Customer Segmentation: A Complete Guide

Each customer is unique.

If you treat all your customers the same way, there is a chance that you might lose the majority of them. You have to be able to meet the various needs of customers from different backgrounds.

And Customer Segmentation does just that.

What is Customer Segmentation?

Customer segmentation is about dividing your potential customers, generally a large heterogeneous group, into logical subgroups based on common characteristics.

The purpose of this process is to enable businesses to target and meet the different needs of different groups. This could be creating marketing materials that will appeal to a certain group, or it could be tailoring goods and services to meet the different needs of different groups.

Customer segmentation is not a new concept. It was already used as a marketing tool by the likes of brands such as Proctor and Gamble and General Foods as far back as the 1950s.

It was formalized as a concept by Wendell Smith in 1956 on his publication Product Differentiation and Market Segmentation as an Alternative Marketing Strategy. But the idea is much older than that. On the streets of Ancient Beijing or Rome, sellers would have had different strategies for dealing with wealthy aristocrats, laborers, and gullible tourists.

Why is Customer Segmentation important?

But why should you spend your time and resources segmenting your audience?

Why is customer segmentation is an important concept?

How does it benefit you and your business?

It is the age of personalization. Every major product tries to offer unique experiences to everyone because this helps you establish a strong bond between you and your users, and boosts your growth.

The exact benefits of customer segmentation depend on your type of business and how you choose to use your customer segments, but here are some of the main benefits that have been identified for this type of activity:

Effectively Engage New Potential Customers

You can develop marketing messages that speak to specific audiences. These will be more effective than generic marketing materials.

For example, you would not use the same language to convince your grandmother, who is trying to make ends meet on her pension, to buy something as you would a high-flying young professional who enjoys spending their expendable income on the finer things. You can create different messages and release them via different channels to ensure you reach the right people with the right message.

Convert Potential Customers into Regulars

Customer segmentation can help you achieve higher conversion rates through personalization.

Once you have engaged a potential customer with your service or product, you have a variety of opportunities to convert them from a potential customer into a regular one.

These generally entail calls to action of some kind. It could be to buy something, sign up for something, download something. Calls to action are more effective if they are personalized to an extent. They should speak to the priorities, needs, or experiences of the customer, informed by their segment.

A recent survey conducted by HubSpot shows that personalized calls to action are 202 percent more effective than generic calls to action.

Personalization also provides more effective opportunities to upsell and cross-sell. You can offer your customers attractive opportunities based on their behavior to date and offers that have appealed to other customers like them.

Retain Customers

Personalization is also an effective way to retain customers.

The kind of general personalization that you can achieve through customer segmentation can help make customers feel like they are individually valuable to a business. These customers are then more likely to feel loyalty to that company, than if they feel like they are being treated like just one more generic source of income.

Why is that important?

Research has shown that 68 percent of customers that leave a company will never return, and it is five times more expensive to cultivate new customers than to retain the ones that you have.

Focus on the Most Profitable Customers

The idea of customer segmentation is not just to let you speak to every customer in a way that is most appropriate to them. It is also to help you decide where to prioritize your resources.

Take for example a furniture design company. Perhaps they have a lot of young people 18 to 29 visiting their site and browsing their products, and maybe buying the occasional piece. But their most profitable audience is 30 to 45-year-olds with disposable incomes and houses to fill.

The company, with a limited marketing budget, can then focus on these high-value customers to ensure they receive the maximum profit for their marketing investment.

Provide Better Service to your Customers

Customer segmentation is not just about marketing and communication.

With good customer segmentation, you can ensure that your products and services are fit for purpose and meet the needs of your customers. If you have a clear understanding of your customer’s motivations for engaging with you are and what they need, you can design products and services that will meet those needs. This means happier customers and better products.

How to Segment Your Customer Base

There are generally five different types of customer segmentation that businesses use:

• Demographic – based on gender, age, marital status, etc.
• Geographic – especially for national or international companies.
• Behavior – for example, contract versus pay as you go customers, online versus physical shoppers, customers that use services once a week, once a month, once a year, and so forth.
• Need – this is why the person is using your product or service, for example for a one-off personal event, as opposed to organizing regular events as part of their own job.
• Customer Journey – where the customer is in their transaction with you, for example, browsing, have items in their cart, already made a purchase, etc.

Exactly how you go about segmenting your customer base depends on what industry you are in, how much data you have about your customers, and what kind of expertise and processing power you have to analyze the available data.

