategy.  The win-back strategy is presently comprised of three different sets of win-back tactics targeting people who have recently canceled their subscriptions (aka “attritors”). Toade has taken this approach to win-backs ever since Toade-ALL was launched.  Selecting which of the three win-back tactics a recent attritor receives has until now been based on “intuition” (aka guessing).

Step 1: Clearly state your segmentation objective (and ensure you & your boss are aligned!).
In this case your goal is to optimize Toade-ALL’s win-back strategy for recent attritors. This is shorthand for saying, “I want to a segmentation scheme that maximizes the ROI on the money I spend to win-back recently-canceled customers”.

Step 2: Determine how effective each win-back tactic would be for each attritor
Without getting into the “calculus”, what you want to do is estimate the expected ROIs associated with each of the three win-back tactics for each & every recent attritor.  For each tactic, this will enable you to identify those attritors with the highest expected ROIs (i.e., those attritors most likely to re-enroll in Toade-ALL after receiving the tactic and then providing Toade with future profits that well-exceeded the cost of the tactic).

Step 3: Identify what the high-ROI attritors have in common 
For each win-back tactic you want to identify those attributes which the high-ROI attritors have in common.  This will allow you to create a profile or persona for “high-ROI attritors” for each tactic.

Step 4: Operationalize & execute your plan
The final step is to “operationalize” the three attritor profiles you’ve created so you can use them to determine which of the three win-back tactics, if any, to send to future attritors.

So how would this work?  You would implement a process in which future attritors would be matched up against the three profiles to determine which, if any, best describe them. A more sophisticated approach would be to build predictive models to calculate the expected ROI for each tactic for each attritor, and then employ the tactic with the highest expected ROI to the attritor. And, for those attritors in which all three tactics have negative expected ROIs you may decide not to do anything.

Closing thoughts on segmentation
In closing, segmentation can be tricky and complex, and no doubt requires real expertise & experience. Putting in place a flawed segmentation strategy can be far more detrimental to a business than not having one at all.

However, when designed the right way, segmentation strategies can provide tremendous returns relative to default, “one-size-fits-all” approaches. In future posts I will tackle other types of segmentation strategies, including those involving new product development and portfolio management.  

More posts on segmentation & marketing strategy:

Great books & articles on segmentation: