Why customer segmentation no longer works
Companies segment their markets because they believe doing so enables them to grow faster. The idea is that sales growth happens when you target your messages and offers to groups of customers (segments) your research reveals are already pre-disposed to the way you position your product: in effect, your message reminds or informs consumers of the benefits of your brand and, having decided they like it, they will hunt it down and buy it.
They can, and do, segment their markets using an astonishingly broad range of techniques. The earliest, and still the most used of the conventional segmentation schemes sort customers by their demographic (firmographic) characteristics, e.g., size, age, etc. and/or by the intensity and frequency of their purchase and usage. These schemes show up in virtually every industry, albeit under a variety of guises, e.g., the ‘platinum/gold/silver’ programs’ of airlines or retailers, or the large (Global/Key) accounts/medium (National/Regional) accounts/small (Transactional) accounts of most manufacturing firms.
The other conventional segmentation schemes, developed later, essentially sort customers by their mental characteristics, such as their beliefs, attitudes, values and needs. These schemes – needs-based, benefits-based, and psychographic being the most common – are also used in virtually all sectors, distinguishing among ‘Price/Value Focused’, ‘Convenience Focused’, ‘Quality Focused’, “Aesthetics/Style Focused” and ‘Performance Focused’ segments (appropriately (re)named, of course, for different B2B or B2C markets).
Except…it hasn’t so far
What’s astonishing, however, is that none of these segmentation approaches works well or reliably, and never have done; today’s market conditions have simply exacerbated and exposed their failings more starkly. Marketing and growth campaigns based on conventional segmentation schemes are notoriously unreliable: more than 90 percent of new product launches fail, and more than 50% of targeted marketing campaigns don’t ‘move the needle.’
Growth campaigns fail primarily because of the design flaws in conventional segmentation schemes
Marketers and managers excuse the all too frequent failures by attributing them to flawed execution: ‘poor creative’, ‘not enough resources/share of voice’, or ‘wrong mix’, and the like. But the real reason for the high failure rates is that the foundation of the campaigns – the conventional segmentation schemes the company has chosen to use – has one or both of two fundamental flaws ‘built into’ them.
One of those flaws is that the segmentation scheme rests on a scientifically incorrect model of consumer decision making. The other is that, practically, none of the conventional segmentation schemes manages to be both actionable and insightful enough for managers to make powerful plans and act efficiently.
How people buy decisively affects what they buy
Conventional segmentation schemes, and the growth campaigns based on them, all assume – incorrectly - that people have fixed, strongly held needs and beliefs about products that drive what they purchase regardless of the conditions they encounter or the particular things they do in actually trying to purchase something. That is, they assume what people want determines the brand they buy. A typical needs based segmentation, for example, will have a ‘Price Sensitive’ segment and ‘Performance Focused’ segment(s), whose customers are assumed to have formed preferences about the various available brands that lead them to always head straight for and purchase what they know to be the low price brand or the high functionality brand, respectively.
But the last twenty years of research in cognitive psychology and behavioral economics shows that, across all continents and cultures, people do not work that way. ‘Price Sensitive’ people often buy higher priced brands and ‘Performance’ people often buy cheaper, less good brands. People don’t form and always act on fixed, strong preferences.
Instead, what the research has conclusively shown is that how people buy – where they are, who they are with, and the specific activities they engage in during the buying process (e.g., looking something up online or trying something in a store) - decisively affects what categories or brands they buy and how much they buy. A consumer interested in redecorating a room who does all their research and purchasing online will end up buying a dramatically different mix of categories and brands than if they do the research and purchasing with a friend in a furniture store. And every B2B salesperson knows that whether, and the way that, their accounts sample and test new products has a tremendous impact on the likelihood of purchase. What turns out to be most important for driving growth is to segment customers by their buying process behavior, i.e. sorting them by both the activities they typically do or don’t do when they are looking to buy and the context (location, people, equipment) in which they do them.
Conventional Segmentation struggles to be both actionable and insightful
The second major design flaw of conventional schemes is their inability to be sufficiently actionable and insightful; they are either very actionable but provide poor insight, or they provide a lot of insight but are very difficult to execute. What makes a growth campaign effective is powerful, proprietary insight into the distinct, different thinking of customers in each segment; what enables a business team to drive growth on their (always) limited budgets is the ability to efficiently identify and target different segments with messages and offers ( that reflect the powerful proprietary insight about them). Unfortunately, the conventional schemes that deliver good insight are almost always hard to execute (not actionable), and the ones that are easy to execute don’t provide much useful insight.
For example, the commonly used ‘large/medium/small’ segmentation schemes allow virtually any firm to quickly and cheaply identify and target customers by segment: myriad databases exist that allow the sorting of firms or consumers by revenue, income, and other demographic characteristics. The problem is that the groupings provide no distinct, powerful insight into what should be said or offered to them: after all, small firms are as likely to be sensitive to price, or want advanced features, as large ones.
Conversely, a classic needs-based segmentation (with its ‘Price’, ‘Convenience’, and ‘High Performance’ segments) groups customers so that marketers can readily develop messages and offers that speak directly to segments’ needs. The problem? It’s usually impossible to precisely and cheaply identify who is really a Price buyer or a Convenience buyer; all too often the demographic profile accompanying a needs, belief, or psychographic based segmentation is so wide as to make it practically useless for targeting.
Characteristics of a Winning Segmentation Scheme
Companies aren’t wrong in their belief that they can grow faster if they segment their markets. But they are going to have to work smarter if they are to unlock the potential of segmentation. They will need an approach to segmentation that rests on a scientifically sound understanding of customer decision making, avoids being trapped by the trade-offs built into current methods, and provides them with proprietary understanding of the market. Practically, that means a segmentation approach that groups customers into segments
- Based on their buying behavior and context, i.e. customers in each segment share a distinct pattern of the conditions in which they buy and their propensity to do certain buying process activities
- So that the ‘go-to-market’ parts of the company, e.g. sales, marketing, etc. can all readily observe, identify, and reach customers in each segment, i.e. segments that are described and characterized in an actionable way
- That competitors don’t know about or see
Robert Lurie is a world-renowned expert in achieving organic growth and co-author with Bernard Jaworski of The Organic Growth Playbook: Activate High-Yield Behaviors To Achieve Extraordinary Results-Every Time priced £15.99 (Emerald)