What is market segmentation?

30 August 2020

While people are endlessly different, often they share some common traits that support grouping people into a handful of categories that marketers call Market Segments. Market segmentation focuses marketing resources to improve efficiency and effectiveness.

Buying anything usually presents the potential buyer with many choices. What suits one buyer doesn't suit another, what makes these people different?

The absolute first step in developing a marketing strategy (and even if you skip this step and jump straight to designing an advertisement, writing a blog article, or undertaking any type of promotion) you must identify who the potential buyers are, and how many.

While business owners like to think the market for what they sell is "all people" because that presents the largest opportunity, the real situation is quite different.

And this difference is often critical to the marketing process; the way you communicate with retired people (for example) is very different to teenagers.

If you ever see an advertisement with strange creative and think "what the heck were thinking when they made that ad?" - you know they aren't talking to you, the advertisement is designed to appeal to a different market segment.

The basic principles of segmentation

Market Segmentation is the grouping of a firm's customers and potential customers into categories based on their salient and distinguishing features.

The purpose of doing this is to enable improved tailoring of marketing strategies (product, price, distribution, and promotion) to match the wants and needs of each segment.

In marketing theory, market segmentation is defined as identifying homogeneous sub-populations in larger heterogeneous populations. Homogeneous means 'of the same kind, having similar traits'. Where as heterogeneous means 'diverse in character or content'.

Hence, the basic principle of market segmentation is to divide a heterogeneous market down until you have identified the homogeneous sub-groups.

Market segmentation – identifying populations which respond similarly to products (or services) and marketing messages – can provide a powerful method from which to design and encourage the consumption of products, services, and ideas.

While there are differing methods to segmenting markets, methods mostly derive from analysis of qualitative or quantitative data to identify the relationships between social, economic, and demographic characteristics, particular goods, services, and ideas and adoption behaviors.

Successful segmentation schemes identify the timing of and reasons behind key decision factors related to different products and services for a given population, so that these elements can be matched with product strategy and promotion messages.

Market segmentation in industrial markets

The value of segmentation is not always obvious. For example, organisation's involved in the generation, transmission and distribution of electricity could assume electricity was a commodity. However, there are clearly different consumer categories...

Potential electricity market segments:

• Industrial: Examples are steel mills, aluminum smelters, pulp and paper mills, and similar. These consumers have high energy requirements and will be supplied electricity at high voltage (>100,000 volts) to improve energy efficiency (reducing transmission losses), supply and maintain their own step-down transformers and high-voltage/high-power switch gear and their high usage justifies the electricity generator to treat them as a priority customer and thus offer significant discounts, but in return asking them to commit to long term contracts. For industrial customers reliability of supply is very important hence, the electricity supplier needs to provide continuity of supply. Aluminum smelters for example (huge electricity users) suffer enormous damage if power fails midway through smelting (potline failure). And since most Aluminum smelters smelt using a continuous 24X7 process, failure is not an option.

• Manufacturing: Typically located within major cities, examples are automotive manufacturing, metal product manufacturers, appliance manufacturing, food processing plants and similar. Their energy requirements are also high but significantly less than industrial customers. Typically supplied with medium-voltage (3,000 to 66,000 volts). Typically, the electricity supplier provides and maintains on site step-down power transformers and primary switch gear.

• Water industry: Typically water supply, sewerage and irrigation. The unique requirement of the water industry is the supply of power to pumping stations at diverse locations. Hence, the delivery of power requires significant investment in transmission networks at a variety of voltages depending on the size and number of pumps. Bundled into supply contracts will be a commitment by the power supplier to provision transmission lines to each site at its cost in exchange for commitment to long term contracts.

• Miming industry: Mine sites are usually at very remote locations often making construction of transmission lines from existing power generation sites impractical. While many mining companies own and operate their own power generation equipment (usually diesel generators) in many countries there are power generator companies who will enter into supply contracts to provide onsite turnkey power generation.

• Retail market: Most familiar to all of us is the supply of electricity to our home. However, included in the retail consumer market is light commercial. Thus a typical retail electricity market consists of the residential market, shops, offices, light-industrial and warehousing. Typically, electricity generators service these markets indirectly through retail distribution specialist companies who buy electricity from power generators at wholesale rates and on-sell to retail customers.

Each of the above 'sectors' requires a different marketing strategy and each sector can be further divided into market segments. For example we are now seeing the emergence of the home solar energy market and customers with a mixed supply require different product options and supply deals. Factor in government subsidies (which vary from time-to-time resulting in legacy tariffs), and the billing calculations become complex.

From a marketing perspective each of these segments requires dedicated business development people and account managers with specialized knowledge of the industries they serve and the ability to understand and negotiate expensive supply deals with many considerations (both technical and legal).

