Market segmentation

Market segmentation is the process of dividing up mass markets into groups with similar needs and wants.[1] The rationale for market segmentation is that in order to achieve competitive advantage and superior performance, firms should: "(1) identify segments of industry demand, (2) target specific segments of demand, and (3) develop specific 'marketing mixes' for each targeted market segment. "[2] From an economic perspective, segmentation is built on the assumption that heterogeneity in demand allows for demand to be disaggregated into segments with distinct demand functions.[3]

The Model-T Ford (1921) is an early example of a mass marketing (undifferentiated segmentation) approach. Initially, it was produced only in black.

The business historian Richard S. Tedlow identifies four stages in the evolution of market segmentation:[4]

• Fragmentation (pre-1880s): The economy was characterized by small regional suppliers who sold goods on a local or regional basis
• Unification or mass marketing (1880s–1920s): As transportation systems improved, the economy became unified. Standardized, branded goods were distributed at a national level. Manufacturers tended to insist on strict standardization to achieve scale economies to penetrate markets in the early stages of a product's lifecycle. e.g. the Model T Ford
• Segmentation (the 1920s–1980s): As market size increased, manufacturers were able to produce different models pitched at different quality points to meet the needs of various demographic and psychographic market segments. This is the era of market differentiation based on demographic, socio-economic, and lifestyle factors.
• Hyper-segmentation (post-1980s): a shift towards the definition of ever more narrow market segments. Technological advancements, especially in the area of digital communications, allow marketers to communicate with individual consumers or very small groups. This is sometimes known as one-to-one marketing.

By the 1930s, Ford was producing Deluxe models in a range of colours such as this Ford Deluxe Coupe (1931)

The practice of market segmentation emerged well before marketers thought about it at a theoretical level.[5] Archaeological evidence suggests that Bronze Age traders segmented trade routes according to geographical circuits.[6] Other evidence suggests that the practice of modern market segmentation was developed incrementally from the 16th century onwards. Retailers, operating outside the major metropolitan cities, could not afford to serve one type of clientele exclusively, yet retailers needed to find ways to separate the wealthier clientele from the "riff-raff". One simple technique was to have a window opening out onto the street from which customers could be served. This allowed the sale of goods to the common people, without encouraging them to come inside. Another solution, that came into vogue starting in the late sixteenth century, was to invite favored customers into a back room of the store, where goods were permanently on display. Yet another technique that emerged around the same time was to hold a showcase of goods in the shopkeeper's private home for the benefit of wealthier clients. Samuel Pepys, for example, writing in 1660, describes being invited to the home of a retailer to view a wooden jack.[7] The eighteenth-century English entrepreneurs, Josiah Wedgewood and Matthew Boulton, both staged expansive showcases of their wares in their private residences or in rented halls to which only the upper classes were invited while Wedgewood used a team of itinerant salesmen to sell wares to the masses.[8]

Evidence of early marketing segmentation has also been noted elsewhere in Europe. A study of the German book trade found examples of both product differentiation and market segmentation in the 1820s.[9] From the 1880s, German toy manufacturers were producing models of tin toys for specific geographic markets; London omnibuses and ambulances destined for the British market; French postal delivery vans for Continental Europe and American locomotives intended for sale in America.[10] Such activities suggest that basic forms of market segmentation have been practiced since the 17th century and possibly earlier.

Contemporary market segmentation emerged in the first decades of the twentieth century as marketers responded to two pressing issues. Demographic and purchasing data were available for groups but rarely for individuals and secondly, advertising and distribution channels were available for groups, but rarely for single consumers. Between 1902 and 1910, George B Waldron, working at Mahin's Advertising Agency in the United States used tax registers, city directories, and census data to show advertisers the proportion of educated vs illiterate consumers and the earning capacity of different occupations, etc. in a very early example of simple market segmentation.[11][12] In 1924 Paul Cherington developed the 'ABCD' household typology; the first socio-demographic segmentation tool.[11][13] By the 1930s, market researchers such as Ernest Dichter recognized that demographics alone were insufficient to explain different marketing behaviors and began exploring the use of lifestyles, attitudes, values, beliefs and culture to segment markets.[14] With access to group-level data only, brand marketers approached the task from a tactical viewpoint. Thus, segmentation was essentially a brand-driven process.

