What is market segmentation?
Market segmentation is the process of dividing a large, homogenous market into smaller subdivisions or niches that group customers together based on shared characteristics.
Whereas the overall market is so broad as to include a wide range of different customers, market segmentation picks out groups of customers based on their differences.
Market segmentation is critically important because no new company is large enough or well enough resourced to fulfill the diverse needs of an entire market.
Instead, they segment the market into smaller sections and strategically target the highest-impact segments.
These market segments could be a high impact because they have a specific problem because they have sufficient disposable income to purchase a specific product or service, or because of the geographic area where they are located.
Market segmentation should address the following questions:
If a market segment can´t be clearly identified, then it might be not a segment at all.
Market segmentation is a strategic process, and if a strategy is based on nebulous information, it will waste resources at best and totally derail efforts at worst.
You must be able to say “Yes, that customer is in our segment” or “No, that customer is not in our segment” with confidence.
It may seem counterintuitive to point out the customers that you will not target, but this reduction in scope is designed to put your resources to best use.
Understanding the effective size of a market segment helps decision-makers compare different segments.
The size of a market segment can determine whether or not it is worth attempting to reach, or whether or not it can be served in an effective way.
A market segment that is prohibitively difficult to reach effectively may not be a good one to target.
The same goes for a market segment that your business doesn´t understand how to reach.
Depending on where your product or service fits into the industry value chain, your customer may not be the end-user.
For example, a commercial bakery that sells bread, cakes, and muffins to stores who then sell those baked goods to their own customers has a customer who is not the end-user. The end-user is the store´s customer – the person who buys and takes home the baked goods. The bakery´s customers are the stores.
- It the market segment a good fit for my company and its resources?
- Is this a market segment that makes sense for the brand?
- Is it a market segment that is in line with your mission and vision?
- Does it fit your strategy?
- Can you reach the market segment with the resources you have available, and will it be profitable enough to meet your financial goals?
- Does the market segment align with your company´s values?
- Could there be a backlash on social media for working with this group?
These are all important questions with no easy, quantifiable answers. These four characteristics of market segmentation:
- ease of identification
- size measurability
- and fitness
are present in all segmenting efforts, no matter which segmentation method is used, and apply to both B2C and B2B customers respectively.
A business that has other businesses as customers is known as a B2B business, which stands for business-to-business (or sometimes brand-to-brand).
A business that has consumers as customers is known as a B2C business, for business-to-customer (or brand-to-customer).
Both B2B and B2C have the same tasks of identifying and segmenting their customers, though the criteria they have select is different by necessity.
But not all customers are created equal. Just as the market is segmented, so are the customers that your business targets.
This allows you to focus your efforts and tailor messaging and product or service offerings to the specific needs of each customer segment.
Market Segmentation Examples
Millennials like me initially proved to be a tough nut for marketers to crack.
- Did they act younger than their age or were they mature as a group?
- Were they frugal or did they spend their money freely?
Marketers quickly learned that traditional methods didn´t gain much traction with millennial customers, who did not spend frivolously and did not place as high value on consumer goods as their parents had.
Nowhere was this clearer, or more public, than with the clumsily executed 2017 Life For Now campaign from PepsiCo.
The ad was a short film that featured a well-known celebrity and popular music with “millennial-themes” of social justice and activism.
It may have seemed like a smash hit to those in the boardroom, but marketers missed the mark in almost every possible way, and the ad was pulled just a day after its release due to tremendous criticism.
Audiences accused PepsiCo of pandering to millennials; viewers pointed out that the portrayals of social activism not only appeared contrived and shallow, but that the overt for-profit approach in fact trivialized important social issues that had real impacts on real people.
The intended millennial audience further compounded the problem for PepsiCo through the use of their social media savvy to draw further attention to what they considered a tone-deaf gaffe on the part of PepsiCo.
In a very high-profile way, PepsiCo demonstrated that they were no closer to understanding millennials than they had been a decade ago and indeed may have lost significant market share and brand currency with the intended audience as a result.
Market Segmentation – Deep Dive
From a product perspective, there are two types of businesses:
- those who sell directly to the end-user (business-to-consumer, or B2C)
- and those who sell to other businesses (business-to-business, B2B).
Market Segmentation follows the same principles for both but is slightly different in practice.
01. B2C Market Segmentation
There are four key methods of business to consumer segmentation:
Let’s take a closer look at each of these segmentation methods.
Behavioral Market Segmentation
Segmenting customers into groups based on how they act as consumers while making purchasing decisions is known as behavioral segmentation.
This type of segmentation is designed to understand, predict, and target the following:
- The purchasing habits of your customers
- The usage habits of your customers
- The spending habits of your customers
Effective behavioral market segmentation helps businesses understand the ways in which their product or service meets (or doesn’t meet) the needs of different behavioral segments.
Additionally, businesses can tailor their marketing efforts to reach customers at times when they are most likely to purchase.
Behavioral data doesn’t exist independently of other customer data; it is better described as an extension of existing segmentation data and can often correlate to demographic data.
Common behaviors to track include the following:
- Purchasing behavior
- Occasion/timing (what triggers a purchase?)
