Customer Segmentation
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Customer segmentation approach application

Customer Segmentation

- Approach & Application


Agenda

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Agenda1

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Context

Context

Customer segmentation is an important tool for customer analysis.

Cost

Customers

Competitors

Capabilities

Strategic Purpose:

  • To identify cost reduction opportunities

  • To identify revenue and profit maximizing strategies

  • To achieve differentiation and to preempt competitors’ moves

  • To determine the strategies that fit best with a company’s core competencies

Tools:

  • Customer Segmentation

  • Purchase Criteria Rating (Importance Analysis)

  • Company Positioning (Effectiveness Analysis)

  • Attractiveness Analysis

  • Value Proposition Development

  • Customer Retention and Loyalty

  • Customer Acquisition


The process

The Process

Customer segmentation is a process of identifying homogeneous groups of customers. Once customers have been segmented, a company chooses target segments and approaches each segment with a value proposition that meets the segment’s needs.

Segment customers(existing and potential)

  • Each customer segment describes a homogeneous group of customers

  • Target segments are the most attractive customer segments for a given company to focus on

Choose target segments*

  • A value proposition is the combination of product, service, and delivery offered to the customer

Create value propositionfor each target segment

  • The potential profit from serving the target segments with proposed value propositions must be determined

Determine profit potential

*In some cases, there will be only one target segment


Why do customer segmentation

Why Do Customer Segmentation?

Customer segmentation is valuable because all customers are not created equal.

  • Each customer segment has a unique set of needs and requires its own value proposition

  • The profit potential differs by customer segment

Customer segmentation helps companies focus scarce resources where they can be most leveraged


Agenda2

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Retention and acquisition

Retention and Acquisition

Customer segmentation is useful for both customer retention and customer acquisition.

Segment customers

Choose target segments

Create value proposition for each target segment

Retain target customers

Acquire target customers


Applications 1 of 2

Applications (1 of 2)

Bain caseteams have used customer segmentation to:

  • Identify gaps or redundancies in the product portfolio

  • Screen out unacceptable new products

  • Choose product features

  • Determine product pricing

  • Establish appropriate service options

  • Determine optimal distribution strategy

  • Advise on advertising strategy


Applications 2 of 2

Applications (2 of 2)

Bain’s customer segmentation work has brought significant results for many clients. Examples of Bain’s work include:

  • A large European beer manufacturer was faced with increasing competition and low market growth. Bain used segmentation to identify product portfolio gaps and determine optimal positioning for new and existing brands. This resulted in an 8% market share increase.

  • An international cosmetics company wanted to identify opportunities in the high growth skin care market. A Bain team identified unmet consumer needs for anti-aging creams and proposed an optimal strategy for targeting the appropriate customers. This resulted in approximately $145MM in value creation.


Agenda3

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Customer segmentation steps

Customer Segmentation Steps

Segment customers

(existing and

potential)

Choose target segments*

Create value proposition for each target segment

Determine profit potential

Process:

  • Choose segmentation method (needs-based, behavioral, or demographic) based on underlying issues

  • Choose target segments based on attractiveness and ability to serve in a differentiated way (in some cases, there will be only one target segment)

  • Create value propositions based on customer needs (each target segment requires its own value proposition)

  • Determine the revenue and cost impacts of offering the proposed value propositions to the target segments

Tips:

  • Segments should be

    • meaningful

    • MECE (only one segment per customer)

    • measurable

    • substantial

    • actionable

  • Attractiveness is based on profit potential (revenue potential and cost to serve)

  • Ability to serve in a differentiated way recognizes both the client’s and the competitors’ core competencies as well as regulatory factors

  • Each value proposition should address:

    • product

    • service

    • distribution

  • Profit potential should include profit as well as “hidden costs” (e.g., increased training and marketing costs for new products)

*In some cases, there will be only one target segment


Agenda4

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Segmentation methods

Segmentation Methods

There are three main types of segmentation:

Needs-based

Behavioral

Demographic

Type of data used to segment:

  • Customer needs (e.g., preferences for low price vs. high service)

    • psycho-graphics

    • attitudes

  • Behaviors (e.g., purchasing patterns, usage patterns)

  • Demographics (e.g., age, income, home ownership)

  • Use ATM vs. use branch

  • Shop weekly vs. monthly for groceries

  • Drink coffee vs. do not drink coffee

Examples:

  • Value high service over low price

  • Value low price over high convenience

  • Value brand name over low price

  • Buy on sale only vs. at full price

  • Young vs. old

  • High income vs. low income

  • Home owners vs. renters


Comparison of segmentation methods

Comparison of Segmentation Methods

Needs-based segmentation is the most time consuming to execute, but also the most valuable. Most of Bain’s work involves needs-based segmentation.

