Segmentation – the basic building block for markets

The market segmentation process is outlined. The steps are: ● market definition; ● market mapping; ● listing who buys; ● combining t...

The market segmentation process is outlined. The steps are:
● market definition;

● market mapping;

● listing who buys;

● combining this into lists of who buys what;

● listing why these micro-segments buy what they buy;

● combining the micro-segments into larger segments by means of cluster analysis.

No accountability system will be effective unless it is measuring metrics by segment as a precursor to higher levels of accountability aggregation. It can be seen from Figure 6.1 that market segments are the central holding point for lower-level data, which in turn feed into higher-level processes such as strategic marketing planning. Hence, market segmentation is crucial to any understanding of systems for marketing accountability.

Information use in marketing

The very term ‘market segmentation’ conjures up images of a whole being divided into smaller parts (segments). Yet market segmentation has become a confusing metaphor, badly explained and poorly implemented. Indeed, a Harvard Business Review article (Christensen, Cook and Hall, 2005) reviews 30,000 failed product launches in the United States and puts their failure down principally to inadequate market segmentation.

The construction industry, until the 2008 global recession, was booming in many countries in the world. During the boom times, we were discussing a superb 185 per cent increase in profit growth with a director of a construction firm but he was not sure how much came from market growth, price increases, share improvement or improved productivity. When pushed, he answered that ‘we had a mild winter’. There is a grossly mistaken view that, in high-growth markets, marketing and market strategy somehow doesn’t matter. But even a cursory glance at the fortunes of US and European companies over the past 20 years reveals how the mightiest firms almost collapse from a position of incredible growth; the market moves or the growth stops.

The defining characteristic of professional marketing strategy has always been market segmentation. Mediocre offers are only going to reap mediocre results. Going a stage further, what sort of company would make a commodity out of bread, fertilizer, glass, paper, chlorine, potatoes or mobile phones? Well, just observe consumers buying potatoes in Marks and Spencer in the UK at a premium price. Then ask whether anyone can tell the difference between Castrol GTX, Alfa Laval Steel, SKF bearings, Apple and its their competitors. Yet these great companies are able to charge premium prices and have massive global market shares.

Practitioners and thought leaders concur over the elements of world-class marketing:
1 a profound understanding of the marketplace;
2 proper market segmentation;
3 powerful differentiation, positioning and branding;
4 integrated marketing strategies.

The order is significant. Even now, many companies are trying to manage their brands without really understanding their market, how it is segmented, or where they are positioned.
Excellent strategic marketing is essential for high-performance outcomes.

Characteristics of successful marketing strategies

Markets we sell to

Companies frequently confuse target markets with products – pensions or desktop computers, for example – and this, coupled with a lack of knowledge about the sources of differential advantage against each segment, signals trouble. Many companies pride themselves on their market segmentation even though these so-called ‘segments’ are in fact sectors, which is a common misconception.

A segment is a group of customers with the same or similar needs and that there are many different purchase combinations within and across sectors. But the gravest mistake of all is a priori segmentation. Most books incorrectly state that there are several bases for segmentation, such as socio-economics, demographics, geo-demographics and the like. But this misses the point. For example, Boy George and the Archbishop of Canterbury are both A-listers, but they don’t behave the same! Nor do all 18- to 24-year-old women (demographics) behave the same! Nor does everyone in our street (geo-demographics) behave the same! All goods and services are made, distributed and used, and the purchase combinations that result make up an actual market, so the task is to understand market structure, how the market works and what these different purchase combinations (segments) are. Firstly, let us examine the factors that cause markets to break into smaller groups (see Figure 6.2).

Non-cumulative diffusion pattern

Many years ago, a US sociologist, Everett Rogers (1976) generated profound observations about how innovation diffuses through a population. His work is still widely cited and we are all familiar with terms such as the early adopter and laggard that he coined. Essentially, for Rogers, adapting new ideas is a social phenomenon and people adapt as a function of the number of people that adapt before them. Some are predisposed to being first and willing to suffer all the consequences of the solutions not being fully worked out: these are innovators. Next are early adopters, followed by the early majority, then late majority and finally the last 16 per cent of the population are considered laggards. The progress through the adaption curve approximates an S shape with which most readers are familiar.