- Usage rate
- Benefits sought
- Status (first-time buyer, repeat buyer, etc.)
Of course, this data shouldn’t be collected for the sake of collecting data—behavior-based data should be collected with a concrete goal in mind.
If a company is looking to increase its regular customer base, the goal of data collection may be to identify the best way to reach customers who purchase infrequently or who make only one purchase and never return.
What about customer loyalty?
Tracking the behavior of loyal customers can help decision-makers understand why those customers became loyal in the first place.
Armed with insight, the process of growing a loyal following is made easier.
Behavior market segmentation provides unique insight, but it isn’t foolproof.
Gathering behavioral data risks providing decision-makers with “false positives” in the sense that one customer may exhibit the same behavior as another but have different motivations.
Demographic segmentation is segmentation based on the personal attributes of your customers.
These attributes include
- income level,
- and occupation
While a market will, of course, include a variety of people with different and unique needs, grouping these people together based on similar characteristics that are relevant to the business helps companies get the most out of their marketing efforts.
A jeweler that sells premium men’s watches is interested in not only a male market segment but men who make enough money to afford a premium watch.
A company that sells retirement planning products is less interested in the gender mix of their market, but very interested in segmenting the market based on age, income, and marital status.
Demographic segmentation is easy to implement and is a good starting point for marketing efforts.
That being said, demographic segmentation makes a lot of assumptions.
Assuming that broad swaths of the population think and feel the same based on age, gender, or socioeconomic status has only so much application.
To increase the effectiveness of marketing efforts, demographic data is usually best paired with another form of segmentation data to build robust and reliable market segments.
Psychographic segmentation divides a market into segments based on emotional, values-based, or interest-based characteristics.
This classifies consumers within a market into groups based on the way they think and the way they want to live.
Psychographic segmentation is based on five general personal characteristics:
- Social status
- Activities, interests, and opinions (AIO)
- Values, attitudes, and beliefs
- Personality traits
Together, these various factors come together to create a customer profile.
A company that produces bottled soft drinks and juices is looking to find a new segment to sell their premium juices to.
A health-and-wellness-minded professional (lifestyle, values, and attitude) who commutes and regularly visits the gym (AIO) wants a convenient, healthy juice blend that signals to others that he or she takes health and wellness seriously (social status).
While demographic segmentation makes sweeping generalizations and assumptions, psychographic segmentation narrows the focus of marketing efforts.
For our beverage manufacturer from the example above, demographic segmentation may narrow the field to working professionals that make more than $65,000 per year.
Some may be interested in health and wellness products, some may not.
In the case of the company’s psychographic segment, the average member of that segment is much more likely to be interested in health and wellness products.
Additionally, the increased level of insight allows the juice manufacturer to better understand their customers’ pain points and produce products that are a better fit and potentially more differentiated from those of the competition.
The downside here is that psychographic information is much harder to gather than demographic data.
Not only is the process time-consuming, but the data that it yields is almost entirely qualitative.
Quantitative data— like the data that comes from the demographic segmentation process— is easy to sort and endlessly model, but qualitative data can be a little trickier to handle and understand in a meaningful way.
Segmentation by psychographic profiles also runs into the same stumbling block that any attempt to sort and classify people runs into: everyone is different.
Despite the increased level of detail and complexity, the simple fact is that two people who have the same
- and interests
may not make the same purchasing decisions.
Geographic segmentation is a broad method of market segmentation that groups consumers together based on their physical location.
The size of the geographic region that identifies each segment varies based on the individual needs of each business, but in most cases geographic segment data is very easy and inexpensive to collect.
This information is often used in conjunction with other segmentation data to augment and focus marketing efforts.
Small businesses that offer on-site services, for example, have an effective range.
Consumers outside of this range cannot be serviced cost-effectively or to the same standard as others.
A good segmentation starting point for that business is to restrict marketing activities to consumers within that range.
Consider seasonal or outdoor products:
- Winter wear,
- bathing suits,
- and outdoor equipment
aren’t going to be a good fit for all geographic areas—a good starting point for market segment definition.
Sometimes the line between geographic data and demographic data blurs.
Some regions have a higher concentration of people who share similar characteristics such as
- age, ethnicity, or affluence.
Also consider geographic segments that are part of a business strategy, such as a move into a new city or an attempt to claim market share from another established business that has a defined territory.
There is no right or wrong answer.
Many market segmentation approaches use multiple methods to paint a picture that is not only helpful and strategic but also relevant to the product and the business model.
The best method of segmentation is the one that makes the most sense for your business model and your product/service.
Resource restrictions play a major role as well.
Every business would love to have extensive behavioral and psychographic profiles to better segment their markets and build better products/services; however, the costs and complexity of gathering that kind of information are prohibitive for many young ventures.
B2C Market Segmentation – Overview
Market Segmentation Examples
Let’s take two yoga studios located in the same town.
Both are using geographic segmentation, as it’s unlikely that customers will drive more than ten or fifteen miles for a yoga class.
However, using demographic and psychographic segmentation, they can appeal to different customers and both be successful—even if they are next door to each other.
