Market Segmentation – Why is it Important?

Market segmentation is an important basis of many successful marketing strategies. Carefully chosen segments allow tailoring the marketing mix to more individual customer needs. Thus, they help to invest marketing spending more effectively.

This article explains what market segmentation is, it discusses why it is important and what advantages it yields. Finally, the article provides a basic framework on how to apply market segmentation.

Introduction and Definition of Market Segmentation

The segmentation of the overall market as well as the derived target markets are the basis for determining any particular marketing mix.

Market segmentation is necessary because in most cases buyers of a product or a service are no homogenous group. Actually, every buyer has individual needs, preferences, resources and behaviors. Since it is virtually impossible to cater for every customer’s individual characteristics, marketers group customers to market segments by variables they have in common. These common characteristics allow developing a standardized marketing mix for all customers in this segment.

Definition:

Market segmentation is the segmentation of customer markets into homogenous groups of customers, each of them reacting differently to promotion, communication, pricing and other variables of the marketing mix. Ideally, relevant differences between buyers within each segment are as small as possible. Thus, every segment can be addressed with an individually targeted marketing mix.

Benefits of Market Segmentation

As already stated, segmentation is the basis for developing targeted and effective marketing plans. Furthermore, analysis of market segments enables decisions about intensity of marketing activities in particular segments.

A segment-orientated marketing approach generally offers a range of advantages for both, businesses and customers.

Better serving customers’ needs and wants

It is possible to satisfy a variety of customer needs with a limited product range by using different forms, bundles, incentives and promotional activities.

The pricing models of many web based services are a good example. They often include a free plan to attract undecided first-time customers (reducing uncertainty and concerns, initiation customer lock-in). In addition, there normally is a moderately priced plan for light users like individuals and small businesses as well as a more expensive plan for heavy users. The paid plans include more features and functions as well as higher service levels.

The underlying product or service is basically one and the same. It is only slightly adjusted to meet the needs of very different market segments.

Up-selling across the customer journey

The above example of web-based services with different pricing plans illustrates that market segments enable businesses to target their customers according to their lifecycle phase.

As users get used to the service and grow their business, they can easily change to the next higher plan or to supplementary services. The service bundle evolves across the customer journey. Thus, segment-specific product bundles increase chances for up-selling and cross selling.

Absorption of purchasing power by price differentiation

It is often difficult to increase prices for the whole market. Nevertheless, it is possible to develop premium segments in which customers accept a higher price level. Such segments could be distinguished from the mass market by features like additional services, exclusive points of sale, product variations and the like. A typical segment-based price variation is by region. The generally higher price level in big cities is evidence for this.

When differentiating prices by segments, organizations have to take care that there is no chance for cannibalization between high-priced products with high margins and budget offers in different segments. This risk is the higher, the less distinguished the segments are.

The theoretical concept behind this price differentiation is price elasticity. In mass markets businesses often compete mainly on price. This is because the products are comparable and may have a high level of price elasticity. A thorough knowledge about customers’ preferences enables businesses to develop more distinguishable offers for particular market segments. Demand for differentiated products that offer a particular (and perceivable) value to customers often has a lower level of price elasticity. Hence, such products can sustain a higher price level and higher margins.

Attract additional customer groups

Targeted marketing plans for particular segments allow to individually approach customer groups that otherwise would look out for specialized niche players. By segmenting markets, organizations can create their own ‘niche products’ and thus attract additional customer groups.

Moreover, a segmentation strategy that is based on customer loyalty (see loyalty ladder model below) offers the chance to attract new customers with starter products and to move these customers on to premium products.

Sustainable customer relationships in all phases of customer life cycle

Customers change their preferences and patterns of behavior over time. Organizations that serve different segments along a customer’s life cycle can guide their customers from stage to stage by always offering them a special solution for their particular needs.

For example, many car manufacturers offer a product range that caters for the needs of all phases of a customer life cycle: first car for early twens, fun-car for young professionals, family car for young families, etc. Skin care cosmetics brands often offer special series for babies, teens, normal skin, and elder skin.

Targeted communication

It is necessary to communicate in a segment-specific way even if product features and brand identity are identical in all market segments. Such a targeted communications allows highlighting those criteria that are most relevant for each particular segment (e.g. price vs. reliability vs. prestige).

Stimulating Innovation

An undifferentiated marketing strategy that targets at all customers in the total market necessarily reduces customers’ preferences to the smallest common basis. Segmentations provide information about smaller units in the total market that share particular needs.

An undifferentiated marketing reduces customers’ preferences to the smallest common basis Click To Tweet

Only the identification of these needs enables a planned development of new or improved products that better meet the wishes of these customer groups. If a product meets and exceeds a customer’s expectations by adding superior value, the customers normally is willing to pay a higher price for that product. Thus, profit margins and profitability of the innovating organizations increase.

In addition, businesses may pay particular attention to the customer segments of innovators and early adopters (according to Diffusion of Innovation Theory). By carefully analyzing these customer groups they can gain valuable insights about new trends that provide direction to their innovation activities.