Industries, Sectors, and Segments

Market segmentation is about identifying different customer groupings (or classifications) with the purpose of tailoring a different marketing approach to each. Hence, any system of classification that achieves a group with homogeneous traits is appropriate.

Hence, market segmentation can be achieved using the following classifications...

• Sector: Economists broadly classify sectors as Primary (extraction and harvesting of natural resources such as agriculture and mining), Secondary (construction, manufacturing, and processing. Basically, this sector comprises industries that relate to the production of finished goods from raw materials), Tertiary (Retailers, entertainment, and financial companies make up this sector. These companies provide services to consumers.) and Quaternary (knowledge or intellectual pursuits including research and development (R&D), business, consulting services, and education).

• Industry: Industry classifications contain far more categories so we won't list them all here, and there are many different industry classifications systems. Typical industry names used in such classification systems are Retail, Hotels Clubs and Restaurants, Accommodation, Accounting, Agriculture, Metals Mining and Manufacturing, Construction etc. The Australian Bureau of Statistics has a comprehensive and standardised system for industry classification called ANZSIC codes.

• Firmographic Segmentation: Firmographic segmentation is the process of analyzing and classifying B2B customers based on shared company or organization attributes and characteristics. Typical factors to identify customer segments can be...

  Industry
  Location
  Company Size
  Status
  Number of employees
  Performance
  Executive Title
  Sales Cycles Stage

• Firmographic segmentation can help form an effective B2B marketing strategy by identifying target customers and tailoring marketing efforts to these specific customer segments.

• Monetary Value: Similar to Firmographic segmentation, some firms classify their customers by deal size. The type of selling approach and support marketing is tailored to the value of the expected deal. Typically, in technical equipment sales (for example automation and electrical industry, or machinery and mechanical component markets) large customers are serviced direct via a team of account managers and technical sales people and smaller customers are handed off to technical product distributors who can more efficiently service the smaller deal sizes.

• Demographic grouping: age, race, ethnicity, gender, marital status, income, education, and employment. Each can be further segmented into subgroups based on, say, income or education level.

• Geographic segmentation: Sometimes it is appropriate to simply divide the market by some sort of geographic segmentation because this closely aligns with other traits like socioeconomic groupings. Put simply, high net worth individuals tend to live in particular suburbs, lower socioeconomic live in others. Geographic segmentation is important for markets that are adjacent to geographic features. For example, surf shops are located in coastal areas, ski-shops adjacent mountain areas, and agricultural products are located in rural centres.

• Behavioral segmentation: Typical behavioral traits include: spending habits, purchasing habits, browsing habits, interactions with the brand, brand loyalty, price sensitivity etc. Some businesses will segment their markets by distribution channel for example segmenting their markets into online customers and in-store customers.

• Psycho-graphic profiling: Yet another segmentation method is based on characterising people by observing their beliefs, attitudes and behaviors. This is particularly powerful for marketing branded goods to consumer markets where the insights into each segment support highly calibrated messaging and tailoring products to appeal to each segment on a deeply psychological level. Read more about Psycho-graphic profiling here.

• Custom or hybrid segmentation categories: Finding the best way to segment a market sometimes requires developing a customised approach. If you are often having difficulty classifying customers because they fit the criteria for two different segments then a customised segmentation system may work better.

Purists will argue that Sectors, Industries and Market Segments have distinct meanings and are not the same thing. Some believe they are hierarchical, meaning that Sectors are divided into Industries which are further divided into Market Segments. In general, this is probably true. However, a more calibrated customised segmentation system might straddle a number of Sectors or Industries. For example classifying along demographic lines might identify a market segment called "degree qualified professionals" these people may work in any number of different sectors or industries.

This then brings-up the topic of segmentation matrices where the market segments may be classified by both industry and a demographic. Each cell in the matrix then identifies a distinct market segment.

Choosing or developing a segmentation system

By now the reader should have better understood the benefits of market segmentation. The obvious next question is how to set-up or choose a segmentation system.

As a guide, several principles apply...

• Seek to achieve a practical level of homogeneity: Ideally, a market segment should be based on traits that all members of the market segment share. However, individuality is endless so depending on how tightly calibrated the criteria are, at the extreme, segmentation will continue until each market segment consists of only one person (or organization). Some products are customised (see solution selling) which tends to obviate the need to develop highly specific market segments (or niches), however, the point is practical segmentation is based on compromise.

• Don't develop too many market segments: Tailoring products and messaging to match the need of each market segment comes at a cost. There is also the potential for confusion. Larger organisations with complex markets may benefit from an extensive segmentation system. Global organisations serving consumer markets tend to develop complex market segments based on local customs, consumer laws and the presence of competitors. This may result in a wide diversity of market segments.

