According to Philip Kotler “Market segmentation is sub-dividing a market into distinct and homogeneous subgroups of customers, where any group can conceivably be selected as a target market to be met with distinct marketing mix.” In other words, Market Segmentation is a method of “dividing a market into smaller groupings of consumers or organizations in which each segment has a common characteristic such as needs or behavior.”
“Finding the most revealing way to segment a market is more an art than a science… Any useful segmentation scheme will be based around the needs of customers and should be effective in revealing new business opportunities.”
All markets are heterogeneous. This is evident from observation and from the proliferation of popular books describing the heterogeneity of local and global markets. Consider, for example, The Nine Nations of North America (Garreau, 1982), Latitudes and Attitudes: An Atlas of American Tastes, Trends, Politics and Passions (Weiss, 1994) and Mastering Global Markets: Strategies for Today’s Trade Globalist (Czinkotaet al., 2003). When reflecting on the nature of markets, consumer behavior and competitive activities, it is obvious that no product or service appeals to all consumers and even those who purchase the same product may do so for diverse reasons.
Effective marketing and business strategy therefore requires a segmentation of the market into homogeneous segments, an understanding of the needs and wants of these segments, the design of products and services that meet those needs and development of marketing strategies, to effectively reach the target segments. Thus focusing on segments is at the core of organizations’ efforts to become customer driven; it is also the key to effective resource allocation and deployment. The level of segment aggregation is an increasingly important issue. In today’s global economy, the ability to customize products and services often calls for the most micro of segments: the segment of one. Following and implementing a market segmentation strategy allows the firm to increase its profitability, as suggested by the classic price discrimination model, which provides the theoretical rationale for segmentation.
The most common B2B segmentation techniques used by software companies are:
SEGMENTING BY HORIZONTAL DISTINCTION
A horizontal market is a market so diversified that its products and/or services are broad enough to meet the needs of multiple industries. The audience for horizontal markets shares characteristics across industries. Based on the scope of horizontal markets, the marketing efforts that support them must reach this spectrum of buyers and prospective buyers.
Because horizontal markets are broad, marketers often segment them into subsets. These groups are typically based on demographic factors such as the prospect’s income, location or job title.
Horizontal Segmentation Example
To use telcos as an example they will even further segment their buyers and prospects to address specific needs. To increase sales of home Internet services, they can target a specific subgroup, such as senior citizens, low income users or parents with school-age children.
SEGMENTING BY SIZE
Because the demands of business-to-business customers are so polarized, a common tactic is to segment markets based on company size. Companies do this because the thinking and strategies behind a larger company is typically radically different from the approach of a smaller business. Larger businesses typically employ a more formal procurement process – seeking the lowest bid possible. Small businesses tend to learn towards a more personal and inclusive type of business arrangement. Sometimes, leveraging basic information like the size of the company, its annual revenues, or the business’ own clientele roster will tell you how you may or may not work together. In some case you can be even more specific and count the number of installs of your software the company could potentially buy.
Size Segmentation Examples
Targeting companies who see $500 million/year in revenue.
Only targeting the largest companies in your region based on number of employees.
I spent a long time in the contact center software space. We sold by number of agent “seats”. If a company had more than 500 agent seats they were “enterprise” and if they had less than 500 seats, they were “mid-market”.
SEGMENTING BY VERTICAL
If a product fulfills a common need that’s widely seen across an industry then vertical segmenting is used. Ineffective for most consumer markets, vertical segmenting is an effective strategy when working with a niche product geared for a niche industry. Single industries like that and other industries commonly identified by Standard Industrial Classification (SIC) system are often identified as vertical segments. Determining the end function of business customer tells how and at what level in the supply chain a company’s product will be used. And this knowledge drives how the company positions and marketsits product. It’s a simple question – how and by whom will my product be used? A hanger warehouse may only target companies in the retail industry, a graphic software firm may only target design departments or design houses, while a supply chain management developer may count freight companies among his prospects.
Vertical Segmentation Examples
A navigation software vendor that only focus on the cruise or trucking industries.
A gauge manufacturer that only services the automotive industry
Selling exclusively to wholesalers in a vertical industry (combined segmenting)
Identifying a department function within a larger corporation
SEGMENTING BY GEOGRAPHY
While geographic segmenting is often used to leverage characteristics shared by a population living in the same region, small businesses, those with capacity limitations, and consumer-driven companies often use geographic criteria to target prospects. As a Silicon Valley-based company, you may not be able to service prospects west of a designated time zone. Or even more specific, you may segment your prospects to a select number of surrounding zip codes. Very plainly, where are your customers concentrated? Once you understand this data, you’ll no longer want to focus on any other geographic information. These same criteria can (and should) be applied to other geographic factors including population growth rates, economic factors, and isolated spoken language.
