The Ultimate Guide to Market Segmentation

Introducing market segmentation

There is no product or service which fits every consumer uniformly. Sometimes there needs to be variation in products to suit different people – compact smartphones for people with smaller hands, for example, or simplified apps for those not so good with tech. It could be different ways of selling a product – appealing to some people with an emotional message and others with a technical pitch.

Knowing the ways consumers behave, feel, think and make decisions can help any business tailor its products and its pitches to meet their needs more fully. By breaking down the market into segments – which share certain traits, are identifiably different from other groups, or have similar attitudes – we can find efficient and effective ways of targeting products and services.

Market segmentation is one of the most commonly used market research and analysis tools. When you call your mobile network provider, for example, you can be sure you’ve been categorized into a tailor-made customer segment, and that the interaction you have with the call center is at least in part defined by the persona you’ve been assigned. It helps them understand how to talk to you, what behaviors you’re likely to exhibit, and the types of need you’ll have.

There are three reasons organizations typically commission a market segmentation project:

They feel they don’t know enough about their customers.
They have some basic ideas about the types of customers they have but they can’t apply that knowledge to meet their marketing needs.
They have a successful segmentation analysis but they’re finding it’s flawed in some way and needs updating.

A segmentation doesn’t just shape the way businesses deal with target customers or existing clients, it informs the design of new products and services and will dictate how they decide to reach you and with what messages. It can shape marketing campaigns and entire brand strategies.

What is market segmentation?

Once upon a time, all business was local. Consumers bought products and services from nearby providers – people from their own communities who understood their needs. There were crude forms of segmentation but they were instinctive and obvious. Salespeople from the dawn of time have tailored their messages according to who they were addressing.

About a hundred years ago, that started to change. Mass-produced goods and emerging global business models meant companies needed to understand in more detail the different markets they might address. Mass media accelerated the trend. When you could reach anyone via a newspaper ad or a TV commercial, understanding who might buy your product, why they might like it, where to reach them and what to say to them became much more important.

Then in July 1958, consultant marketer Wendell Smith wrote an article in the Journal of Marketing titled ‘Product Differentiation and Market Segmentation as Alternative Marketing Strategies’ – the first time the word ‘segmentation’ had been used in this context. He argued that understanding the basic facts, personality traits and needs of different groups of potential customers – and tailoring products or messaging to suit – would increase sales.

By the 1970s, Smith and his colleagues were using what became known as ‘psychographics’ (psychology plus demographics) to come up with classic market segmentations, such as the Values Attitude and Lifestyle Study (VALS) – featuring segments such as “innovators” (high-income, motivated by status and exploration) and “thinkers” (well-educated, thoughtful decision-makers open to new ideas).

The forms of segmentation have evolved over time, as have the specific categories and personas that companies target. Sometimes it’s as crude as defining a target audience as a particular age group but it can also be a sophisticated analysis of deep emotional needs. Methodologies have adapted and diversified, too. But a couple of things remain constant for market segmentation projects. First, they look for definable truths about customers – reliable information that enables you to group them in useful ways. And segmentation remains a cornerstone of marketing campaigns. Segmentation allows companies to target high value consumers and position their product or brand in ways to maximize their performance. That ‘STP’ approach remains fundamental to good marketing.

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Different ways of segmenting your customer base

There are four main categories of information we can use to segment a market:

Geographic: where do people live? What is their environment like? What local factors might influence them?
Demographic: how old are they? What social groups do they fall into? How educated are they? How big is their family?
Behavioral: how do they make decisions? How do they use products? What are their attitudes to brands?
Needs based: What are their needs? What are their attitudes and values?

One of the most obvious ways to approach market segmentations is by generations. But people quickly realized that simply looking at age groups glossed over huge variation in attitudes and needs within generations. There are relatively few ways in which an age cohort behaves uniformly. You must ally demographic with behavioral and attitudinal insights to create segments that are truly useful.

This is illustrated by the rise and fall of the concept of ‘Millennials’. There have been a number of well publicized marketing fails of companies targeting millennials. Lumping them all together – rich and poor, graduates and school-leavers, different countries and cultural backgrounds – is a major misstep. Millennials are hardly homogenous and treating them as one group risks alienating your customer base.