Although this is not the purpose of this chapter, it is useful to note, before we leave Rogers’s diffusion of innovation curve, that when launching a new product or service it is advantageous to know who the opinion leaders are in a market, as these people should be targeted first by the sales force and by other promotional media, as they will be the most likely to respond. For example, certain doctors will be more open-minded about new drugs, whereas other doctors will not risk prescribing a new drug until it has been on the market for a number of years.

The diffusion of innovation curve also explains the phenomenon known as the product life cycle, and why, after the 50 per cent point on the diffusion of innovation curve is reached, the market continues to grow but the rate of growth begins to decline until maturity is reached (see Figure 6.3).

Market life cycles and managerial phases

At the beginning of any market, technology tends to be the driving business force, largely because new products tend to be at the cutting edge. As the new technology begins to take hold, as explained in the earlier references to the research of Everett Rogers, production tends to be very important, because at this stage it is not unusual for demand to be greater than supply. However, as the market grows and new entrants begin to introduce competitive products, sales as a function becomes increasingly important, as the new competition entails a growing consumer choice. A problem frequently occurs at the next stage of the market life cycle, as there is now more supply than demand, so frequently organizations attempt to cut costs, so accountancy tends to come to the fore. Finally, however, all organizations come to the same conclusion, which is that they need to understand their consumers and customers better in order to meet their needs, and this of course is where market segmentation becomes crucial.

All this has been explained in order to introduce the key concept of market segmentation and why it happens. Clearly, in the early days, markets will tend to be homogeneous. But, as demand grows rapidly with the entry of the early majority, it is common for new entrants to offer variations on the early models, as just explained, and consumers now have a choice. In order to explain this more clearly, let us illustrate the approximate shape of markets. If we were to plot the car market in terms of speed and price (see Figure 6.4), we would see very small, inexpensive cars in the bottom left-hand corner. In the top right, we would see very fast, expensive cars. Most cars, however, would cluster in the middle, what we might call ‘the Mr and Mrs Average Market’. Similarly, the lawnmower market would look very similar (see Figure 6.5). With lawn size on the vertical axis and price on the horizontal axis, at the bottom left would be small, inexpensive, hand-pushed mowers, with expensive sit-on machines for large estates in the right-hand corner. That leaves the mass of the market with average-sized lawns and average-sized lawnmowers, which is where the mass market is.

The natural shape of markets – cars

We can now redraw this to represent the shape of any market, particularly at the early growth stage (the shape on the left in Figure 6.6). But when rapid growth begins, new entrants join the market and offer variations on standard products in order to attract sales, and it is at this stage that markets begin to break into smaller groups, while still growing overall (this is represented by the shape in the middle).

The natural shape of markets – lawnmowers

Eventually, when markets mature and there is more supply than demand, any market growth tends to come in the lower price end of the market, while the top end of the market tends to be immune (this is represented by the shape on the right). It is usually the middle market that suffers at this stage, with many competitors vying with each other on price. This, however, is the whole point of market segmentation, for competing only on price is to assume that this is the main requirement of customers, whereas the truth is that this is rarely the case. It is just that a general lack of understanding about market segmentation on the part of suppliers about the real needs of customers in mature markets forces them to trade on price, so encouraging the market to become a commodity market.

The shape of markets from birth to maturity
The starting point in market segmentation is correct market definition, which is crucial for measuring market size, growth and share, identifying relevant competitors and formulating strategies to deliver differential advantage. Few companies give sufficient attention to correct market definition, and few can draw an accurate market map and therefore have little chance of doing anything remotely resembling correct market segmentation at the key influence points or junctions on the map. At each if these junctions, segmentation is not only possible but crucial.
(McDonald and Dunbar, 2012)

The difference between customers and consumers

Let us start with the difference between customers and consumers. The term ‘consumer’ is interpreted by most to mean the final consumer, who is not necessarily the customer. Take the example of parents who are buying breakfast cereals. The chances are that they are intermediate customers, acting as agents on behalf of the eventual consumers (their family) and, in order to market cereals effectively, it is clearly necessary to understand what the end-consumer wants, as well as what the parents want. It is always necessary to be aware of the needs of eventual consumers down the buying chain.