Geographical Segmentation Examples
Introducing a unique product for the same unique geographic segment.
A promotional campaign targeting one region to increase sales.
SEGMENTING BY BEHAVIOR
Very simply, this segmenting targets prospect groups based on their buying behavior. How are your customers using your product, how often are they using it, and what is the challenge your prospects face? Those questions, coupled with the propensity of your prospect to actually pull the ‘buy’ trigger, are the cornerstone of behavioral segmenting. Other behavioral segmenting rules may include brand loyalty, order sizes, and any purchase procedure requirements.
Behavioral Segmentation Examples
A software company that releases a product geared for early technology adopters.
A travel agency targeting travelers who prefer vacationing during the Christmas holiday.
Between 80 and 90% of software startups fail within the first three years, depending on how failure is defined. While they mostly run out of money, the root of the problem is often poor marketing, specifically poor segmenting and targeting. Most people think of marketing as promotion through events, advertising, social media, direct email, or viral methods. But those activities, correctly and collectively known as marketing communications, are the very last marketing activities that should be done. Marketing is better described as bringing the right product to the right market at the right price at the right place. If this function is executed poorly, nothing else matters and nothing else can be done to fix the problem. No amount of promotion or creative sales technique will save a company that practices poor segmenting and targeting.
A common mistake, made by open source and proprietary software companies alike, is to create something and then look for a market that will buy it. The company that designs a product and then enters the market looking for a customer will struggle. The company that first asks potential customers about their most pressing problems and then designs a compelling product to solve one of these problems is far more likely to succeed, even more so if the problem is a priority to the customer. Unfortunately, software companies tend to have a technology bias rather than a market bias.
Why do so many software companies get this wrong? And more importantly, what can they do to get it right, or at least as right as possible? There are a number of reasons why poor marketing is prevalent, including technology arrogance, lack of market information, indecision, and ignorance of segmenting and targeting. The latter is particularly common, and in open source and other software communities, it generally takes the form of creating differently priced product feature sets, licensing, and support packages for different target segments. That kind of segmenting only starts to be successful after a company becomes well established and has enough customers that meeting their differing needs becomes a priority. A new open source company trying to go to market for the first time should instead focus on developing a clear idea of who they are selling to, what their customers’ problems are and why the customers would use this product over any other. Pricing models should clearly serve the needs and preferences of that single target.
Ideally, a company should identify their target market and the value they bring to it before their product even enters the design stage. But that rarely happens. At a minimum, they should have a market in mind before they take the product to market. It is less important that the target market is the absolute right one than it is to have a target market that is more or less in the right direction. If there is no target to aim for, there is no way to measure progress or success. If there is no target market, it is impossible to build critical mass or penetration. And, trying to sell into multiple segments to see which one works the best usually fails as the company will run out of time and money before finding the answer.
Segmentation Challenges In Business-To-Business Market
Business-to-business markets are characterized in a number of ways that makes them very different to their consumer cousins. Below summarizedare the main differences between consumer and business-to-business markets, and set out the implications for segmentation:
B2B markets have a more complex decision-making unit: In most households, even the most complex and expensive of purchases are confined to the small family unit, while the purchase of items such as food, clothes and cigarettes usually involves just one person. Other than low-value, low-risk items such as paperclips, the decision-making unit in businesses is far more complicated.
Segmenting a target audience that is at once multifaceted, complex, oblique and ephemeral is an extremely demanding task. Do we segment the companies in which these decision makers work, or do we segment the decision makers themselves? Do we identify one key decision maker per company, and segment the key decision makers. In short, who exactly is the target audience and whom should we be segmenting?
B2B products are often more complex: Just as the decision-making unit is often complex in business-to-business markets, so too are b2b products themselves. Even complex consumer purchases such as cars and stereos tend to be chosen on the basis of fairly simple criteria. Conversely, even the simplest of b2b products might have to be integrated into a larger system, making the involvement of a qualified expert necessary. Whereas consumer products are usually standardized, b2b purchases are frequently tailored.