• Measurability: Choose market segments where the cost of obtaining data is affordable. A key measurement is market size - is it relatively easy to determine the market size from available data?

• Accessibility: can we access and provide products/services to this group?

• Substantiality: Is the segment large enough to be “profitable” –how many people, what percentage of population?

• Action ability : Can marketing strategies be designed to attract and service this segment?

• Resource focus and tailoring of strategies: The whole purpose of segmentation is to focus resources. Usually this means tailoring methods to suit different segments. However, sometimes the business strategy for segments is identical, but the result measurement is still separate for each segment. Different segments can be impacted by different market forces. Segmentation allows more finely calibrated analysis and adjustment of business activity in response.

Instead of saying "sales are down due to the economy" it's better to be able to say "the economy has impacted the building and construction segments, but hasn't impacted Defence or industrial."

Multi-variate and cluster analysis

Sometimes the traits that bind together market segments into a homogeneous group are not obvious and/or existing segmentation systems are not sufficiently calibrated to drive strategic focus. However, the marketer can use intelligent tools that will assist in identifying a bespoke segmentation system specifically tailored to an organization's products/services and their most prospective customer types.

A powerful tool employed by more sophisticated marketers to identify market segments is multivariate analysis.

To explain how this works, start first by noting a form of analysis that we are already familiar with - plotting data on two dimensional axes.

The results are hardly surprising showing that younger people are more likely to shop online peaking at age thirty where purchasing power coincides with familiarity with the internet. What is surprising is the small cluster (circled) comprising people aged in their mid-sixties who show a tendency to purchase more often online than people slightly younger and older - what is going on here? A marketer may have reason to investigate this cluster in more detail.

The example shows a cluster identified from just two variables. In multi-variate analysis, the number of variables has no limit (within reason). However, because the results cannot be plotted (it's difficult to plot more than 3 dimensions) instead of identifying clusters visually, mathematical tools and data processing are used instead.

The principal however is the same. Multi-variate analysis simply identifies people who have similar traits to see if they form clusters (data points more tightly packed than simply spread all over the chart). In this way, people with common traits can be identified and through further study - the reasons for being clustered can be better understood thus developing insights to guide marketing strategy tailored to those segments.

Market segmentation for casino customers - an example:

When I was working as a marketing manager for a casino we conducted a door survey of some 5,000 customers at randomly stratified times over a 3 month period. Randomly selected visitors were interviewed and asked some 30 questions relating to their demographics, geographic location (postcode), gambling habits, what games they played at the casino, their gambling budgets, and frequency of visits.

The data was analyzed using multivariate analysis to identify clusters which lead to the development of the following market segments...

• High rollers: Played mainly baccarat, black jack and craps. A high proportion were male, they lived mainly interstate (Sydney, Melbourne) or were international visitors.

• Day-Time-Rollers: These people played mainly weekdays. A high proportion were of European ancestry and 95% male. Most owned cash businesses (restaurants, hotels, bars, and night clubs). Favorite games were blackjack, roulette, craps, two-up and poker.

• Good-Timers: Visited average 6 times per year. Used F&B facilities and played most games. They weren't serious about gambling and tended to ear-mark a few hundred dollars for gambling and played until their budget ran out. Their primary motivation was entertainment. Mostly visited Thursday, Friday and Saturday nights.

• Tourists-And-Special-Eventers: Similar to the Good Timers group, this segment only visited the casino on special occasions typically when they were entertaining visitors from out-of-town or were themselves tourists.

• Food & Beverage Customers: These people rarely gambled, they simply visited the casino to enjoy the bars and restaurants. However, they were distinguished from 'Tourists-And-Special-Eventers' because they only lived locally, visited significantly more frequently, and were far less likley to gamble.

• Grey Power: The final group were people aged 65+ They visited mainly weekdays arriving when the casino opened at 10 AM and leaving at 3 PM in time to catch the bus home before the discount bus tickets changed to commuter pricing. They mostly played keno (a type of automated BINGO).

Along with identifying each cluster (which we then labelled as "high roller", "day-time-roller", etc.) the market research data provided comprehensive information about each (income, occupation, post code distribution, ethnicity etc.). Such information was useful for targeting. The research data gathered also enabled us to estimate the value of each segment to the casino and thus set appropriate marketing strategies and budgets for each.

Casino industry professionals would note the absence of the traditional market segments such as 'Grind Market', "Slot Players" and "Coach Market". However, at the time of the survey the casino hadn't introduced slot machines (banned by legislation until several years later) and the market segmentation system we had developed provided more insight into the low-win/high-volume market traditionally termed "grind-market."

By Justin Wearne