For example, a small local fruit and vegetable shop with limited resources for analyzing customer data might segment their audience into just two groups: (1) those that visit the physical shop, and (2) those that order a weekly fresh box delivered to their door. Their customer could no doubt be segmented further, but would that be a useful way to use time and resources?

A company like Amazon, on the other hand, has big budgets and lots of data about their customers. They will be able to create more nuanced segments around browsing and buying habits, the types of items the customer is interested in, where they are located, and much more.

While the scale of the operation may be different, the process of developing customer segmentation generally consists of 3 steps.

1- Hypothesize

Based on your knowledge of your business and its aims, and your knowledge of your customer base, you hypothesize about what useful customer segments might be.

For example, if you run a hotel booking website, you might consider behavior a useful segment: business travelers, single leisure travelers, couples traveling together, families traveling together, and so forth.

You can then also hypothesize about what they need, and what kind of products and marketing will appeal to them.

2- Validate Hypothesis with Data

The next step is to test your hypothesis with actual data about your customers. You can procure this data in a variety of ways:

• Existing market research in the public domain (or available for purchase).
• Data that you have already collected about your customers. In the example of our travel company, they may have the details of the customers that have registered on their website to make purchases, and analytics data about how they used the website, what kinds of things they purchased, when, how often, etc.
• New data-gathering activity through surveys, interviews with customers, focus groups, etc.

You can then use this data to validate and amend your hypotheses.

For example, our travel company might be looking for ways to make it easier for customers to find what they are looking for. That way there will be fewer opportunities for them to abandon and not buy. They hypothesize that the kind of travel the person is planning is the most important factor. Is it a business trip, a solo backpacking adventure, or a romantic couple’s getaway?

But when looking at the data, what the company learns is that it is more important whether the buyer is already familiar with the location, or is visiting for the first time. People who have visited before have a particular hotel, or maybe just a particular neighborhood, in mind. They want to navigate to exactly what they are looking for without much distraction.

Someone who is visiting for the first time needs to spend more time browsing. They also need information about nearby attractions and so forth. Thus, their hypothesis is amended and updated based on hard data.

3- Strategize and Act

The business then needs to strategize about how they will use their customer segments to reach their desired business goals.

For example, a travel company looking to promote itself that has separated single travelers into business and leisure travelers. They might focus on email communications for business travelers, that will organize most of their travel at their desks. Alternatively, they might use social media marketing for leisure travelers that are more interested in being inspired by interesting destinations during their free time.

A strategy moving forward should also include methods for gathering further data to continue to validate and amend hypotheses.

It should also test the effectiveness of strategies for engaging and meeting the needs of the different segments, in order to ensure the desired return on investment.

Common Customer Segmentation Mistakes

When companies aren’t seeing their desired return on investment from customer segments, it is often because they are making one of these common mistakes.

Creating Too Many Segments

If you are too refined with your segments, the process of engaging with them can be unrealistic.

The idea is that segments let you generalize about a group to personalize their experience as much as possible. This way you get the personal touch without having to understand them specifically as an individual. In that way, you get the benefits of personalization while still being able to deal with your customers in bulk.

If you make your segments too detailed, you can lose the cost-benefit advantage.

Targeting All Segments

While you want to be able to engage well with all of your customers, again, this is often too resource-intensive.

You do not need to prioritize all of your customer segments. Part of the process should be to identify your most valuable segment. These are the customers that engage with you the most and spend the most. Focus your efforts there.

In this way, you can focus your limited resources on maximizing profits.

Being Too Clever

When you gather a lot of new and interesting data about your customers, it can be tempting to dig deep into that detail and look for clever ways to engage with them.

You could waste a lot of time. Maybe you delve into the type of video content that is likely to appeal to your target audience on Facebook. Then you spend a lot of time and money crafting the perfect one-minute clips.

But the bigger picture information was that they spend much more time on Facebook than browsing websites. Your time is better invested in creating a Facebook shop. Then these customers can purchase without leaving their favorite social media network.

Before You Go

Creating customer segments requires gathering data on your customers. Data protection and privacy are one of the hottest legal topics of the decade. Therefore, you should limit yourself to collecting the data that you actually need and will use. Don't try and collect everything “just in case”. You should have a justification for every piece of data that you collect.

Moreover, you should be transparent and honest about the data that you collect and how you use it. Customers are often willing to give their data when they know that they are getting something of value in return.

But there is a low tolerance level for data abuse.