Customer Segmentation and Targeting

1. Customer Segmentation and Targeting BA 6324: Fundamentals of Marketing Professor Dillon Lecture Notes: Set #6

2. Customer Segmentation and Targeting • 1. Overview • 2. Why Segment • 3. Rationale • 4. Bases for Segmentation • 5. Understanding Consumers • 6. Evaluating Market Segments • 7. Segmentation Approaches • Targeting Customers • Practice Problems 2

3. Customer Segmentation & Targeting 1. Overview Lets return to two core questions facing marketing managers • Who are my customers? • What products/services do they want? But these questions take on more complexity if we believe that all of our customers are not alike All Customers Different All Customers Alike

4. Customer Segmentation & Targeting 1.1. Definition Segments refer to groups of customers who are similar in the sense that they respond to changes in one or more of the marketing mix elements in the same way; in other words, segments are groups of customers who exhibit differential sensitivity to one or more of the marketing mix elements. Key Ingredients Groups of Customers Homogeneous Differential Sensitivity

5. Recognize Segments Differential Targeted Increased Heterogeneity Identified Sensitivity Marketing Share & Profit Customer Segmentation & Targeting 2. Why Segment Economic Justification: Suppose, for example, a firm is spending the same amount of promotional funds on all customers. Furthermore, suppose that it is trying to sell as much product as possible, given its promotional budget. The firm is considering increasing its promotional budget. Should the firm extend this offer to all of its customers? If customers have different sensitivities to promotion the answer is NO. The concept of market segments was developed in economic theory to show how a firm producing homogeneous products to a market characterized by heterogeneous demand (tastes) could maximize profits. The focus is on differential marketing mix sensitivity - use mix elasticities to establish segments and set individual mix elements so that the marginal profits in each segment are equal. When not to Segment?

6. Differential sensitivity to one or more marketing mix elements (price, promotion, product features, distribution). Allows marketing manager to optimize offerings by customizing. End Result Increased Profits Customer Segmentation & Targeting 3. Rationale

7. Customer Segmentation & Targeting Example: RJ Reynolds Company Sells Several Brands • Question: How should RJR allocate its marketing resources in the Dallas market? • The usage rate of RJR brand cigarettes varies across the city. • This usage rate seems to be related to the socio-economic characteristics of the smokers • Higher education level smokers use low tar cigarettes; “Blue collar” folks smoke Winston, and African-American smokers prefer menthol (found in Salem) • North of Dallas HH have higher education levels; the South of Dallas neighborhoods tend to be blue-collar with a larger percentage of African-American residences • So, RJR allocates its promotion money based on brand & geography

8. Customer Segmentation & Targeting Segmentation Model • In the above example, the usage rates of the different brands of cigarettes formed the basis for the entire segmentation scheme. Hence, this variable is referred to as a basis variable. • In a regression context, think of the basis variable as a “dependent variable. The basis variable should capture the heterogeneity of interest to the marketer, i.e., the differences across consumers. • The geographic and socio-economic characteristics in the RJR example are referred to as the descriptor variables. • In a regression context, think of the descriptor variables as the “independent variables.” • The descriptor variables help the marketer deliver different 4P levels to the different segments - different products (cigarette brands); prices (low / medium / high); promotions (advertising in specific magazines); place (different kinds of stores)

9. Customer Segmentation & Targeting Irrelevant Descriptor Relevant Descriptor Own Microwave Do Not Own Microwave Low Education High Education Fraction of Customers 20% 80% 30% 40% Likelihood of Smoking Low-Tar Cigarettes given Smoker Likelihood of Smoking Low-Tar Cigarettes given Smoker

10. Product-Specific General Observable Unobservable Customer Segmentation & Targeting 4. Bases for Segmentation 4.1 Consumer: A segmentation basis is defined as the customer characteristic or set of customer characteristics that are used to assign customers to segments. Classification of Segmentation Bases - Consumer Cultural Geographic Demographic Geo-demographic Socio-economic Psychographics Life style-AIO’s Personality User status Usage frequency Brand choice Brand loyalty Store patronage Store loyalty Usage context Benefits sought Perceptions Attitudes Preferences and Intentions

