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Divide & Conquer
Segmenting your customers according to their needs will result in more loyal customers.
For the rest of the October 2000 issue of CRM magazine please click here
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In the last issue, I discussed the first three steps to effective customer segmentation- -step 1: Identify your best customers, step 2: Identify customer needs and concerns, step 3: Compare customer needs to your strengths. In this month's article, I will describe what to do with that information.

step 4: Develop segments based on customer needs

Marketing "best practices" demand that you hunt for other current or potential customers who "look" as much as possible like your best, core customers- -those whose needs best coincide with your strengths- -because it is within their ranks that you're most likely to be able to develop still more loyal, profitable customers.

You may identify only one segment- -your full universe of target customers and prospects- -or you may be able to recognize several clusters who share similar sets of unfulfilled needs and buying behavior. The process can be enhanced with the addition of complex basis variables. In either case, there are two key questions: Who are those most loyal customers, those most interested in the service values that best differentiate you from your competitors? And what differentiates them from the mass of customers? When you have those answers, you'll be halfway home.

Critical to effective segmentation is making each segment as unlike any other as possible. And this is the point at which the process becomes more of an art (of interpretation) than a science (of data analysis). A well-constructed database, however, with its ability to slice and dice customer characteristics many different ways, gives you a wealth of tools to turn data into information.

To be of value to you, that information must be actionable. That means it must include a customer profile (most often consisting of firmographics, unfulfilled needs, value sought and buying behavior) that enables you to assign customers- -not just your selected "best" customers, but all your customers, and perhaps prospects- -to one or another of your defined segments.

You will now have a good sampling of your best customers, each identified by the needs that are most important to them. (Keep in mind that a customer, in B2B marketing, is an individual who buys on behalf of an organization.) They are also tagged by firmographic data. Is there a relationship between needs and firmographics? Your database program can let you mine the information to find out.

start with a list of identified needs and buying behaviors. Then query your database as to how many customers cluster into groups that care about each various combination of those needs. Where you find larger numbers, you have identified "need clusters" that are common to particular segments of your marketing universe. And that's the raw material for needs-based segmentation.

Now, what easily identifiable characteristics do the customers in each cluster have in common in addition to those needs? Here's where firmographic data comes into play. You may, for instance, discover that many of them share geographical, SIC code, company size or some other combination of characteristics.

In other words, it permits you to define very specific needs-based market segments into which you can divide your entire customer universe, present and potential.

step 5: Grade customers within each segment

Marketers often use the terms "grading" and "segmentation" interchangeably. And that's unfortunate, since they are two very distinct actions and since it is important to maintain the distinction. The two are entirely different processes. Together, they create a very powerful economic model for customer selection.

Grading, or "valuation" is strictly an economic concept. It is done only within a segment, defining various levels of economic value within that segment. It temporarily sets aside the issue of customer needs or other characteristics, and can usually be accomplished using only data you already have in-house.

Grading is a means of estimating the revenue available, currently and potentially, from that segment. The valuation process allows you to identify which groups are most responsive to what you have to offer. The insights valuation affords can also help you to increase profits- -therefore they are really key to the success of your business. This, in turn, allows you to make intelligent decisions about investment choices and resource allocation to acquire and nurture more of this kind of business by targeting those segments to which you can deliver superior value in a profitable manner.

Here's how it works. Within each segment, divide all customers into six "grades" (or valuation levels) based on the revenue you received from them over a given period of time. The top 1 percent are rated AAA; the next 4 percent are AAs; the next 15 percent, A; the next 25 percent, B; the following 25 percent, C; and the bottom 30 percent, D. A pyramid, as J. Curry points out in his recent book, The Customer Marketing Method, is a great tool for visualization.

You can fine-tune your grading system further by determining not just raw historic sales volume, but potential or projected Lifetime Value of these customers to you- -understanding that realization of the LTV has more to do with how you treat your customers after you've acquired them than with the method of acquisition. Given what it costs you to acquire, supply and service this customer, the anticipated length of time you'll retain his loyalty and the revenue that this will generate, how much profit will he bring to you over the expected duration of the relationship (expressed in terms of Net Present Value)?