Consider the case of the industrial purchasing officer buying raw materials such as wool tops for conversion into semi-finished cloths, which are then sold to other companies for incorporation into the final product, say a suit, or a dress, for sale in consumer markets. Here, we can see that the requirements of those various intermediaries and the end-user are eventually translated into the specifications of the purchasing officer to the raw materials manufacturer. Consequently, the market needs that this manufacturing company is attempting to satisfy must in the last analysis be defined in terms of the requirements of the ultimate users – the consumer
– even though the direct customer is quite clearly the purchasing officer.

Given that we can appreciate the distinction between customers and consumers and the need constantly to be alert to any changes in the ultimate consumption patterns of the products to which our own contributes, the next question to be faced is: who are our customers?

Direct customers are those people or organizations that actually buy direct from us. They could, therefore, be distributors, retailers and the like. However, there is a tendency for organizations to confine their interest, hence their marketing, to those who actually place orders. This can be a major mistake, as can be seen from the following example.

A fertilizer company that had grown and prospered during the 1970s and 1980s, because of the superior nature of its products, reached its farmer consumers via merchants (wholesalers). However, as other companies copied the technology, the merchants began to stock competitive products and drove prices and margins down. Had the fertilizer company paid more attention to the needs of its different farmer groups and developed products especially for them, based on farmer segmentation, it would have continued to create demand pull-through differentiation.

The segmentation study revealed that there were seven distinct types of farmer, each with a different set of needs. See Figure 6.7. Firstly, there was a segment we called Arthur (the person at the top of the figure), a television character known for his deals. He bought on price alone but represented only 10 per cent of the market, not the 100 per cent put about by everyone in the industry, especially the sales force. Another type of farmer we called Oliver (the figure in the bottom right of the figure). Oliver would drive around his fields on his tractor with an aerial linked to a satellite and an on-board computer. He did this in order to analyse the soil type and would then mix P, N and K, which are the principal ingredients of the fertilizer, solely to get the maximum yield out of his farm. In other words, Oliver was a scientific farmer, but the supply industry believed he was buying on price because he bought his own ingredients as cheaply as possible. He did this, however, only because none of the suppliers bothered to understand his needs. Another type of farmer we called David (the figure in the bottom left of the figure). David was a show-off farmer and liked his crops to look nice and healthy. He also liked his cows to have nice, healthy skins. Clearly, if a sales representative had talked in a technical way to David, he would quickly switch off. Equally, talking about the appearance of crops and livestock would have switched Oliver off, but this is the whole point. Every single supplier in the industry totally ignored the real needs of these farmers, and the only thing anyone ever talked about was price.

The result was a market driven by price discounts, accompanied by substantial losses to the suppliers. ICI, as it was then, armed with this new-found information, launched new products and new promotional approaches aimed at these different farmer types, and got immediate results, becoming the only profitable fertilizer company in the country.

Personalizing segments

Let us now return to market dynamics and what happens to markets at the rapid growth stage. At this stage, new entrants come into the market, attracted by the high sales and high profits enjoyed by the industry. Let us illustrate this with another example.

In the early 1970s, a photocopier company had an 80 per cent market share and massive profit margins. This is represented by the big circle in the middle of Figure 6.8. When a Japanese newcomer entered the market with small photocopiers, the giant ignored it. The Japanese product grew in popularity, however, forcing the giant to reduce its prices. Within three years, the giant’s share was down to 10 per cent, and the battle was lost. It had failed to recognize that the market was segmented and tried to compete in all segments with its main product, a mistake made by hundreds of erstwhile market leaders. The main point about this example is that companies should not attempt to compete in all segments with the same product, but should recognize that different segments or need groups develop as the market grows, and
that they should develop appropriate products and services, and position and brand them accordingly.

Perceptual map of the photocopier market

Let us summarize all of this by showing a product life cycle representation with some generalizations about how marketing strategies change over time. Figure 6.9 illustrates four major changes that occur over the life cycle. At the top of the far right-hand column, at maturity, most offers end up as commodities. However, this is contestable and good strategic marketing can resegment markets to renew growth as in the fertilizer example. There are other options, of course, including the option to get out of mature markets. Another is to move the goal posts, as it were, somewhat in the manner of First Direct, Direct Line, Dell, Virgin, and countless others. The strategy we want to concentrate on here, however, is market segmentation, which in our view should be the very first consideration as markets begin to mature.

