Market segmentation is a process that companies use to divide their customers into groups based on one or several criteria. The customers in one group either have common needs or respond similarly to the marketing campaigns. Market segmentation can be used to develop the company’s products, to plan sales and marketing strategy, and to analyse the company’s performance.
Types of Market Segmentation
Most of the criteria (often called “bases”) used for market segmentation fall into one of the four categories:
- Geographic segmentation divides customers by their location. Depending on the company’s target market, customers can be divided by countries, regions, cities or city districts, with the assumption that customers have different tastes, needs, etc, depending on where they live. An example of geographic segmentation is regional menu items in McDonald’s.
- Demographic segmentation is done based on the customers’ age, gender, family status, education level, income level, or any other demographic characteristic. Think of a taxi company offering a service with female drivers targeting a certain demographic segment — women.
- Psychographic segmentation takes into account the intrinsic characteristics of the customers, such as personality traits, motivations, interests and opinions. For instance, Coca-Cola Light is a product targeting people who are mindful of their calorie intake.
- Behavioural segmentation looks at the customers’ purchasing behaviour: how they make decisions, their brand loyalty, frequency of purchases, etc. For example, compulsive spending or buying only discounted goods are characteristics for behavioural segmentation.
The choice of a base (or bases) for the segmentation depends on the type of product, marketing needs and company’s stage of life. For example, B2B companies often use straightforward characteristics, such as location or size of the customer company, while B2C companies might look into more complex behavioural and psychographic traits.
Advantages of Market Segmentation
The main benefits of market segmentation for a company include:
- Developing more targeted marketing instruments which can reach the target audience more often and with lower cost. A company organising a music festival is more likely to reach generation Z customers through Instagram and Facebook than through TV ads.
- Designing products that better match customers’ needs. Market segmentation helps to uncover common preferences and needs of a particular group of customers. Then, a tailored product can be offered to this segment. For example, some companies have developed special mobile phones which are convenient to use for older people and people with disabilities: the phones have bigger buttons and “talking keypad”.
- Developing different price offers for different segments according to their willingness to pay. This is known as price discrimination. While discrimination is usually considered negative, price discrimination is a common business practice that helps companies earn higher profits. An example is a software company selling products at different prices to corporate and private users.
- Better customer retaining management. Measuring retaining rates in different segments, a company can see which types of customers need more convincing to stay loyal to the brand. This helps develop more targeted and efficient retention campaigns.
How Market Segmentation is Done
There are two main ways to do market segmentation: using statistical methods and using analytical methods.
Statistical methods (e.g. clustering) are quantitative methods that require a company to have an extensive database with customers and their characteristics (think of Google and Netflix, or any other multinational).
Analytical methods are qualitative methods. The decision is made based on the knowledge and expertise of the company, or on the existing industry experience. For instance, a company might use a “segmentation tree” method, or some form of generic market segmentation. It can also look at the segments used by other companies working on the same market.
The choice of methods depends on the needs of a company and the data that the company has on its customers. For a startup, a simple analytical method often will be sufficient. With the growth of the customer base, the methods will become more complex.
- Not defining the market correctly. To do the segmentation, a company needs to establish its base target market first. The base market includes all existing and potential customers. Then this market is divided into segments. Defining a base market too broadly or too narrowly will result either in missed opportunities, or wasted efforts.
- Separating a segment without money. The ultimate goal of market segmentation is to generate higher profit for a company. If a company chooses a segment with nice characteristics but without an opportunity to pay for the product, there is a risk that the marketing budget will be spent without any return.
- Too many or too few segments. Having too many segments might result in an overly cluttered and complex marketing strategy with results that are difficult to measure. A company having too few segments will most likely miss on the benefits of market segmentation. There is no rule about the number of market segments. Most importantly, market segmentation should make sense and give some real feedback. As a reference, a startup might have 2- 4 segments, while some big companies have 20 and more.