Needs-based

Behavioral

Demographic

Segmentation process:

  • Primary research necessary

  • Primary research necessary only if behavioral data not available from client database

  • No primary research necessary

  • Demographic data sometimes readily available from client

  • High (shows causation)

  • Descriptive and actionable (describes customers and drivers of purchase)

  • Moderate (shows correlation, not causation)

  • Descriptive, not actionable (describes purchasing behavior, but does not address drivers or purchase)

  • Low (occasionally shows correlation, never causation)

  • Descriptive, not actionable (describes customers but does not address drivers of purchase)

Usefulness in creating value propositions:


Needs based segmentation

Needs-Based Segmentation

Defining customer groups in a needs-based segmentation begins with identifying the likely customer and non-customer needs.

Create a needs list

Collect data

Conduct Factor/Clusteranalysis to determine statistical segments

Steps:

  • Make a complete list of potential customer and non-customer needs

    • focus groups or a small number of unprompted customer interviews

    • brainstorming

    • previous client work or Bain research

  • Ask a representative sample of customers and non-customers a battery of questions designed to gauge their needs concerning a product/service

  • Customers and non-customers are placed into segments based on their responses to the key variables that drive purchase behavior


Factor cluster analysis

Factor/Cluster Analysis

Factor Analysis and Cluster Analysis are statistical tools used to determine appropriate needs-based customer segments.

  • The Bain Research and Data Analysis Group in Boston should be contacted when running a needs-based segmentation to ensure proper, statistically valid analysis

  • These tools could generate a number of statistically valid answers. In that case, the segmentation options must then be screened using business judgement.


Behavioral and demographic segmentation

Behavioral and Demographic Segmentation

There are two methodologies for segmenting a database of behavioral or demographic information.

80/20

CHAID - an analytical tool that uses the Chi-Square statistic to find the drivers of a dependent variable

Process:

  • Divide customers according to their profitability

  • Hypothesize as to the variables that drive profitability. Combine variables to create segments.

  • Choose dependent variable (e.g., profit), hypothesize as to the segmentation variables, collect data on variables, run CHAID, reality check results, and create segments based on the CHAID

Statistical validity:

  • Low

  • High

Drawbacks:

  • Iterative, manual process

  • Requires solid intuition

  • Risks leaving out important variables

  • Does not address causation

  • Process requires contacting the Bain Research and Data Analysis Group in Boston for software/ statistical expertise in conducting CHAID analysis


Chaid

CHAID

CHAID is a statistically robust method used to segment a demographic or behavioral database.

  • CHAID analysis determines and ranks all of the statistically significant drivers of a chosen dependent variable (e.g., profit, retention, productivity)

  • Specifically, it groups independent variables into subgroups

    • independent variables are categorized according to their statistical significance (e.g., store location, age)

    • CHAID identifies interactions/effects between variables

    • CHAID yields subgroups which are statistically significant and MECE


Segmentation requirements

Segmentation Requirements

Regardless of the type of segmentation used, the customer groups determined by the segmentation process must have the following characteristics:

  • Meaningful - there should be enough differentiation among segments such that each segments seems unique

  • MECE - each customer should belong to one, and only one, segment

  • Measurable - clearly defined with a market share that can be quantified

  • Substantial - there should be enough volume in a segment to merit analysis

  • Actionable - we should be able to design a value proposition for each segment


Agenda5

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Target segment selection

Target Segment Selection

The target segments should be chosen based on their attractiveness to a given company and that company’s ability to serve the target segments in a differentiated way.