11. Customer Segmentation & Targeting 4.2. Bases for Segmentation: Business-to-Business Industry Company Size Key Accounts Location Type of business Technology User/NonUser Customer capabilities Purchasing process Buying criteria: benefits sought Power structure Organizational culture Stage in the decision process

12. Equity Axis A B HIGH C D LOW Power Axis LOW HIGH Customer Segmentation & Targeting 4.2.1.AB-B Segmentation Framework PRICE Cost-to-Serve

13. Customer Segmentation & Targeting Abstract, Centrally Held Enduring beliefs concerning states of existence or modes of Behavior (1) Terminal & Instrumental Values Beliefs relevant to economic, social, religious, and other activities Dozens Sociocultural, Economic, and Familial Influence (2) Personal Beliefs and Attitudes Evaluative beliefs about products and attributes Hundreds Concrete, Less Centrally Held (3) Evaluations of Products and Product Attributes Thousands 5. Understanding Consumers Source: Vinson, Scott, and Lamont (1977), “The Role of Personal Values in Marketing and Consumer Behavior.” Journal of Marketing. 13

14. Customer Segmentation & Targeting 5.1.Level 1: Instrumental & Terminal Values 5.1.1. Terminal Values: Consumers rank the importance of the following end-state goals in their lives. 14

15. Customer Segmentation & Targeting 5.1.2. Instrumental Values: Consumers rank the importance of the following modes of behavior that facilitate the attainment of the broader end-goals. 15

16. Customer Segmentation & Targeting Prosocial —Individual needs tied to a positive, active concern for the welfare of others Enjoyment — Individual needs tied to physiological gratification and transformed to socially acceptable values Restrictive Conformity — Individual needs require individual to restrain unruly impulses and inhibit actions that might hurt others’ interests to ensure smooth functioning of society 5.1.3.Value Typologies Terminal and Instrumental values can be grouped into seven topologies. These topologies have consistently been identified across a variety of cultures.* Maturity —Individual needs shaped by individual’s experiencing and coming to terms with life, by learning to understand, to make peace with, and to appreciate the social and physical reality as it is Self-Direction —Reliance on and gratification from one’s independent capacities for decision-making, creativity, and action Achievement — Needs that represent a desire for social recognition and admiration Security — Individual needs tied to safety and security, both physical and psychological *Schwartz and Bilsky (1987), “Toward a Universal Psychological Structure of Human Values.” Journal of Personality and Social Psychology 16

17. Customer Segmentation & Targeting Maturity MIXED Self-Direction Prosocial Value Domains Enjoyment Security INDIVIDUAL COLLECTIVE Restrictive Conformity Achievement At a higher level, the seven value topologies can be classified into three broad domains — individualist, collectivist, and mixed. For example, Self-Direction is an individual domain where individuals are driven by one's own independent capacities rather than societal expectation or guidance. Conversely, Prosocial is a collectivist domain where people tend to act with the good of the group in mind, over their own. 17

18. Customer Segmentation & Targeting Although the Value System Topologies are consistently identifiable in most countries across the globe, the way in which they manifest may result in different relationships between the seven topologies — in particular, with respect to their location on the "value Circumplex," as well as their relative sizes.  The seven topologies are ordered around the circle whereby topologies with similar personal attitudes (instrumental attributes) and goals (terminal attributes) are located nearest to each other. Although the core values remain the same, slight variations in the way personal attitudes and goals exist together (or separate) within different cultures may affect certain characteristics in each of the seven topologies, resulting in new dynamics between them. For example, Culture A Culture B Maturity Prosocial Self- Direction Within Culture B, for example, the Maturity topology reflected personal attitudes and goals that were more similar to the Security topology than the Self-Direction, as was the case in Culture A. Self- Direction Prosocial Maturity Achievement Security Security Enjoyment Achievement Restrictive Conformity Restrictive Conformity Enjoyment  In addition, the resulting sizes of each of the seven topologies will likely vary across cultures. Culture A Culture C Maturity Maturity Within Culture C, for example, the incidence of Prosocial individuals is much higher in Culture C (21%) compared to Culture A (13%). Conversely, the Maturity topology is much smaller. Self- Direction Self- Direction Prosocial Prosocial Achievement Achievement Security Security Restrictive Conformity Enjoyment Enjoyment 18 Restrictive Conformity

