Updated: Nov 19, 2019
The perfect number of market segments all companies should have.
A question I frequently get is how many customer segments a company should have. And my answer is always eight. Eight is the golden ratio. If you use fewer segments, approaching 4, will make the segments heterogeneous and therefore less useful. The customers in the segments are far too different from each other, muddling the picture. On the other hand, if you use to may, over 12, will make them difficult for the organization to remember and manage, and are therefore also less useful. The crux of the matter is to use sub-segments if you need a more finely divided structure.
Market segmentation has been taught at business schools for decades, and most people in charge of making market segmentation's are cast in the same mold. A definition similar to this is what most people have learned: Market segmentation is the subdividing of a market into homogeneous sub-sections of customers, where any sub-section may conceivably be selected as a market target to be reached with a distinct marketing mix.
Most companies, therefore, have a market segmentation made with the objective to sell more of an existing product portfolio, which is wrong. And this is why.
Geographical variables are common descriptive segmentation variables used when segmenting the market from a sales perspective. Other popular variables are applications or demographic variables. The market segments created using such variables become heterogeneous from a customer value standpoint. The customers in the segments have different needs, resource concerns and behavior. However, the segments are homogeneous from other aspects that simplify short terms goals. After the company has reaped the first initial benefits from the market segmentation made, it quickly becomes a drawback for developing new successful product offerings.
Typical signs of poor market segmentation are that the company starts developing one or several of the following type of products:
the one size fits all type of products. I call this type of products for tube socks. Featureless products that poorly fits a large number of customers, but perfectly none. Consequently, nobody wants to pay a premium price for tube socks.
the over-featured product with everything for everybody included. Every foreseeable functionality is included in an attempt to satisfy all customers in a heterogeneous segment. I call them for the Christmas tree type of products. As nobody uses all the features included is it very hard to get full compensation for the costly design.
the company starts tailor-making products to individual customers or small groups of customers, so everybody gets exactly what they want. And the company begins a journey that will end up in a variant jungle. The administrative burden to manage all the different variants of the product will eventually eat up the profit. Sometimes is the variant jungle the step companies take after failing with tube socks or Christmas tree types of products.
The market segmentation used is like an invisible hand that either steers your company around problems or into a head-on collision with them. Poor market segmentation can be the underlying reason for a whole range of issues. It is not always easy to understand that it is the root cause for low profitability, lack of growth or an increasing number of customer complaints. Excellent market segmentation, on the other hand, is reflected in the opposite, high profitability, growth and unrivalled customer value. Whether the market segmentation is good or bad, its consequences appear in many different guises.
I believe that market segmentation is currently in a transitional period in which classical truths no longer apply. The old worn-out phrase that all business is local needs to be replaced with all business is global. The old worn-out strategy to focus on making it easy for the organization to sell needs to be replaced by making it easy for customers to buy. Today’s customers have many and cost-effective alternatives available for finding potential suppliers. It’s no longer just a case of receiving a visit from the traditional salesperson or visiting the nearest shop.
It is both a science and an art to successful market segmentation. It is a complex task that will have a pivotal impact on growth, profitability and survival for all organizations. Despite the fact that market segmentation is one of the most critical activities in a company, it doesn’t receive the attention it deserves. Even more troublesome is that most market segmentation's made are cast in the same old mold. If you segment your market in the same way as your competitors, how likely is it that you will identify underserved sweet spots in the market?
The first step in creating a more innovative way to segment your market is to through the old definition you learned in business school on the pile of obsolete business concepts. This is the new definition that can help your company take a quantum leap in business performance:
Market segmentation is the process of dividing a large number of customers into several homogeneous subgroups sharing the same perception of customer value and selecting the subgroups with the biggest potential.
The key to success is to create focus. The focus should be on creating unrivalled customer value. If you can get your organization to focus on enhancing customer value, profitability and growth will take care of itself. There is a clear and direct correlation between customer value and all essential financial metrics in your company. It is a cause and effect type of relationship. A relationship in which unrivalled customer value increase things like profitability, growth and shareholder value. The opposite is also true. If customer value goes down, profitability, growth and shareholder value will follow. It is a cause and effect relationship. And if you think about it, you quickly realize that it makes sense. Focusing on customer value is the best strategy forward to sustainable business success.
So, let us get rid of the three traditional and standard methods used for market segmentation:
Product – out
A method using mostly descriptive segmentation variables to identify new customers for an existing product portfolio. The most common method used today. It may provide some initial benefits, but quickly becomes a burden.
Marketing – to
A method using mostly psychographic segmentation variables to differentiate and fine-tune the marketing message. Ok, if you want to fine-tune the marketing message, but it cannot be the foundation for your market segmentation.
Customer – in
A method using mostly behavioral segmentation variables to tailor products and services to different segments. Tailor how? It is easy that you are led down the garden path by influential internal voices if you use this method.
And this is what I believe is the method for the future:
Value – for
A method using a melting-pot of different segmentation variables creating homogenous segments from a value standpoint and selecting the subgroups with the biggest potential for your company.
In our latest book, which by the way is a flipbook, a whole chapter is describing this method. It can be purchased in our shop and instantly downloaded.
I hope this article inspired you to refine your customer segments. And please share the article with people you think would benefit from reading it. I spend a lot of time making these articles and I would appreciate your help.
If you want to learn more on customer value, follow "The customer value challenge". Several videos and posters on how to turn customer value into a concrete and practical tool to drive profitability, growth and sustainability. All is free.