This raises the question as to whether segmentation is possible in such markets – if every customer has complex and completely different needs, it could be argued that we have a separate segment for every single customer. In most business-to-business markets, a small number of key customers are so important that they ‘rise above ‘ the segmentation and are regarded as segments in their own right, with a dedicated account manager. Beneath these key customers, however, lies an array of companies that have similar and modest enough requirements to be grouped into segments.
B2B target audiences are smaller than consumer target audiences: Almost all business-to-business markets exhibit a customer distribution that confirms the Pareto Principle or 80:20 rule. A small number of customers dominate the sales ledger. Nor are we talking thousands and millions of customers. It is not unusual, even in the largest business-to-business companies, to have 100 or fewer customers that really make a difference to sales.
Personal relationships are more important in b2b markets: A small customer base that buys regularly from the business-to-business supplier is relatively easy to talk to. Sales and technical representatives visit the customers. People are on first-name terms. Personal relationships and trust develop. It is not unusual for a business-to-business supplier to have customers that have been loyal and committed for many years.
There are a number of segmentation implications here. First, while the degree of relationship focus may vary from one segmentation to another, most segments in most b2b markets demand a level of personal service. This raises an issue at the core of segmentation – everyone may want a personal relationship, but who is willing to pay for it? This is where the supplier must make firm choices, deciding to offer a relationship only to those who will pay the appropriate premium for it. On a practical level, it also means that market research must be conducted to provide a full understanding of exactly what ‘relationship’ comprises. To a premium segment, it may consist of regular face-to-face visits, whilst to a price-conscious segment a quarterly phone call may be adequate.
B2B buyers are longer-term buyers: Whilst consumers do buy items such as houses and cars, which are long-term purchases, these incidences are relatively rare. Long-term purchases – or at least purchases, which are expected to be repeated over a long period of time – are more common in business-to-business markets. In addition, the long-term products and services required by businesses are more likely to require service back up from the supplier than is the case in consumer markets. A computer network, a new item of machinery, a photocopier or a fleet of vehicles usually require far more extensive aftersales service than a house or the single vehicle purchased by a consumer. Businesses’ repeat purchases (machine parts, office consumables, for example) will also require ongoing expertise and services in terms of delivery, implementation/installation advice, etc that are less likely to be demanded by consumers.
In one sense this makes life easier in terms of segmentation. Segments tend to be less subject to whim or rapid change, meaning that once an accurate segmentation has been established, it evolves relatively slowly and is therefore a durable strategic tool. The risk of this is that business-to-business marketers can be complacent and pay inadequate attention to the changing needs and characteristics of customers over time. This can have grave consequences in terms of the profitability of a segment, as customers are faced with out-of-date messages or benefits that they are not paying for.
B2B markets drive innovation less than consumer markets: B2B companies that innovate usually do so as a response to an innovation that has happened further upstream. In contrast with FMCG companies, they have the comparative luxury of responding to trends rather than having to predict or even drive them. In other words, B2B companies have the time to continually re-evaluate their segments and CVPs and respond promptly to the evolving needs of their clients.
B2B markets have fewer behavioral and needs-based segments: The small number of segments typical to b2b markets is in itself a key distinguishing factor of business-to-business markets. A review of over 2,500 business-to-business studies shows that B2B markets typically have far fewer behavioral or needs-based segments than is the case with consumer markets. Whereas it is not uncommon for an FMCG market to boast 10, 12 or more segments, the average business-to-business study typically produces 3 or 4.
Part of the reason for this is the smaller target audience in business-to-business markets. In a consumer market with tens of thousands of potential customers, it is practical and economical to divide the market into 10 or 12 distinguishable segments, even if several of the segments are only separated by small nuances of behavior or need. This is patently not the case when the target audience consists of a couple of hundred business buyers.
The main reason for the smaller number of segments, however, is simply that a business audience’s behavior or needs vary less than that of a (less rational) consumer audience. Whims, insecurities, indulgences and so on are far less likely to come to the buyer’s mind when the purchase is for a place of work rather than for oneself or a close family member. And the numerous colleagues who get involved in a B2B buying decision, and the workplace norms established over time, filter out many of the extremes of behavior that may otherwise manifest themselves if the decision were left to one person with no accountability to others.
It is noticeable that the behavioral and needs-based segments that emerge in business-to-business markets are frequently similar across different industries. Needs-based segments in a typical business-to business market often resemble the following:
A price-focused segment, which has a transactional outlook to doing business and does not seek any ‘extras’. Companies in this segment are often small, working to low margins and regard the product/service in question as of low strategic importance to their business.
