I remember a business school professor proclaiming, “diversification is the only free lunch.” He meant that diversification is the only technique in finance that simultaneously lowers risk and increases returns (click here if you don’t believe me).
I’d argue that there’s another free lunch in the business world: segmentation. Segmentation allows companies to simultaneously lower marketing costs and increase sales.
When I’ve led formal segmentation projects, I’ve seen incredible results, like a 50 percent increase in email conversion rates, a 10 point increase in profit margins, and a $300,000 reduction in marketing spend without a drop in sales.
So what exactly is segmentation, and what can it do for your business? Let’s take a closer look.
Segmentation is the process of dividing your customer base into identifiable categories based on their wants, needs, and characteristics.
It’s impossible for one company to meet the needs of all their customers with one product or service. Segmentation allows you to create marketing materials and offerings that are tailored to each subset of your customer base. By breaking your entire customer pool into smaller segments, you can target each group in the way they want to be targeted.
No! This is a common concern. Many businesses are afraid to zoom in on a subset of the market for fear that it will damage their chances of success with the broader population. But the opposite is actually true. Companies both big and small benefit immensely from segmentation.
Let’s take a giant, mass-market company as an example. McDonald’s has something for everyone, so they must target everyone all at once, right? Actually, no. McDonald’s relies on segmentation. Three of their sample segments are travelers, teenagers, and busy moms. This make sense once you look at their marketing activities.
They target travelers by placing locations in key travel spots, like along highway exits and in airport terminals. Teenagers are drawn in by the high quantity, low quality offerings on their Dollar Menu. Meanwhile, the Play Places in their restaurants and toys in their Happy Meals keep kids distracted and give busy moms a break.
So if you’re afraid that focusing on a segment will stunt growth, think of it this way: You can always hone in on more than one segment to grow your business. But trying to be everything to everyone is costly, and it doesn’t work.
In short, segmentation helps companies in two ways. First, it increases empathy with customers. Second, segmentation helps leaders make better tradeoffs in a world of limited resources.
By focusing on a niche, firms can precisely dial in on the needs and wants of their target audience. Personalization has become increasingly important to consumers, so if you can show people that your brand gets them and is here to help, you can win major brownie points.
Plus, once you develop an understanding of your target market, you can do a better job allocating money and time. For example, let’s say you are building a new website aimed at Millennials. You only have the resources to implement five out of the ten conceptualized features. If you have a good grasp on your target segment, then you can evaluate the options based on Millennials’ prioritization and go from there.
There are four primary ways to segment your customer base: behavioral, demographic, psychographic, and geographic.
A behavioral segmentation clusters together consumers who act similarly. These behaviors might be things like when, what, and how they buy or browse. Modern predictive analytics focus on this type of segmentation. Think about the Amazon recommendation engine. Many research projects have shown this is the most effective type of segmentation.
Demographic segmentation divides your audience based on observable traits about the customers’ age, gender, ethnicity, etc. Demographic segmentation is popular because it’s easy to measure these attributes. Most beauty care product companies segment based on gender, for example.
A psychographic segmentation groups people into categories by their attitudes and beliefs. Underlying this type of segmentation is the assumption that consumers are interested in the technical attributes of a product or service as well as the ensuing emotional benefits.
Psychographic segmentation goes deeper than simple demographics, but, understandably, is more challenging to measure. Typically, firms need to conduct expensive market research and surveys to develop this type of segmentation. Car companies are known for using psychographic segmentation. For example, Volkswagen targets different subsets of the population with different lines of cars based on their lifestyles. Volkswagen markets the Passat to families who need more space and enhanced safety features, while they market the Beetle to Boomers who remember the original iteration but want the comfort of driving a modern car.
Finally, geographic segmentation helps companies regionalize their offerings to local tastes, preferences, and needs. For example, clothing companies may differentiate offerings to account for variations in climate, selling shorts in Florida and parkas in Maine.
The best place to start is with the data. Even if you’re not yet putting it to good use, you’re already collecting a tremendous amount of data on your customers and prospects. How people interact with your website, respond to your email campaigns, and react on your social media pages is already being tracked and registered in each system’s analytics. If you can unite that data, you can learn an awful lot about the wants and needs of the people who interact with your business.
That’s where a tool like a Customer Data Platform (CDP) comes in. CDPs unify all of the data you have on each person’s interactions with your brand, and from there, you can begin to analyze it to build your segments.
It’s common to perform a cluster analysis on your customer database. This is an advanced analytical technique that Wikipedia defines as “the task of grouping a set of objects in such a way that objects in the same group (called a cluster) are more similar (in some sense or another) to each other than to those in other groups.”
Still not sure what that means? Actually you don’t need to worry about the how—you just need a data scientist to crunch the numbers. Experts in the field widely understand this technique, so it’s relatively straightforward to implement.
Customer segmentation is a win-win for your business. By better understanding your customers, you narrow your focus, develop better products and smarter marketing campaigns, and reduce marketing costs while increasing sales. While there is an up-front investment required, the long-term benefits can far outweigh those costs.
So, are you ready to make reservations for your free lunch?
The Sterling Woods Group’s mission is to help clients make sense of their data to predictably grow sales. We apply data science to help you optimize your sales funnel, improve your marketing ROI, launch new products successfully, and enter new markets profitably.
We use a hypothesis-driven, data-supported methodology to discover insights that no one else is paying attention to. Then, we help you assemble the right sales strategies, marketing plans, technologies, and resources to seize this opportunity.
Rob Ristagno, founder and CEO of the Sterling Woods Group, previously served as a senior executive at several digital media and e-commerce businesses, including as COO of America’s Test Kitchen. Starting his career at McKinsey, his focus has always been on embracing digital technology and data science to spur strategic growth.
Rob is the author of A Member is Worth a Thousand Visitors and is a regular keynote speaker at conferences around the world. He has been featured on ABC, NBC, CBS, Fox, and Digiday.
He holds degrees from the Harvard Business School and Dartmouth College and has taught at both Harvard and Boston College.
Rob lives outside Boston, MA with his wife, Kate; daughter, Leni; and black lab, Royce.