Studio A wants to focus on women who are either new to yoga or want to get in shape and meet new people similar to themselves.
Their customer avatar is a 35-year-old mother of two elementary-school-age children who is very busy and doesn’t have a lot of time for herself.
Her problem is trying to stay in shape with limited time. She is also feeling a little isolated and would like to meet other moms for support and socializing.
The resulting customer segmentation might look like this:
- Women between the ages of 25 and 45
- Average of two children aged 2 to 10
- Family income over $70,000/year (yoga classes are relatively expensive and appeal to a more affluent clientele with disposable income)
- Interested in being healthy and attractive
- Interested in meeting other moms
This studio might focus on daytime classes with special Mommy & Me yoga, gentle/yin yoga, and intro classes, and vegan lunchtime meet-and-greets or other social events.
Studio B has an entirely different customer avatar.
Their ideal customers are hardcore fitness enthusiasts who like to compete at sports and stay in peak condition.
They are high-achieving professionals interested in mindfulness and Eastern philosophy.
While Studio A’s customer avatar may feature Trader Joe’s as a brand that their ideal customer would patronize, Studio B’s customer avatar would feature Whole Foods.
The resulting customer segmentation for Studio B is completely different:
- Men or women, ages 18 to 60
- Married or single
- Family income over $100,000/year
- Interested in peak fitness and competition
This studio might offer hot/power yoga, early morning boot camps, lots of evening classes to accommodate busy schedules, and power juice cleansing happy hours.
This is not to say there won’t be customers to whom both studios appeal, or who switch from one to another, or who fall completely outside their target demographics. The point is that these two studios are offering the same basic product (yoga classes), but for entirely different customer segments.
02. B2B Customer Segmentation
Instead of the four general segmentation methods used by B2C firms, B2B firms use a mix of three key segmentation methods:
- Firmographic Segmentation -Firmographic segmentation is based on firm characteristics such as size or industry—demographic segmentation for businesses.
- Tiering – Tiering segmentation organizes customers based on their fitness for the goals of your firm, such as CLV (customer lifetime value), or short-term revenue goals.
- Needs-Based Segmentation – This method organizes and classifies customers based on their need profile, such as a need for a low-cost solution or a need for a local supplier rather than one that is based far away.
Let’s take a closer look at these segmentation methods.
Firmographic segmentation is demographic segmentation for business customers.
It segments business customers into groups based on shared qualities.
Instead of age, gender, or income, firmographic data looks at such qualities as annual revenue, the number of employees, or location.
Firmographic data is easy and inexpensive to collect but it is vulnerable to the same shortcomings that plague demographic data for B2C businesses.
Just as we can’t assume that every member of a demographic group thinks or feels the same way, we can’t assume that all businesses that have been opened in the last two years, or that have fewer than twenty-five employees, have the same needs.
Let’s say your venture sells enterprise-level shipping and inventory management software solutions.
The cost and scope of your product mean that companies with less than $25 million annual revenue or fewer than 200 employees will not see your product as a need or be able to afford it.
Obviously, your product is only applicable to companies that make and ship physical products.
These two firmographic segmentation provides a good starting point for understanding your addressable market.
Tiering is a segmentation method that classifies your business customers into different segments known as tiers.
These tiers are organized by how valuable the customer is to the business, often in terms of the metric “customer lifetime value” (CLV).
Tiering is generally combined with firmographic data to home in on target segments.
If a graphical representation of customers who are segmented based on tiers looks like a pyramid with a narrower focus yielding a smaller pool of more and more valuable customers, then the effort to reach and sell to those customers is an inverted pyramid.
The more valuable the customer is, the more effort is devoted to closing a sale with that customer.
If you have ever heard of the Pareto principle—that 80 percent of your revenue will come from 20 percent of your customers—then you understand the thought process behind tiering.
The goal is to identify those high-CLV customers, then focus marketing efforts on those businesses.
As the name implies, this form of segmentation involves classifying your business customers by their needs.
Unlike readily available firmographic data, identifying the diverse needs of different companies can be a real challenge.
On the other hand, there is no better customer than one who needs what you are selling.
The process of identifying the needs of businesses is simplified in the digital age with the rising popularity and efficacy of content marketing and other user-intent-based advertising such as pay-per-click advertising and search engine result page advertising.
There is no one segmentation method that is best for each market—that’s why there is more than one.
When determining how to segment your customers, the best solution is the one that makes the most sense for your business, your market, and your industry.
That best solution could be a mix of segmentation methods, such as using firmographic data to exclude companies that are too small, too large, too far away, etc., and then segmenting those businesses that fit the bill into tiers based on potential CLV.
Wrapping it up…
There are numerous ways to segment markets and it is important to use the segmentation method(s) that make sense for you.
A B2C business (one that sells to consumers) can segment customers based on their
- demographic characteristics,
- psychographic characteristics,
- where they are located geographically,
- or with a combination of methods.
A B2B business (one that sells to other businesses) can segment customers based on
- the characteristics of their business (firmographics),
- into tiers based on their potential value to the business,
- and segment them based on their organizational needs.