A quality and brand-focused segment, which wants the best possible product and is prepared to pay for it. Companies in this segment often work to high margins, are medium-sized or large, and regard the product/service as of high strategic importance.
A service-focused segment, which has high requirements in terms of product quality and range, but also in terms of aftersales, delivery, etc. These companies tend to work in time-critical industries and can be small, medium or large. They are usually purchasing relatively high volumes.
A partnership-focused segment usually consists of key accounts, which seeks trust and reliability and regards the supplier as a strategic partner. Such companies tend to be large, operate on relatively high margins, and regard the product or service in question as strategically important.
Some Common Traps of Segmenting Customers
Segmentation is the action – not the objective
Segmentation has to stem from clear objectives and strategy. All too many businesses are still picking through the leftovers of static, research-based segmentation projects based on little more than executive philosophy. With no financial modeling to back them up, no wonder these projects failed.
The Smart Marketer’s Handbook (circa 1970) may well say ‘segment or die’ but that doesn’t mean segmentation works – or that it has to be the same for every business.
Too big to handle
To make segmentation easy to grasp, it’s all too tempting to split the marketplace into a few simple customer segments. For instance, five to ten segments makes it all straightforward enough for a business to understand, and large enoughâ€¨to allow economies of scale in product development. However, it’s no help with customer management or value engineering.
After all, for any large business, some of the segments could contain millions of consumers. That’s hardly ‘getting close to the customer’!
The frozen state
Another key requirement of most legacy segmentation approaches is stability. If an organization is going to create a few large segments and develop propositions for them, the last thing they want is a customer jumping from one segment to another.
That means segments are designed to be static, or frozen. Businessesâ€¨can then measure performance over time and be confident about returnâ€¨on investment. But the awkward customers keep getting in the way. They will insist on changing: age, jobs, homes, marital status, parental status, consumption to name but a few. Fixed state segmentation fails to reflect the dynamic behavior of customers and becomes increasingly irrelevant in marketing campaigns.
Problems with referencing
Market research can be a wonderful thing, but when an individual focus is needed it becomes less helpful. Unfortunately, many companies rush into segmentation by starting with market research. Customers and prospective customersâ€¨are asked what they want, need and do, and the research project then builds segmentation models.
However, once a company starts referencing these segments back to the existing and prospective customer databases it hits some serious problems:
The only way to create references, within the rules of the Marketing Research Society on respondent anonymity, is to set up algorithms using common data and recreates the segments on the database. However, if you didn’t start with the database itself, there will be very few common items to draw upon.
The scoring process therefore becomes very unsophisticated and insensitive, and the chance of placing more than 50% of customers into the right segments with anything above 70% probability are quite slim.
That means companies can spend years (and millions) picking up the pieces.
The solution is to start with your own data, and any data from a third party, to build the segmentation upwards. Once you’ve identified the key variables, then you can do the market research.
Differentiation or just different colored envelops?
The best segmentation framework in the world will still not deliver a return if a business cannot conceive and execute worthwhile strategies. After all, what’s the point in having segments if the customer experience is hardly different across each one?
All too often organizations think the best use of segmentation is in creating different communications for different groups of people. Frankly, if that’s the only reason for segmentation, it’s not worth the expense. It creates minimal difference, and won’t justify the cost. At the end of the day segmentation can only pay for itself by delivering lower conversion costs, higher prices and improved margins.
True segmentation means different propositions for different customer groups, not just different colored envelopes in their direct mail.
Poor resource allocation and ROI assessment
All too often organizations allocate resources by product or business function. Yet if you are serious about segmentation, you need to follow a scientific method to allocate resources and assess returns across different segments.
One challenge to this is, of course, the fact that segments are not stable. How can you allocate suitable resources if customers shift segments? The answer for many organizations is to only segment at the macro level, for example:
By consumer / B2B
Segment bleed – this sector is not for you
Segmentation may look good on paper, but customers are forever breaking out of their segments. If someone from the ‘Medium Size segment takes a shine to a proposition developed for ‘Small Size Segment,’ you don’t want to turn their business down. Yet this can ultimately damage a brand, particularly in a mature market.
Segmentation isn’t monotheism
Segmentation is most powerful when it addresses a specific problem. Moreover, as most businesses face many problems, segmentation must be multi-dimensional. Value, needs, behavior, product, demographics, customer state, preference, credit – segmentation can take any number of approaches, making your organization as flexible as possible to meet business challenges.