Attractiveness(profit potential)

Ability to serve in a differentiated way

Revenue potential

Cost to serve

Client’s core capabilities vs. competitors’

External factors

  • Size

  • Growth potential

  • Buyer power

  • Product requirements

  • Price sensitivity

  • Advertising requirements

  • Channel preference

  • Service requirements

  • Strategic objectives

  • Ability to leverage:

    • technology

    • costs

    • skills

    • existing resources

  • Existing market perceptions

  • Existing base in segment

  • Legal restrictions

  • Regulatory requirements

Note: In some cases, there will be only one target segment


Target segment selection matrix

Target Segment Selection Matrix

High

Develop Capabilities to Serve this Segment

Target this Segment

Segment Attractiveness (Lever = Value Proposition)

Adjust Value Proposition to Improve Attractiveness of this Segment

Avoid this Segment

Low

Low

High

Ability to Serve Segment in a Differentiated Way(Lever = Capabilities)


Agenda6

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Value proposition development

Value Proposition Development

After customers have been segmented and the most attractive segments have been chosen, a customized value proposition should be created for each target segment by trading off among the following elements:

Product

Service

Distribution

  • Features

  • Price

  • Quality

  • Brand

  • Positioning

  • Promotion/advertising

  • Before sale

  • During sale

  • After sale

  • Delivery channels

  • Speed

Actions should leverage strengths and optimize resources with the goal of increasing market share of the target segments


Agenda7

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Profit potential quantification

Profit Potential Quantification

Once the value propositions have been established, the potential profit to be gained from providing them to the target segments should be quantified.

Determine profit potential

Calculate revenue increase

Calculate cost to serve

New customers

New customers

Current customers

Current customers


Agenda8

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Smith s fashion center process

Smith’s Fashion Center* - Process

Smith’s Fashion Center is a large discount women’s retailer in the Northeast that wants to understand its customer base to determine expansion options.

A list of the drivers of retail purchasing behavior was made

Customers were asked ~20 questions to record their needs

Factor/Cluster analysis was used to determine the segments

Segment size and revenue potential were calculated

An expansion market was chosen and the merchandise strategy was adjusted based on the segmentation results

*Disguised client case


Smith s fashion center segments

Smith’s Fashion Center - Segments

A five segment solution was chosen from the Factor/Cluster analysis.

Female apparel shoppers

Primary motivation:

Fashion

Bargains

Utility

Secondary motivation:

Fun

(love to shop)

High quality bargains

Bargains

Efficiency/service

Fashion

Not motivated by:

Bargains

Service

Fashion

“Fashion

on a Shoestring”

“Unfashionable Bargain Lover”

“Rich but Unfashionable”

Segment name:

“Fashion Forward Shopping Lover”

“Fashion Value”

Average spending per year:

$1,400

$1,350

$950

$750

$850


Smith s fashion center current customers

Smith's Fashion Center - Current Customers

Smith determined that its target segments were “Fashion Value” and “Fashion on a Shoestring”.

Ability to serve in a differentiated way

*In this case, spending was a good proxy for profit


Smith s fashion center expansion city customers

Smith's Fashion Center - Expansion City Customers

Smith chose an expansion city with a high mix of its target segments.

Chosen Expansion City


Smith s fashion center merchandising strategy

Smith's Fashion Center - Merchandising Strategy

Based on the needs of the target segments, the merchandise strategy was adjusted to include accessories and more low quality brands.

Importance of Accessories

Merchandise Quality


Agenda9

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Highland hotels background

Situation:

  • The client, Highland Hotels, has high margins and is one of the five largest hotel/conference center chains in Europe

Complication:

  • The market is coming to the end of a period of rapid growth and Highland’s relative cost position is worse than its competitors’

Question:

  • How can Highland preserve its high margins in a slowing market where it finds itself at a cost disadvantage?

Hypothesis:

  • By offering a differentiated value proposition to the most profitable customer segment, Highland can preserve its high margins

Highland Hotels* - Background

Bain used customer segmentation to determine the target segments for Highland Hotels and to create value propositions for those target segments.

*Disguised client case


Highland hotels process

Highland Hotels - Process

Bain conducted an 80/20 behavioral/demographic segmentation for Highland Hotels.