Wendell R. Smith is generally credited with being the first to introduce the concept of market segmentation into the marketing literature in 1956 with the publication of his article, "Product Differentiation and Market Segmentation as Alternative Marketing Strategies."[15] Smith's article makes it clear that he had observed "many examples of segmentation" emerging and to a certain extent saw this as a "natural force" in the market that would "not be denied."[16] As Schwarzkopf points out, Smith was codifying implicit knowledge that had been used in advertising and brand management since at least the 1920s.[17]

Until relatively recently, most segmentation approaches have retained a tactical perspective in that they address immediate short-term decisions; such as describing the current “market served” and are concerned with informing marketing mix decisions. However, with the advent of digital communications and mass data storage, it has been possible for marketers to conceive of segmenting at the level of the individual consumer. Extensive data is now available to support segmentation in very narrow groups or even for a single customer, allowing marketers to devise a customized offer with an individual price that can be disseminated via real-time communications.[18] Some scholars have argued that the fragmentation of markets has rendered traditional approaches to market segmentation less useful.[19]

The limitations of conventional segmentation have been well documented in the literature.[20] Perennial criticisms include:

• That it is no better than mass marketing at building brands[21]
• That in competitive markets, segments rarely exhibit major differences in the way they use brands[22]
• That it fails to identify sufficiently narrow clusters[23]
• Geographic/demographic segmentation is overly descriptive and lacks sufficient insights into the motivations necessary to drive communications strategy[24]
• Difficulties with market dynamics, notably the instability of segments over time[25][26] and structural change which leads to segment creep and membership migration as individuals move from one segment to another[27]
• Segments are categories that marketers create for consumers, but consumers do not self-identify with them.[28]

Market segmentation has many critics. But in spite of its limitations, market segmentation remains one of the enduring concepts in marketing and continues to be widely used in practice. One American study, for example, suggested that almost 60 percent of senior executives had used market segmentation in the past two years.[29]

A key consideration for marketers is whether to segment or not to segment. Depending on company philosophy, resources, product type, or market characteristics, a business may develop an undifferentiated approach or differentiated approach. In an undifferentiated approach, the marketer ignores segmentation and develops a product that meets the needs of the largest number of buyers.[30] In a differentiated approach the firm targets one or more market segments, and develops separate offers for each segment.[30]

In consumer marketing, it is difficult to find examples of undifferentiated approaches. Even goods such as salt and sugar, which were once treated as commodities, are now highly differentiated. Consumers can purchase a variety of salt products; cooking salt, table salt, sea salt, rock salt, kosher salt, mineral salt, herbal or vegetable salts, iodized salt, salt substitutes, and many more. Sugar also comes in many different types - cane sugar, beet sugar, raw sugar, white refined sugar, brown sugar, caster sugar, sugar lumps, icing sugar (also known as milled sugar), sugar syrup, invert sugar, and a plethora of sugar substitutes including smart sugar which is essentially a blend of pure sugar and a sugar substitute. Each of these product types is designed to meet the needs of specific market segments. Invert sugar and sugar syrups, for example, are marketed to food manufacturers where they are used in the production of conserves, chocolate, and baked goods. Sugars marketed to consumers appeal to different usage segments – refined sugar is primarily for use on the table, while caster sugar and icing sugar are primarily designed for use in home-baked goods.