19. Customer Segmentation & Targeting 5.1.4.Value System Topologies in Five Countries Cultural difference in each of the five countries mapped below yield varying sizes of the seven value topologies within each of them. HONG KONG UNITED STATES Restrictive Conformity Security Enjoyment Security Prosocial Achievement BRAZIL Achievement Maturity Prosocial Restrictive Conformity Self- Direction Achievement Restrictive Conformity Self- Direction Enjoyment Security Maturity Enjoyment FINLAND ISRAEL Prosocial Prosocial Maturity Security Security Self- Direction Self- Direction Self-Direction Restrictive Conformity Prosocial Maturity Achievement Maturity Enjoyment Restrictive Conformity Enjoyment Achievement 19 *Schwartz and Bilsky (1987), “Toward a Theory of the Universal Content and Structure of Values: Extensions and Cross-Cultural Replications.” Journal of Personality and Social Psychology

20. Customer Segmentation & Targeting 6. Evaluating Market Segments A. Identifiability: it should be possible to identify segments. This means that segments must be different and that there is a way to classify customers into their relevant segment with some level of accuracy. Fixed segment membership - customers belong to one and only one segment. Fuzzy segment membership - customers belong to more than one segment with some nonzero probability. B. Substantiality: Segments should be large enough to ensure profitability of targeted marketing programs. Both the number of customers and their purchasing power are important. C. Responsiveness: Segments should respond uniquely to marketing efforts targeted at them. Preferably segments should reflect a gap in the market. D. Accessibility: It should be possible and feasible to reach segments through conventional communication, promotional and distributional channels. E. Stability: Segment membership, accessibility, size and responsiveness should remain fairly stable for some reasonable period of time, at least to allow implementation of targeted marketing programs and validation of predictions. F. Actionability: Segmentation engagements should provide strategic directions and explicit implementation strategies and tactics.

21. Customer Segmentation & Targeting 7. Segmentation Approaches A-priori approaches to segmentation: Segments and their number are determined by the researcher. Post-hoc approaches to segmentation:Segments and their number are dependent on data and method applied. Descriptive approaches to segmentation:No dependent variables is specified. Predictive approaches to segmentation:Dependent variable(s) is specified.

22. Segmentation Basis: Purchase or Usage Rate Example: PCs for home use Total Adults (US) = 184.117 million Adults with a PC at home = 43.379 million % adults with PC at home = 23.6% Cost of Average Buyers Purchase Volume Last PC Amount Number % Dollars % (million) ($billion) > $1,999 $2,500 15.685 8.5 3.92 56.6 $1,000 - 1,999 $1,500 15.046 8.2 2.26 33.1 < $1,000 $ 500 12.684 6.9 0.63 9.3 TOTAL Customer Segmentation & Targeting 7.1. Apriori Segmentation

23. 5692 24497 .131 .133 % Penetration Penetration Age # Adults Own % Vol. Rate Index 18 - 24 24497 13.3 5692 13.1 23.2 98.5 25 - 34 43260 23.5 9932 22.9 23.0 97.4 35 - 44 35986 21.2 11996 27.7 30.8 130.6 45 - 54 25970 14.1 7848 18.1 30.2 128.4 55 - 64 21094 11.4 3887 9.0 18.4 78.9 65+ 30310 16.5 4024 9.3 13.3 56.4 See similar information for other demographic descriptors. What conclusions do you arrive at? Customer Segmentation & Targeting Segmentation Basis: Volume and penetration Rate •Volume % category sales to a segment •Penetration rate % within segment buying the product Example: PCs for home use Total Adults (US) = 184.117 million Adults with a PC at home = 43.379 million % adults with PC at home = 23.6%

24. Customer Segmentation & Targeting 7.2. Post-hoc Segmentation Oftentimes, one needs to use multiple bases for segmentation. For example, size of firm, order size and nature of application in an industrial marketing application. Or in a financial services application, the bases might be - number of accounts held with the bank, frequency of ATM visits, volume of transactions, etc. Suppose there are N such basis variables. Let each variable have L levels. Then the number of possible segments are NL. Obviously, there may be too many segments to be meaningful Hence, we need some procedure that can take the data across consumers on all the relevant bases variables and then group those consumers together who have similar values on the bases variables 25