Customers were divided into groups based on their profitability

The behavioral and demographic drivers of profitability were determined

High profit customers were segmented based on their behavioral and demographic characteristics

A target segment was chosen based on its attractiveness and Highland’s ability to serve it

A value proposition was created for the target segment


Highland hotels customer profitability

Highland Hotels - Customer Profitability

One third of Highland’s customers account for more than 60% of its total profits.


Highland hotels profitability drivers

Highland Hotels - Profitability Drivers

The primary drivers of profitability are visit frequency, length of visit, and occasion.

Visit Frequency

Length of Visit

Occasion


Highland hotels high profit segments

Highland Hotels - High Profit Segments

Highland identified four types of high value customers based on the profitability drivers.

High Profit Segments

Annual Frequency

Length of Stay

Occasion

  • “Hotel-aholics”

Very frequent

(9.2x)

Medium

(3.9 days)

Business/leisure

  • “Honeymooners”

Infrequent

(1.5x)

Long

(10.0 days)

Leisure

Business

  • “Hello again”

Frequent

(6.2x)

Short

(1.8 days)

Business

  • “One-timers”

Infrequent

(1.3x)

Long

(5.4 days)


Highland hotels target segment

Highland Hotels - Target Segment

Highland decided to target “hotel-aholics” because they were the most attractive segment and a good fit with the company’s capabilities.

Ability to serve in a differentiated way


Highland hotels value proposition

Highland Hotels - Value Proposition

Bain designed a value proposition for the “hotel-aholic” segment that differentiated Highland from its competitors.

Priority service

Special services

Rewards

  • Favorite room ready

  • “Permanent” electronic key

  • Complimentary dry cleaning

  • Two phone lines

  • Fax machine in room

  • One 20 minute complimentary call to home

  • Frequent flier miles

  • “Kids Stay Free” days


Agenda10

Agenda

  • The customer segmentation concept

  • Applications

  • Customer segmentation steps

    • segment customers

    • choose target segments

    • create value propositions for target segments

    • determine profit potential of serving target segments with value propositions

  • Examples

    • needs-based

    • behavioral

  • Key takeaways


Key takeaways 1 of 2

Key Takeaways (1 of 2)

Customer Segmentation Steps

  • Customer segmentation involves separating customers (existing and potential) into homogeneous groups, choosing target segments (or one target segments), creating value propositions for each target segment, and determining the profit potential of serving the target segments with the proposed value propositions

Types of Segmentation

  • There are three main types of customer segmentation: needs-based, behavioral and demographic. Needs-based segmentation is the most difficult to execute, but the most valuable. Most of Bain’s work involves needs-based segmentation

    • needs-based segmentation involves creating a list of needs, collecting data, and conducting Factor/Cluster analysis to identify segments

    • there are two methodologies for segmenting a database of behavioral or demographic information

      • the 80/20 method involves dividing customers according to their profitability, hypothesizing as to the variables that drive profitability, and combining variables to create segments

      • the CHAID method involves choosing a dependent variable, hypothesizing as to the segmentation variables, collecting data, running the CHAID, reality checking the results, and creating segments

  • Regardless of the type of segmentation used, the resulting segments must be meaningful, MECE, measurable, substantial, and actionable


Key takeaways 2 of 2

Key Takeaways (2 of 2)

Applications

  • Customer segmentation, done properly, helps companies focus scarce resources where they can be most leveraged

  • Bain uses customer segmentation for both customer retention and customer acquisition

Target Segments

  • Target segments are chosen based on their potential profitability and the client’s ability to serve the segments in a differentiated way

  • Determining the profit potential of serving the target segments with the proposed value propositions consists of calculating the revenue and cost impact of serving both current and new target customers

  • The three major elements of a value proposition are product, service, and distribution


Takeaway slides 1 of 3

Segment customers

(existing and

potential)

Choose target segments

Create value proposition for each target segment

Determine profit potential

Needs-based

Behavioral

Demographic

  • Choose segmentation method (needs-based, behavioral, or demographic) based on underlying issues

  • Choose target segments based on attractiveness and ability to serve in a differentiated way (in some cases, there will be only one target segment)

  • Create value propositions based on customer needs (each target segment requires its own value proposition)

  • Determine the revenue and cost impacts of offering the proposed value propositions to the target segments

Process:

Segmentation process:

  • Primary research necessary

  • Primary research necessary only if behavioral data not available from client database

  • No primary research necessary

  • Demographic data sometimes readily available from client

Tips:

  • Segments should be

    • meaningful

    • MECE (only one segment per customer)

    • measurable

    • substantial

    • actionable

  • Attractiveness is based on profit potential (revenue potential and cost to serve)

  • Ability to serve in a differentiated way recognizes both the client’s and the competitors’ core competencies as well as regulatory factors

  • Each value proposition should address:

    • product

    • service

    • distribution

  • Profit potential should include profit as well as “hidden costs” (e.g., increased training and marketing costs for new products)

Usefulness in creating value propositions:

  • High (shows causation)

  • Descriptive and actionable (describes customers and drivers of purchase)

  • Moderate (shows correlation, not causation)

  • Descriptive, not actionable (describes purchasing behavior, but does not address drivers or purchase)

  • Low (occasionally shows correlation, never causation)

  • Descriptive, not actionable (describes customers but does not address drivers of purchase)

Create a needs list

Collect data

Conduct Factor/Cluster analysis to determine statistical segments

Takeaway Slides (1 of 3)

Customer Segmentation Steps

Comparison of Segmentation Methods

Behavioral and Demographic Segmentation

Needs-Based Segmentation

80/20

CHAID - an analytical tool that uses the Chi-Square statistic to find the drivers of a dependent variable

Process:

  • Divide customers according to their profitability

  • Hypothesize as to the variables that drive profitability. Combine variables to create segments.

  • Choose dependent variable (e.g., profit), hypothesize as to the segmentation variables, collect data on variables, run CHAID, reality check results, and create segments based on the CHAID

Steps:

  • Make a complete list of potential customer and non-customer needs

    • focus groups or a small number of unprompted customer interviews

    • brainstorming

    • previous client work or Bain research

  • Ask a representative sample of customers and non-customers a battery of questions designed to gauge their needs concerning a product/service

  • Customers and non-customers are placed into segments based on their responses to the key variables that drive purchase behavior

Statistical validity:

  • Low

  • High

Drawbacks:

  • Iterative, manual process

  • Requires solid intuition

  • Risks leaving out important variables

  • Does not address causation

  • Process requires contacting the Bain Research and Data Analysis Group in Boston for software/ statistical expertise in conducting CHAID analysis


Takeaway slides 2 of 3

Takeaway Slides (2 of 3)

Segmentation Requirements

Target Segment Selection Matrix

High

  • Meaningful - there should be enough differentiation among segments such that each segments seems unique

  • MECE - each customer should belong to one, and only one, segment

  • Measurable - clearly defined with a market share that can be quantified

  • Substantial - there should be enough volume in a segment to merit analysis

  • Actionable - we should be able to design a value proposition for each segment

Develop Capabilities to Serve this Segment

Target this segment

Segment Attractiveness (Lever = Value Proposition)

Adjust Value Proposition to Improve Attractiveness of this Segment

Avoid this segment

Low

Low

High

Ability to Serve Segment in a Differentiated Way(Lever = Capabilities)

Value Proposition Development

Profit Potential Quantification

Product

Service

Distribution

Determine profit potential

  • Features

  • Price

  • Quality

  • Brand

  • Positioning

  • Promotion/advertising

  • Before sale

  • During sale

  • After sale

  • Delivery channels

  • Speed

Calculate revenue increase

Calculate cost to serve

Current customers

New customers

Current customers

New customers

Actions should leverage strengths and optimize resources with the goal of increasing market share of the target segments


Takeaway slides 3 of 3

Customer Retention

100%

Bad

Percent of Replies

Okay

Good

Time

Takeaway Slides (3 of 3)

Segment Needs

Segment Share

Revenue and Profit

Comb Chart

Total market = $

Segment

Client

#

$

$

$

$

$

$

$

Client

A B C D

Competitor

Low price

High quality

Fast delivery

Competitors (% of Total Sales)

Satisfaction Over Time

Attractiveness

Value Proposition

Size of segment

Product

Service

Channel

Hi

Target segment

A

Segment

Financial

Attractiveness

C

Segment A

Segment B

Segment C

Segment D

B

C

Acquisition Cost

Lo

Ease of Implementation


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