Many factors are likely to affect a company's segmentation strategy:[32]

• Company resources: When resources are restricted, a concentrated strategy may be more effective.
• Product variability: For highly uniform products (such as sugar or steel) undifferentiated marketing may be more appropriate. For products that can be differentiated, (such as cars) then either a differentiated or concentrated approach is indicated.
• Product life cycle: For new products, one version may be used at the launch stage, but this may be expanded to a more segmented approach over time. As more competitors enter the market, it may be necessary to differentiate.
• Market characteristics: When all buyers have similar tastes or are unwilling to pay a premium for different quality, then undifferentiated marketing is indicated.
• Competitive activity: When competitors apply differentiated or concentrated market segmentation, using undifferentiated marketing may prove to be fatal. A company should consider whether it can use a different market segmentation approach

The process of segmenting the market is deceptively simple. Marketers tend to use the so-called S-T-P process, that is Segmentation→ Targeting → Positioning, as a broad framework for simplifying the process.[33] Segmentation comprises identifying the market to be segmented; identification, selection, and application of bases to be used in that segmentation; and development of profiles. Targeting comprises an evaluation of each segment's attractiveness and selection of the segments to be targeted. Positioning comprises the identification of optimal positions and the development of the marketing program.

Perhaps the most important marketing decision a firm makes is the selection of one or more market segments on which to focus. A market segment is a portion of a larger market whose needs differ somewhat from the larger market. Since a market segment has unique needs, a firm that develops a total product focused solely on the needs of that segment will be able to meet the segment's desires better than a firm whose product or service attempts to meet the needs of multiple segments.[34] Current research shows that, in practice, firms apply three variations of the S-T-P framework: ad-hoc segmentation, syndicated segmentation, and feral segmentation.[28]

• Ad-Hoc segmentation closely resembles the original S-T-P framework in that firms initiate and conduct independently a market segmentation project. Firms focus on a category of offerings as the starting point for identifying a base of consumers and performing analysis to validate distinct consumption profiles. The resulting market segmentation profiles are often treated as trade secrets.[28]
• Syndicated segmentation means that firms purchase segmentation frameworks that are commercially available from specialized firms that apply data science to generate consumer profiles. The resulting segments are available for commercial distribution, and clients can consult the segments for a fee.[28]
• Feral segmentation: it is the process in which cultural intermediaries coin, circulate, and validate the consumer categories that some marketers use as market segments - consumer categories emerge, unsolicited, in popular culture.[28] Segments are "feral" because consumer categories emerge in the public domain, unsolicited, without the direct involvement of professional marketers, outside managerial control, and without mobilizing the prescribed market research techniques.[28]

The market for any given product or service is known as the market potential or the total addressable market (TAM). Given that this is the market to be segmented, the market analyst should begin by identifying the size of the potential market. For existing products and services, estimating the size and value of the market potential is relatively straightforward. However, estimating the market potential can be very challenging when a product or service is totally new to the market and no historical data on which to base forecasts exists.

A basic approach is to first assess the size of the broad population, then estimate the percentage likely to use the product or service, and finally to estimate the revenue potential.

To estimate market size, a marketer might evaluate the adoption and growth rates of comparable technologies (historical analogy method).

Another approach is to use a historical analogy.[35] For example, the manufacturer of HDTV might assume that the number of consumers willing to adopt high-definition TV will be similar to the adoption rate for color TV. To support this type of analysis, data for household penetration of TV, Radio, PCs, and other communications technologies are readily available from government statistics departments. Finding useful analogies can be challenging because every market is unique. However, analogous product adoption and growth rates can provide the analyst with benchmark estimates, and can be used to cross-validate other methods that might be used to forecast sales or market size.

A more robust technique for estimating the market potential is known as the Bass diffusion model, the equation for which follows:[36]

N(t) – N(t−1) = [p + qN(t−1)/m] × [m – N(t−1)]

Where:

• N(t)= the number of adopters in the current time period, (t)
• N(t−1)= the number of adopters in the previous time period, (t-1)
• p = the coefficient of innovation
• q = the coefficient of imitation (the social contagion influence)
• m = an estimate of the number of eventual adopters

The major challenge with the Bass model is estimating the parameters for p and q. However, the Bass model has been so widely used in empirical studies that the values of p and q for more than 50 consumer and industrial categories have been determined and are widely published in tables.[37] The average value for p is 0.037 and for q is 0.327.

