What is Customer Segmentation?

Customer segmentation deals with grouping potential customers according to their preferences or characteristics. 

In a way, customer segmentation is a form of stereotyping. It assumes that like customers with certain, specified characteristics will have similar needs or wants with respect to your product or service. 

Understanding the preferences and characteristics of customers is the subject of marketing study. At this stage, you will have to undertake research to find out much of this information. 

In the next chapter, we discuss primary and secondary research techniques to help you identify customer segments and characteristics about particular markets.

• Side Note: Marketing analytics firms provide value to businesses by analyzing market segments for customer preferences. These firms conduct research or purchase massive amounts of consumer data to make determinations about the purchasing activity of customers that share like or identifiably similar characteristics.

Even with the use of research techniques, grouping potential customers according to their characteristics requires a great deal of assumption about their general preferences. 

Without detailed information about your customers and the market in general, this practice can be inaccurate. Also, other factors, such as new trends or economic changes, can heavily influence a customer segment. 

Nevertheless, understanding who are your potential customers is instrumental in adequately evaluating an idea.

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How to Identify the Customer Segments?

You are conducting the market analysis in order to determine whether sufficient customer demand for your product or service exists at any given price point (discussed below) so that it will create the amount and type of desired value. All of this is considered in light of the costs associated with operations (discussed below).

Here are some questions to ask in determining whether the market potential is sufficient to create the amount and type of desired value.

• Identifying Your Customer Segments
  • Who are your primary, secondary, and tertiary target customers?
    • Note: You may be able to break apart your target customer markets into segments based on any number of defining characteristics. You should try to identify the factors that are most important to each potential customer segment (price, quality, efficiency, easy of use, etc.)
  • What are the defining characteristics of each segment?
    • Note: Explain why these characteristics create a need or want that your product or service will fulfill.
  • Is there potential overlap of your customer segments?
    • Note: For any given product or service, different customer segments may overlap in their specific needs or wants. The minimum viable product that serves the greatest target market often provides the greatest total revenue. However, it may not provide the greatest margin for each product or service sold.
• Further Understanding Your Target Customer Attributes - The attributes that you identify in your target customer audience will help you make strategic marketing decisions in the future. For each customer segment, make certain that the characteristics you identify are:
  • Recognizable
  • Significant
  • Measurable
  • Compatible (with the business mission, strength, and ability)
• Characteristics that Often Constitute Segments
  • Demographic Information
    • Demographic information about your customer segment often provides the greatest accuracy for prediction of consumer activity. That is, members of a particular demographic group tend to demonstrate very similar consumer characteristics.
    • The first step is separating your customers into businesses (Business to Business or B2B) and individuals (Business to Consumer or B2C). Obviously, individuals will demonstrate drastically different consumer tendencies from businesses.
    • For B2B target customers, you should, at a minimum, identify the following business characteristics:
      • # Employees,
      • Industry
      • Revenues and other financial characteristics (such as margins, market concentration, total capitalization, etc.)
    • Other classifications include: Age, Gender, Ethnicity, Income, and Level of Education.
• Psychological Information Segmenting customers according to psychology generally deals with characterizing their mental outlook that characterizes the way they live. Examples of psychological segments include:
  • Religious beliefs,
  • Morals or Values,
  • Political Beliefs
  • Sources of entertainment (also behavioral)
• Behavioral Segmentation - Regards the activities that people undertake, the frequency with which they undertake those activities, and other metrics that measure the degree or extent of activity by an individual. Examples of behavioral segments include:
  • Unique benefits sought,
  • Rate of individual or group consumption or use
  • Other behavioral patterns (ice cream during summer)
• Behavioral segmentation has given rise to various methods and theories for determining customer behavior. Research Day-in-the-Life-of-the Customer (DILO) technique for an example.
• Geographic Location - Different customer segments may be local, national, international, geographically dispersed, or concentrated in certain markets.
  • Note: This is often a subject of strategic decision-making.
  • Example: David Hasselhoff sold very few records in the United States, but was extremely successful in Germany. Recognizing where his target market was located, he toured and market his records in that area of Europe.

What are the Results of Customer Segmentation?

Grouping your potential customers in this fashion allows you to examine key characteristics about the customer group, such as:

• number of customers (size of market segment),
• value of product or service (price point),
• type of need or want (type of features for product or service),
• the level of need or want (the priority or urgency that they have for buying the product).

Later, you will use this information to market your products or services toward those customers who will provide the greatest net transfer of value for the product or service (greatest profit). This is why companies will often create multiple versions of the same product. They seek to capture multiple customer segments with the same product, without cannibalizing sales of other versions or another similar product.

• Example: The smartphone serves a number of customer segments. Early in the development of the smartphone industry, phones were equipped with diverse features at varying price points in order to attract business professionals and teenagers alike. Adding additional features or functionality to a product that are not valued by customers forfeits value and profitability. Likewise, charging a lower price for a far less expensive product may produce greater total profit than charging a higher price and selling fewer products.

The point to take away from this scenario is that it is important to segment your potential customers in order to adequately position your product in the market and to meet the targeted customers desired value. Later we will discuss arriving at a minimum viable product, which involves developing a product that meets the minimum customer expectations and thereby creates the greatest value for the customer at the lowest cost to the business.