Why ‘needs’ make for compelling segments

We believe that identifying segments by exploring the needs of your potential customers is much more valuable than thinking about any demographic aspects. And this is why the vast majority of market segmentation projects are now needs-based.

For example, you might discover that there’s a portion of the population whose prime need is for low-cost products; another seeks quality or status from their purchases; and some need to have products that meet exacting technical specifications. Once you have those needs-based segments mapped, you can cross-reference by demographics or behaviors if that looks like a useful way of finding other people who might fall into those need groups.

Behaviors are harder to use in a predictive sense. They can change rapidly, especially as a result of external influences. Attitudes and needs, on the other hand, are more revealing and often more predictive. For example, we worked with one academic institution to segment their alumni in order to target graduates with a high propensity to make donations. The value of ‘attitude’ was illustrated by two graduates who both worked in finance in the City. They were the same age, had similar jobs and backgrounds. But one had enjoyed their time at the school and saw it as a springboard for their career; the other had not relished their time there and was considering a career change. The demographics said they were the same segment. But attitudinally, they were poles apart. Creating a segment of ‘inspired graduates’ made more sense than one of ‘rich bankers’.

Getting granular: what really makes a difference when it comes to market segmentation?

Working towards a granular market segmentation is important. If your category is too broad (e.g. ‘millennials’), it’s likely that you’ll capture too many different attitudes to be able to develop compelling strategies. When you mash together a lot of different colors, you just end up with brown. You need to be able to pick out individual colors – those different attitudes and needs – so they can be addressed in a compelling way.

How you’re planning to address your different segments should also help frame your market segmentation strategy. For example, if you’re planning to promote a product through newspaper advertising or on TV, there’s a limit to how granular you need to get.

But as new ways of interacting with customers have evolved – particularly in the digital era – the value of finer segmentations has risen sharply. Today, using tools like email, targeted advertising, or big data analytics, the subtleties between segments can really make a difference.

Imagine you have a product to help pensioners release equity in their homes, for example. There’s an obvious demographic segmentation: you’re only interested in the over-65s. You need to conduct an inspection of their home when they apply and your valuers only cover the South East of England. In this situation, a geographic segmentation is a no-brainer.

But then you know from your existing customer data that people with grandchildren are much more likely to want to free up cash so differentiating between them and the childless elderly is worthwhile. Financial literacy is also a key factor and how trusting of financial services companies they are. Risk appetite can’t be measured demographically but it might define your segmentation.

How to use market segments

So when companies debate which kinds of factors will define the customer personas – and how finely to segment their audience – the most useful question to ask is: how are you actually going to use the segments?

You might be a global business, looking to understand how the same six segments present in multiple countries. Will you actually be able to tailor the product or service around those segments? Can a central marketing function use them in the same way in every country? Or will local teams who understand the nuances of their own markets offer more valuable insights, and perhaps even more relevant segmentations of their own?

Or if you have 15 market segments, for example, and identify seven of them as high priority targets, are you going to tailor your product around every one of them? If not, might there be more value in a more limited approach?

We were approached by a large global business who had segmented the entire personal care market in the UK, which resulted in a lot of different segments. These included people who did the minimum to appear presentable, using the cheapest products infrequently. At the other end were big spenders on grooming who were the real target for that brand’s products.

How might that segmentation have been done differently? In terms of time and money, making a first cut to eliminate the parts of the market that have never shown propensity to buy the brand’s categories of product creates headroom for a deeper segmentation of those more lucrative parts of the population, allowing for more effective targeting.

Embarking on market segmentation? Start with what you already know

The first step of that segmentation journey is looking at what you already know about your existing customers. What is your data telling you? If you’re a pay TV network, for example, your database contains a lot of raw material for market segmentation. You can analyze by frequency of contact, whether someone has switched away and come back to you, whether they opt in to promotional emails, etc. Those kinds of factors alone are a good start to segmentation.

For example, we worked with an online dating service to comb through their database, identifying key segments based on usage patterns and other behaviors, then assigning all existing members to one of those segments. It was a powerful tool for the company’s call center operators who quickly got a sense of the type of member they were talking to from the persona that popped onto their screen, as well as targeting email marketing and much more. The segments became a lens for the business to view its own customers but also gain insights into the wider market of potential users.