Major bases used for segmenting a market

A major step in the segmentation process is the selection of a suitable base. In this step, marketers are looking for a means of achieving internal homogeneity (similarity within the segments), and external heterogeneity (differences between segments).[38] In other words, they are searching for a process that minimizes differences between members of a segment and maximizes differences between each segment. In addition, the segmentation approach must yield segments that are meaningful for the specific marketing problem or situation. For example, a person's hair color may be a relevant base for a shampoo manufacturer, but it would not be relevant for a seller of financial services. Selecting the right base requires a good deal of thought and a basic understanding of the market to be segmented.

In reality, marketers can segment the market using any base or variable provided that it is identifiable, substantial, responsive, actionable, and stable.[39]

• Identifiability refers to the extent to which managers can identify or recognize distinct groups within the marketplace
• Substantiality refers to the extent to which a segment or group of customers represents a sufficient size to be profitable. This could mean to be sufficiently large in number of people or in purchasing power
• Accessibility refers to the extent to which marketers can reach the targeted segments with promotional or distribution efforts
• Responsiveness refers to the extent to which consumers in a defined segment will respond to marketing offers targeted at them
• Actionable – segments are said to be actionable when they provide guidance for marketing decisions.[40]

For example, although dress size is not a standard base for segmenting a market, some fashion houses have successfully segmented the market using women's dress size as a variable.[41] However, the most common bases for segmenting consumer markets include: geographics, demographics, psychographics, and behaviour. Marketers normally select a single base for the segmentation analysis, although, some bases can be combined into a single segmentation with care. Combining bases is the foundation of an emerging form of segmentation known as ‘Hybrid Segmentation’ (see § Hybrid segmentation). This approach seeks to deliver a single segmentation that is equally useful across multiple marketing functions such as brand positioning, product and service innovation as well as eCRM.

The following sections provide a detailed description of the most common forms of consumer market segmentation.

Demographic segmentation

Further information: Demographic targeting

Segmentation according to demography is based on consumer demographic variables such as age, income, family size, socio-economic status, etc.[46] Demographic segmentation assumes that consumers with similar demographic profiles will exhibit similar purchasing patterns, motivations, interests, and lifestyles and that these characteristics will translate into similar product/brand preferences.[47] In practice, demographic segmentation can potentially employ any variable that is used by the nation's census collectors. Examples of demographic variables and their descriptors include:

• Age: Under 5, 5–8 years, 9–12 years, 13–17 years, 18–24, 25–29, 30–39, 40–49, 50–59, 60+[48]
• Gender: Male, Female[49]
• Occupation: Professional, self-employed, semi-professional, clerical/ admin, sales, trades, mining, primary producer, student, home duties, unemployed, retired[50]
• Socio-economic: A, B, C, D, E, or I, II, III, IV, or V (normally divided into quintiles)[51]
• Marital Status: Single, married, divorced, widowed
• Family Life-stage: Young single; Young married with no children; Young family with children under 5 years; Older married with children; Older married with no children living at home, Older living alone[52]
• Family size/ number of dependants: 0, 1–2, 3–4, 5+
• Income: Under $10,000; 10,000–20,000; 20,001–30,000; 30,001–40,000, 40,001–50,000 etc.
• Educational attainment: Primary school; Some secondary, Completed secondary, Some university, Degree; Postgraduate or higher degree
• Home ownership: Renting, Own home with a mortgage, Home owned outright
• Ethnicity: Asian, African, Aboriginal, Polynesian, Melanesian, Latin-American, African-American, American Indian, etc.
• Religion: Catholic, Protestant, Muslim, Jewish, Buddhist, Hindu, Other

In practice, most demographic segmentation utilizes a combination of demographic variables.

Visualisation of two approaches to demographic segmentation using one and two variables. On the left, a single variable (age) is used. On the right, two variables (income and occupation) are used to form the segments.

The use of multiple segmentation variables normally requires the analysis of databases using sophisticated statistical techniques such as cluster analysis or principal components analysis. These types of analysis require very large sample sizes. However, data collection is expensive for individual firms. For this reason, many companies purchase data from commercial market research firms, many of whom develop proprietary software to interrogate the data.