Higher Market Shares

The above points have already highlighted that market segmentation is an ideas basis for pursuing additional growth opportunities. This translates in higher market shares in many cases.

In contrast to an undifferentiated marketing strategy, segmentation supports the development of niche strategies. Thus marketing activities can be targeted at highly attractive market segments in the beginning. Market leadership in selected segments improves the competitive position of the whole organization in its relationship with suppliers, channel partners and customers. It strengthens the brand and ensures profitability. On that basis, organizations have better chances to increase their market shares in the overall market.

Summarizing all these advantages, the need for market segmentation is closely related to strategic decisions:

Market segmentation is the basis for customer orientation and differentiation.


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A framework for conducting market segmentation

From market segmentation to marketing planning

Literature suggests the following steps from market segmentation to marketing planning:

Steps from market segmentation to marketing planning

Steps from market segmentation to marketing planning

Adapted from Kotler and Doyle

Criteria for Market Segmentation

There are a huge number of variables that could be used for market segmentation in theory. They comprise easy to determine demographic factors as well as variables on user behavior or customer preferences. In addition, there are differences between private customers and businesses. The following table shows the best known examples – but is not exhaustive.

Consumer Markets

Geographic:

  • Land or region
  • Rural or metropolitan area

Demographic:

  • Age, sex, marital status
  • Income, occupation, education
  • Religion, nationality, ethnical group

Psychographic:

  • Social status
  • Lifestyle-type
  • Personal type

Behavioral:

Industrial Markets / B2B Markets

  • Industry
  • Intermediary or final consumer
  • Type of corporation (public or private sector)
  • Size of corporation
  • Geographical location
  • Intensity of product use
  • Organization of purchasing function
    • Centralized or decentralized
    • Purchasing policies, rules and criteria

Since customer orientation of organizations is growing, segmentation as the basis for establishing customer relationships and customer loyalty gains importance. In this context, the elements of the loyalty ladder model could be used as segmentation variables:

Loyalty Ladder is a tool for market segmentation. It segments customers by loyalty level

Loyalty Ladder

Marketers have to choose those variables that are relevant for segmenting the market for a particular product or service. The basic rule is to focus on a limited number of important variables. To segment the market into too many small, slightly distinct segments would require splitting up the marketing budget into too many ineffective chunks. Such varied marketing activities in the diverse segments could confuse customers and would lead to cannibalization effects.

Kotler mentions five criteria for an effective segmentation:

  • Measurable: It has to be possible to determine the values of the variables used for segmentation with justifiable efforts. This is important especially for demographic and geographic variables. For an organization with direct sales (without intermediaries), the own customer database could deliver valuable information on buying behavior (frequency, volume, product groups, mode of payment etc).
  • Relevant: The size and profit potential of a market segment have to be large enough to economically justify separate marketing activities for this segment.
  • Accessible: The segment has to be accessible and servable for the organization. That means, for instance, that there are target-group specific advertising media, as magazines or websites the target audience likes to use.
  • Distinguishable: The market segments have to be that diverse that they show different reactions to different marketing mixes.
  • Feasible: It has to be possible to approach each segment with a particular marketing program and to draw advantages from that.

Summary

Market segmentation is the basis for better targeting different customer groups. It enables businesses to grow in sales and profits by

  • Reaching additional customers,
  • Differentiating prices and absorbing purchasing power
  • Achieving customer lock-in, up-selling and cross-selling
  • Staying innovative

A strong focus on attractive market segments is of special relevance in our fast moving times of Internet economy. Kalakota and Whinston* say in their law of differentiation:

As the blurring of distinctions among firms increases in electronic markets, survival requires identifying your unique role in the marketplace in terms of value to the customer.”

Following that, Kalakota and Whinston perceive segmentation as the basis for offering superior value to particular customer groups and thus for developing a stable and profitable market position.

*(Ravi Kalakota and Andrew B. Whinston: Do or Die: Market Segmentation and Product Positioning on the Internet – this article is not longer available online)

 

(c) Dagmar Recklies, 2001, updated 2015


Our literature recommendation on segmentation and target marketing

  • Market Segmentation: How to Do It and How to Profit from It
    by Malcolm McDonald
    This book spells out a totally dispassionate, systematic process for arriving at genuine, needs-based segments that can enable organizations to escape from the dreay, miserable, downward pricing spiral which results from getting market segmentation wrong. Nothing in business works unless markets are correctly defined, mapped, quantified and segmented.
  • Market Segmentation: An Introduction and Review
    by Dr. Steven Struhl
    Part 1 discusses the terminology and basics–and cuts through the jargon that so often can confuse the subject (and the reader). Part 2 explains the steps you need to take in a successful segmentation study, with detailed descriptions of the methods you will encounter, and a step-by-step explanation of how to do segmentation, from preparing the survey to the final deliverables.
  • Why Marketing to Women Doesn’t Work: Using Market Segmentation to Understand Consumer Needs
    by Jenny Darroch
    Practical and well-researched, this book provides deep insights into the principles of market segmentation, and recommends a new approach that thoroughly examines the issue of human needs, regardless of gender, in order to properly target and effectively reach female customers.
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