A high-quality customer relationship management (CRM) system is obviously a big help. You need to be in compliance with GDPR and be responsible in how data is used, of course. (And bear in mind: if you formally assign customers to a segment, they might one day see how that’s defined thanks to GDPR’s focus on subject access rights). But allying CRM analysis with an attitudinal, needs-based market segmentation can help extrapolate the behaviors you see in existing contacts to potentially untapped audiences, too.

Many traditional (typically pre-digital) businesses have started to accumulate a lot of data about customers but struggle to make the connection between what they know about them and how that might fuel a market segmentation project. Conversely, online-only businesses are typically built from the ground up around careful segmentations, whether they emerge organically from CRM data or are built as part of a formal project.

Why market personas must be instinctive

It’s important to create segments that are meaningful. The key to a really good market segmentation is that anyone can use it.

It should be intuitive – so the personas you create from your segments are recognizable and understandable.
It should be useful to people in different functions – whether that’s new product development, marketing, communications, sales, customer service or even the finance function.
It should work as well for people in the boardroom as it does for people at the front line.

That means how you brand your segments is actually a very important part of the process. We all know some famous segment names – DINKYs (Dual Income No Kids); Yuppies (Young Urban Professionals); Mondeo Man and Worcester Woman in the UK, and Soccer Moms in the US. They’re memorable and self-explanatory.

When you’re working on a market segmentation project, you need to bear in mind who’ll be using the segment analysis. That should be everyone, from the board to the call center operative. Without their buy-in (and their insights) it’s much harder to make the segmentation intuitive. Each segment must make sense to them and tell at least part of the story.

At Kadence, we also have a graphic design team in-house. The use of visuals to bring a segmentation to life is critical, not only to make it live on in the organization but to frame an understanding of the segments. We often produce documentary videos to show what kind of people are in each segment and how they behave or react.

The impact of market segmentation

What difference does market segmentation make to key decisions? Which decisions does it most affect? We see many different benefits from market segmentations. For example:

Incremental gains in congested markets. Successful products and services rely on fine-tuning to gain market share or increase sell-through with existing audiences. Segmentation allows you to identify how to exploit opportunities in underserved areas, or segments where rivals currently outperform.

Product evolution. Segmenting the market allows you to see what other underserved needs exist in groups that are already customers, allowing you to fine-tune your offer, especially if the product or service has flexible elements built in.

Targeted communications. Even email costs money (and goodwill, if it’s perceived as spam). Identifying common traits among high-propensity segments not only allows for less wasted communications, it also allows those comms to be fine-tuned for maximum impact.

Smarter automation. Customer service and call centers are increasingly reliant on automated systems. A solid market segmentation can help ensure those interactions are properly tailored and high-value segments are prioritized.

Extrapolating from the existing customer base. Market segmentation can help identify traits in existing customers that might be shared by other segments that don’t seem at first glance to be fertile markets.

New product development and launch. You might already have an idea of the types of customers a product will work for, or situations where it might be applied. You might not even need a market segmentation in the development phase but once a product or service has launched, the need to optimize its performance becomes much greater. Who’s actually using it? How? Why? Those early adopters (another classic segment) can help define and exploit other segments of consumers.

The role of market segmentation within your long-term strategy

A market segmentation project, done right, is extremely valuable but it’s also a significant undertaking. Segmentation studies aren’t designed to be done every year – ideally it should have a five or even ten year shelf life.

Even then, some events are so huge as to require a fresh look at segmentation. The Covid-19 pandemic has prompted many businesses to refresh their buyer personas. For the bulk of 2020, people’s lives have been artificially constrained. How someone behaves or reacts, what they prioritize in life, and even what values they have, are all affected by ‘not going out’.

Even when lockdowns (hopefully) abate in 2021, how the market breaks down for previously predictable products – from personal grooming and alcohol, to cars and holidays – is going to be quite different to what went before. And it’s very unlikely the old segments will move to adapt to the new reality in precisely the same ways.

We’ve already seen some significant pandemic-inspired segmentation projects, with brands wanting to understand how their market breaks down now that people are eating out much less and work-from-home consumers are shopping differently. Previous segments might not be helpful: do you need to re-cut by job status, for example, given higher unemployment?

It doesn’t matter whether you’re targeting niche markets and need to understand where to find them, or want to tailor a broad-based approach to maximize penetration among different personas, an effective segmentation will set you up for success. Find out more about our experience in running market segmentation studies, or get in touch with our team to discuss a specific challenge.