It's not unusual to find substantial surprises in a buyer behavior, or
LTV, analysis. Inside this portfolio analysis you most likely will find the most valuable nuggets of insight. A demanding customer who buys primarily on price, for instance, on condition that you shave your margins paper-thin, may be less than profitable to serve- -no matter how great his purchase volume. On the other hand, a smaller, relatively low-purchase-volume customer, who ranks high relative to the other criteria above, may be significantly more profitable per dollar you invest. Understanding his priorities may well point you toward other companies with similar needs, but much larger budgets. In short, it's critical to use your marketing imagination to manage the LTV of your customer.

Even in isolation, grading can be a significant productivity tool. Not only does it allow you to direct your investments more effectively, it also serves as a foundation for developing a better field sales force effectiveness, or optimization, plan as well as the targeted communications strategy to support the coverage model. Clearly this approach is more desirable and more effective than treating everyone the same.

step 6: Validate your segmentation model and your hypotheses

As a result of your segmentation analysis, you will be able to develop hypotheses. For example: "Quick response, 99 percent fill-rate at the counter, 24-hour turnaround, combined with e-mail ordering capability, are top priorities for our decentralized customers in the automotive aftermarket in the Northeast with annual sales volumes of $50 to $150 million."

Before you take action, you'll want to validate your conclusions. The segmentation model you've devised should, first of all, make intuitive sense based on your marketplace experience- -and especially on that of your sales and customer service people. Where findings are at issue, you may want to see if customer focus groups or telephone surveys confirm them. A great deal rides on having accurate information from which to work.

step 7: Target your marketing resources in

proportion to potential return

Unless you're ready and able to use the results of all this effort to alter your marketing strategy, your money is probably better spent elsewhere. Segmentation is not designed to be an intellectual exercise. It pays off only if you then apply it to fine-tune your marketing program.

At this point, your grading results take center stage. Especially if you've factored in the LTV of each segment, you can now make a very scientific assignment of resources to customer groups. You can surely be selective in this process, if you choose, focusing on just a few segments- -or even one. The important thing is that you do use the information to catalyze marketing action and to create an integrated marketing plan to support the segmentation and grading exercise.

For starters, you can redeploy dollars previously spent in pursuit of unprofitable business- -because you can now recognize it for what it is. Perhaps there was a time when "everyone is my potential customer" was a viable strategy. But the simple fact is that we can no longer be all things to all people (if we ever could) and those who try to be are seldom able to provide superior service to anyone. Screening out can be as important as targeting.

You can assign a percentage of your marketing budget to each segment that merits pursuit, echoing the percent of potential profits that segment can generate. You may want to examine and cultivate lower grades within a well-defined, profitable segment as an area of opportunity: It's already been established that companies with this particular set of needs and buying behaviors can be attracted to your offerings and way of doing business; all that remains is to focus on expanding your penetration. The goal is to raise the level C accounts to Bs, the Bs to As and so on.

Because you understand the priorities of each segment so well, you'll have the inside track on the right message to deliver, and the media that can do it most effectively, within a given segment's allotted portion of your budget. Managing the integration of contacts across all media, you will be able to leverage the higher cost contact media such as face-to-face visits with the lower cost media such as direct mail, e-mail or the Web while effectively managing the investment at the grade level.

Ultimately, most of your dollars will be invested where the profit potential for developing loyal customers is the greatest- -a strategy that appears to be self-evident, but seldom is practiced in real-life decision-making, since quantification of LTV and contribution margin potential by segment is sadly lacking.

And I am not talking just about purportedly naïve and unsophisticated businesses. Consider, for instance, the millions, even hundreds of millions, of dollars this nation's leading long-distance carriers have paid out to obtain the wrong type of customers, relying upon the lowest common denominator- -price competition. It would be sage to guess that these customers, in the long run, will for the most part have cost far more than they will be worth.

It has been our experience that effective data-based, loyalty-focused marketers escape that kind of tunnel vision. And, in the process, they find that they are investing a lot more of their budgets in highly targeted communications to the segments most likely to become loyal customers, rather than through more traditional mass-media attempts to send one watered-down message to their entire, undifferentiated universe.

They have the tools to become more active managers of relationships with both employees, customers and prospective customers- -educating their organizations about the needs of individual segments, enhancing the delivery of products and services, developing targeted offers more likely to draw response and better allocating resources in the design of sales territories.

And, since they're talking to each customer in terms specific to their own concerns, a dialog is established; relationships are formed; satisfaction, growth and profits follow; and, with them, employee performance and morale are increased. This reinforcing feedback loop leads to sustainable competitive advantage.

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