The labels applied to some of the more popular demographic segments began to enter the popular lexicon in the 1980s.[53][54][55] These include the following:[56][57]

DINK: Double (or dual) Income, No Kids, describes one member of a couple with above-average household income and no dependent children, tend to exhibit discretionary expenditure on luxury goods and entertainment and dining out

GLAM: Greying, Leisured and Moneyed. Retired older persons, asset rich, and high income. Tend to exhibit higher spending on recreation, travel, and entertainment

GUPPY: (aka GUPPIE) Gay, Upwardly Mobile, Prosperous, Professional; blend of gay and YUPPY (can also refer to the London-based equivalent of YUPPY)

MUPPY: (aka MUPPIE) Mid-aged, Upwardly Mobile, Prosperous, Professional

Preppy: (American) Well-educated, well-off, upper-class young persons; a graduate of an expensive school. Often distinguished by a style of dress.

SITKOM: Single Income, Two Kids, Oppressive Mortgage. Tend to have very little discretionary income, and struggle to make ends meet

Tween: Young person who is approaching puberty, aged approximately 9–12 years; too old to be considered a child, but too young to be a teenager; they are 'in between'.

WASP: (American) White, Anglo-Saxon Protestant. Tend to be high-status and influential white Americans of English Protestant ancestry.

YUPPY: (aka yuppie) Young, Urban/ Upwardly-mobile, Prosperous, Professional. Tend to be well-educated, career-minded, ambitious, affluent, and free spenders.

Another major decision in developing the segmentation strategy is the selection of market segments that will become the focus of special attention (known as target markets). The marketer faces important decisions:

• What criteria should be used to evaluate markets?
• How many markets to enter (one, two, or more)?
• Which market segments are the most valuable?

When a marketer enters more than one market, the segments are often labeled the primary target market and secondary target market. The primary market is the target market selected as the main focus of marketing activities. The secondary target market is likely to be a segment that is not as large as the primary market, but has growth potential. Alternatively, the secondary target group might consist of a small number of purchasers that account for a relatively high proportion of sales volume perhaps due to purchase value or purchase frequency.

In terms of evaluating markets, three core considerations are essential:[82]

• Segment size and growth
• Segment structural attractiveness
• Company objectives and resources.

The marketing program is designed with the needs of the target market in mind

When the segments have been determined and separate offers developed for each of the core segments, the marketer's next task is to design a marketing program (also known as the marketing mix) that will resonate with the target market or markets. Developing the marketing program requires a deep knowledge of key market segments' purchasing habits, their preferred retail outlet, their media habits, and their price sensitivity. The marketing program for each brand or product should be based on the understanding of the target market (or target markets) revealed in the market profile.

Positioning is the final step in the S-T-P planning approach; Segmentation → Targeting → Positioning; a core framework for developing marketing plans and setting objectives. Positioning refers to decisions about how to present the offer in a way that resonates with the target market. During the research and analysis that forms the central part of segmentation and targeting, the marketer will have gained insights into what motivates consumers to purchase a product or brand. These insights will form part of the positioning strategy.

According to advertising guru, David Ogilvy, "Positioning is the act of designing the company’s offering and image to occupy a distinctive place in the minds of the target market. The goal is to locate the brand in the minds of consumers to maximize the potential benefit to the firm. A good brand positioning helps guide marketing strategy by clarifying the brand’s essence, what goals it helps the consumer achieve, and how it does so in a unique way."[84]

Perceptual map of the U.S. motor vehicle category

The technique known as perceptual mapping is often used to understand consumers' mental representations of brands within a given category. Traditionally two variables (often, but not necessarily, price and quality) are used to construct the map. A sample of people in the target market are asked to explain where they would place various brands in terms of the selected variables. Results are averaged across all respondents, and results are plotted on a graph, as illustrated in the figure. The final map indicates how the average member of the population views the brand that makes up a category and how each of the brands relates to other brands within the same category. While perceptual maps with two dimensions are common, multi-dimensional maps are also used.