The product/market life cycle and market characteristics

An excellent example of good practice is Procter & Gamble in the United States supplying Wal-Mart, the giant food retailer. As can be seen from the simple diagram in Figure 6.10, P&G create demand pull (hence high turnover and high margins) by paying detailed attention to the needs of consumers. But they also pay detailed attention to the needs of their direct customer, Wal-Mart. Wal-Mart is able to operate on very low margins because, as the bar code goes across the till, this is when P&G invoice Wal-Mart, produce another and activate the distribution chain, all of this being done by means of integrated processes. This way, they have reduced Wal-Mart’s
costs by hundreds of millions of dollars.

simplified market map

Closely related to the question of the difference between customers and consumers is the question of what the term ‘market share’ means.

Market share

Most business people already understand that there is a direct relationship between relatively high share of any market and high returns on investment, as shown in Figure 6.11.

market share and return on investment

 Clearly, however, since BMW are not in the same market as Ford, for example, it is important to be most careful about how ‘market’ is defined. Correct market definition is crucial for: measuring market share and market growth; the specification of target customers; recognition of relevant competitors; and, most importantly of all, the formulation of marketing strategy, for it is this, above all else, that delivers differential advantage.

The general rule for ‘market’ definition is that it should be described in terms of a customer need in a way that covers the aggregation of all the products or services that customers regard as being capable of satisfying the same need. For example, we would regard the in-company caterer as only one option when it came to satisfying lunchtime hunger. This particular need could also be satisfied at external restaurants, public houses, fast food specialists and sandwich bars. The emphasis in the definition, therefore, is clearly on the word ‘need’.

To summarize, correct market definition is crucial for the purpose of:
● share measurement;
● growth measurement;
● the specification of target customers;
● the recognition of relevant competitors;
● the formulation of marketing objectives and strategies.

Market segmentation

We can now begin to concentrate on a methodology for making market segmentation a reality, market segmentation being the means by which any company seeks to gain a differential advantage over its competitors.

Markets usually fall into natural groups, or segments, which contain customers who exhibit a similar level of interest in the same broad requirements. These segments form separate markets in themselves and can often be of considerable size. Taken to its extreme, each individual consumer is a unique market segment, for all people are different in their requirements. While customer relationship management (CRM) systems have made it possible to engage in one-to-one relationships, this is not viable in all organizations. Most firms still produce offers that appeal to groups of customers who share approximately the same needs for reasons of scale, complexity and indeed, customer preference.

There are certain universally accepted criteria concerning what constitutes a viable market segment (McDonald and Dunbar, 2012): segments should be of an adequate size to provide the company with the desired return for its effort; and members of each segment should have a high degree of similarity in their requirements, yet be distinct from the rest of the market. Criteria for describing segments must enable the company to communicate effectively with them.

While many of these criteria are obvious when we consider them, in practice market segmentation is one of the most difficult of marketing concepts to turn into a reality. Yet we must succeed; otherwise we become just another company selling what are called ‘me too’ products. In other words, what we offer the potential customer is very much the same as what any other company offers and, in such circumstances, it is likely to be the lowest-priced article that is bought. This can be ruinous to our profits, unless we happen to have lower costs, hence higher margins, than our competitors.

There are basically three stages to market segmentation, all of which have to be completed:

● The first establishes the scope of the project by specifying the geographic area to be covered and defining the market that is to be segmented, followed by taking a detailed look at the way this market operates and identifying where decisions are made about the competing products or services. Successful segmentation is based on a detailed understanding of decision makers and their requirements.

● The second is essentially a manifestation of the way customers actually behave in the marketplace and consists of answering the question ‘Who is specifying what?’

● The third stage looks at the reasons behind the behaviour of customers in the marketplace, answers the question ‘Why?’ and then searches for market segments based on this analysis of needs.



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The Digital Media Strategy Blog: Segmentation – the basic building block for markets
Segmentation – the basic building block for markets
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