25. Customer Segmentation & Targeting Volume of Transactions Group 1 Group 3 Group 5 Group 2 Number of Accounts Group 4

26. Customer Segmentation & Targeting 7.3 Profiling the Segments • When there are several bases variables, the statistical procedure that is used to group consumers is called cluster analysis. • Once the clusters (or segments) have been identified using the bases variables, the next step is to describe (or profile) them using the descriptor variables • For example, in the financial services case, one can compute the average income, age, family size, and media habits of the consumers belonging to each of the 5 groups in the figure • If the average profile of each group is “sufficiently” different, then we have “good” descriptors • Question: How do we decide how many segments to have?

27. BANK BENEFIT SEGMENTS Segment 1 2 3 4 5 Front Loan Representative value One-stop Name runners seekers subgroup seekers bankers Principal benefits sought Banks favored Demographic characteristics Lifestyle characteristics *Large *Bank for all *Good advertising *Commercial bank A *Young *Rent home High ability to manage money *Good reputation *Loans easily available *Low loan interest *Commercial B *Savings X *More transient More blue collar *Liberal about use of credit *Positive about bank loans *No differences (about average on all benefits sought) *Commercial A *Commercial B *High savings interest *Quick service *Low loan interest Plenty of parking *Savings Y *Savings Z *Tend to save more *Conservative overall lifestyle *Conservative about use of credit Low propensity toward risk taking *Wide variety of services *Convenient hours *Quick service Encourages financial responsibility Convenient branch *Commercial A Commercial B Older *Conservative about use of credit Positive toward checking account Size (n) 8 51 118 89 78 Customer Segmentation & Targeting 25

28. First-Time Prospects Novices Sophisticates Customer Segmentation & Targeting Dominant Theme: “Take care of me” Benefits Sought: Knowledge of my business Honest Sales representative Vendor who has experience Sales representative who can communicate in an understandable manner What’s Less Important: Sales representative’s knowledge about products and services Dominant Theme: “Help me make it work” Benefits Sought: Easy-to-read manuals Technical support hotlines A high level of training Sales representative knowledgeable about products and services What’s Less Important: Honest sales representative Knowledge of my business Dominant Theme: “Talk technology to me” Benefits Sought: Compatibility with systems Customization Track record of vendor Sales support and technical assistance What’s Less Important: Sales representative who can communicate in an understandable manner Training Trial Easy-to-read manuals Robertson and Barich’s classification of three generic segments in industrial markets and what they value. Source: Robertson and Barich 1992

29. Customer Segmentation & Targeting 7.4 3 Steps in a Segmentation Study • Survey stage: • Gathering data on a random sample of consumers for several different bases and descriptor variables • Analysis stage • Cluster analysis • Profiling stage

30. Customer Segmentation & Targeting 8. Targeting Opportunities for Profit * Size * Growth Potential TARGET MARKET SELECTION Competitive Intensity * Unmet Needs * Entry Barriers • Firm’s Objectives • Firm’s Capabilities • Synergies across Segments

31. Market A (Without Segmentation) 100,000 X 16% 16,000 X 40% 6,400 X 18% 1,152 X 5% 58 $20,000 Market B (With Segmentation) 50,000 X 30% 15,000 X 60% 9,000 X 23% 2,070 X 7% 145 $30,000 Total Prospect Universe = 100,000 High Opportunity Prospects Response to initial telemarketing Leads generated Response to in-person call/direct mail Highly qualified leads Consideration Subtotal Close rate 2.5 X Improvement New Sales Profit Per Customer 50% Improvement Customer Segmentation & Targeting Example:Focusing telemarketing and sales force initiatives on “hot prospects” can substantially boost productivity and profitability.

32. Customer Segmentation & Targeting 8.1 Targeting Steps • Select factors that drive segment attractiveness and the firm’s relative position • Attach a weight to each of the above factors. The weights reflect the relative importance of the factors • Rate each segment on each of the above attractiveness and position factors • Compute the weighted sum to give you an index of the attractiveness of each segment and an index of the firm’s position in each of the segments. • Select a mass marketing; multi-segment or niche marketing strategy • Sequential targeting is also possible

33. Customer Segmentation & Targeting 9. Practice Problem • DLJ Direct