There are different approaches to positioning:[85]

1. Against a competitor
2. Within a category
3. According to product benefit
4. According to product attribute
5. For usage occasion
6. Along price lines e.g. a luxury brand or premium brand
7. For a user
8. Cultural symbols e.g. Australia's Easter Bilby (as a culturally appropriate alternative to the Easter Bunny).

Segmenting business markets is more straightforward than segmenting consumer markets. Businesses may be segmented according to industry, business size, business location, turnover, number of employees, company technology, purchasing approach, or any other relevant variables.[86] The most widely used segmentation bases used in business to business markets are geographics and firmographics.[87]

The most widely used bases for segmenting business markets are:

Geographic segmentation occurs when a firm seeks to identify the most promising geographic markets to enter. Businesses can tap into business census-type products published by Government departments to identify geographic regions that meet certain predefined criteria.

Firmographics (also known as emporographics or feature based segmentation) is the business community's answer to demographic segmentation. It is commonly used in business-to-business markets (an estimated 81% of B2B marketers use this technique). Under this approach the target market is segmented based on features such as company size, industry sector or location usage rate, purchase frequency, number of years in business, ownership factors, and buying situation.[88][87]

Key firmographic variables: standard industry classification (SIC); company size (either in terms of revenue or number of employees), industry sector or location (country and/or region), usage rate, purchase frequency, number of years in business, ownership factors and buying situation

The basic approach to retention-based segmentation is that a company tags each of its active customers on four axes:

Risk of customer cancellation of company service

One of the most common indicators of high-risk customers is a drop off in usage of the company's service. For example, in the credit card industry, this could be signaled through a customer's decline in spending on his or her card.

Risk of customer switching to a competitor

Many times customers move purchase preferences to a competitor brand. This may happen for many reasons those of which can be more difficult to measure. It is many times beneficial for the former company to gain meaningful insights, through data analysis, as to why this change of preference has occurred. Such insights can lead to effective strategies for winning back the customer or on how not to lose the target customer in the first place.

Customer retention worthiness

This determination boils down to whether the post-retention profit generated from the customer is predicted to be greater than the cost incurred to retain the customer and includes evaluation of customer lifecycles.[89][90]

This analysis of customer lifecycles is usually included in the growth plan of a business to determine which tactics to implement to retain or let go of customers.[91] Tactics commonly used range from providing special customer discounts to sending customers communications that reinforce the value proposition of the given service.

The choice of an appropriate statistical method for the segmentation depends on numerous factors that may include, the broad approach (a-priori or post-hoc), the availability of data, time constraints, the marketer's skill level, and resources.[92]

Statistical techniques used in segmentation

Marketers often engage commercial research firms or consultancies to carry out segmentation analysis, especially if they lack the statistical skills to undertake the analysis. Some segmentation, especially post-hoc analysis, relies on sophisticated statistical analysis.

Visualisation of market segments formed using clustering methods

Common statistical approaches and techniques used in segmentation analysis include:

• Clustering algorithms[97] – overlapping, non-overlapping and fuzzy methods; e.g. K-means or other Cluster analysis
• Conjoint analysis[98]
• Ensemble approaches – such as random forests[99]
• Chi-square automatic interaction detection – a type of decision-tree[100]
• Factor analysis or principal components analysis[101]
• Latent Class Analysis – a generic term for a class of methods that attempt to detect underlying clusters based on observed patterns of association[102]
• Logistic regression[103]
• Multidimensional scaling and canonical analysis[104]
• Mixture models – e.g., EM estimation algorithm, finite-mixture models[105]
• Model-based segmentation using simultaneous and structural equation modeling[106] e.g. LISREL
• Other algorithms such as artificial neural networks.[107]

• Acorn – geo-demographic segmentation[111]
• Claritas Prizm – geo-demographic segmentation[112]
• CanaCode Lifestyle Clusters - geo-demographic and psychographic segmentation[112]
• Experian – geo-demographic segmentation
• Mosaic – geo-demographic segmentation
• Roy Morgan Research Values Segments -psychographic/ psychometric[113]
• VALS-psychographic/ psychometric
• Values Modes-psychographic/ psychometric

• Customer Segmentation A Step-by-Step Guide

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