One hurdle to overcome is the senior executive’s preference for simpler, easy to understand concepts. Today’s marketer has to be able to explain and demonstrate the benefits of multi-dimensionality against seductively simpler segmentation.
Some examples of failed products because of faulty segmentation:
BPL – Batch Programming Language Interpreter.
Why it was judged a commercial failure
I sold about 10 copies.
What went wrong
I didn’t really do enough research to find out if the target market was in existence. I was hoping that network admins and support staff members would find it easier to use than batch files and less complicated than any of the free scripting language options available. So, I just rushed to get the MVP  (Minimum Viable Product) out the door.
I never did provide a compiler that would build a stand-alone EXE. I think that might have met with more success.
I didn’t do much as far as advertising the existence of the product.
I only spent a few weeks coding and documenting it in my spare time. Support issues sometimes took a whole evening, but nothing major. It did not have any impact on my finances, as I had invested nothing but my time.
Current product status
I will still address support issues with this product for registered users, but I don’t actively sell it. I’ve open-sourced the program and it still really isn’t seeing heavy use.
Here the contributor does recognize that there was a need for a proper market analysis before investing time and efforts in developing the product. The product developed did not have a clear market to cater to and had some essential features missing which the segment to which it was marketed needed. Another reason for the failure of the product could be that it was focused on a very small niche.
DRAMA (Design RAtionaleMAnagement) was a commercialization of a University prototype for recording the decision-making process during the design of complex and long-lived artifacts, for example nuclear reactors and chemical plants. By recording it in a structured database this information would still be available long after the original engineers had forgotten it, retired or been run over by buses. This information was believed to be incredibly valuable to later maintainers of the system, engineers creating similar designs and industry regulators. The development was part funded by 4 big process-engineering companies.
Why it was judged a commercial failure
Everyone told us what a great idea it was, but no one bought it. Despite some early funding from some big process engineering companies, none of them put it into use properly and we never sold any licenses to anyone else.
What went wrong?
Lack of support from the people who would actually have to use it. There are lots of social factors that work against engineers wanting to record their design rationale, including:
The person taking the time to record the rationale probably isn’t the person getting the benefit from it.
Extra work for people who are already under a lot of time pressure.
It might make it easier for others to question decisions and hold companies and engineers accountable for mistakes.
Engineers may see giving away this knowledge as undermining their job security.
Problems integrating with the other software tools that engineers spend most of their time in (e.g. CAD packages). This would probably be easier with modern web-based technology.
It is difficult to capture the subtleties of the design process in a structured form.
A bad hire. If you hire the wrong person, you should face up to it and get rid of them. Rather than keep moving them around in a vain attempt to find something they are good at.
We took a phased approach, starting with a single-user proof of concept and then creating a client-server version. In hindsight it should have been obvious that not enough people were actively using the single-user system and we should have killed it then.
At least 3 man-years of work went into this product, with me doing most of it. Thankfully I was a salaried employee. But the lack of success of this product contributed to the demise of the part of the company I was in.
Current product status
The product is long dead.
In addition to what the entrepreneur mentioned about what went wrong with the product, we can see that the early adopters (4 companies) are not stable customers. From what the entrepreneur has mentioned, it does seem that the four big companies were approached without having a product.
How do you measure the effectiveness of the segmentation process?
Net Marketing Contribution
Marketing profitability is based on an investment in marketing and sales required to achieve certain levels of sales and gross margins. Net marketing contribution is a financial measure of marketing profitability and is computed as shown below:
Net Marketing Contribution = Segment Size x Market Share within Segment x Product Price x Product Margin – Marketing Expenditure
Net Marketing Contribution for Segment
NMC for segment = Segment Size x Market Share within Segment x Product Price x Product Margin – Marketing Expenditure
Marketing Return on Sales for segment = NMC for segment/Sales for Segment
Marketing ROI for Segment = NMC for Segment/ Marketing Expenditure for Segment
How exactly are companies segmenting?
The trends in the product development process of companies as per our survey results is shown below
If we see the result according to the size of the respondent companies the small and medium companies show the below trend
The large companies showed the below trend
The two most important factors when deciding a segment for all the companies were the value proposition fit and then the revenue potential of the segment, the size of the segment in terms of importance came after the aforementioned factors.
The general trend across companies shows that Vertical and Horizontal segmentation are the most important basis for targeting segments, the next most important basis is the size of the clients.
However, there is a clear variation in this trend according to the size of the companies. For the large companies the most important basis for targeting segments is the business vertical, Horizontal distinction and size of the clients share the position of being sec