CUSTOMER SEGMENTATION
AND
EXTENSIVE STRATEGY MAKING
“ Exploring New Approaches for Higher Profit
Impact”
Ümit ÖNER
İzmir,
2005
INTRODUCTION
Fierce competition in the current business life force firms to pay attention to keeping
what they had in hand. One of the most important assets in a business account is the
customer according to these new competition conditions. A loyal customer means a
certain level of value created continuously, thus the more it is reserved the higher
returns are possible from an individual consumer. Customer Relationship
Management (CRM) is a modern attitude towards consumer-seller relationships in a
manner that consumer with his all expectations and utilities is at the center of all kind
of transactions. From now on, corporations should be re-structured keeping that
invaluable asset in the target and as the ultimate aim. It is considered that loyalty and
satisfaction level of the consumer is the source of the profit, so it should be
reengineered all design, production, marketing, sales and after sales actions
according to a precise CRM vision where consumer’s benefits are truly appreciated.
Every consumer has a certain value. However, each consumer is ranked at a
different value creation level according to his consumption patterns, volume of his
consumption, and its frequency. That is all consumers form a value pyramid with the
sales revenue created by each one. Since the consumers are varied in value terms,
strategic decisions of the firms should be varied accordingly. According to Pareto
Principle, 20% of the consumers produce the 80% of the business in general
(Peppers, 2002).
That principle explains why firms should concentrate their actions on the first 20%
class of consumers. Surely, defining the limits, characteristics, behaviors and
psychological patterns of that specific consumer class is a crucial step of establishing
a relevant CRM project. Any business considered would produce several consumer
classes called segments with different features and value returns. Customer
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Segmentation comes to the front at that point while it describes the procedure of that
classification.
Customer Segmentation has its roots in an efficient customer database and
knowledge management. Knowledge in sales business might be created by working
experience of salesmen, the behavioral patterns embodied in products, seasonal or
periodical revenue cycles, or with all data about the incoming customer collected in
consumer databases. A customer database would not only help in monitoring the
consumer behaviors but also expecting the prospective consumption trends in the
market. Ideal management of a customer database would even reach up to directing
customer to a specific consumption pattern which could be a product, service or both.
In addition, a database should be organized in order to fill in the customer segments
defined distinctly, to report the requested answers, to derive effective expectations
and so on. The aim of that task is exploring management of the knowledge a to
reach CRM solutions, modern approaches to customer segmentation and finally the
methods for strategically decision making process in today’s business life.
First of all it would be defined what customer relationship management (CRM)
means. The conceptions and misconceptions about CRM projects would be listed
comparatively in order to understand the limits of the process. Then the strategic
meaning of CRM would be figured out of these conceptions.
Secondly, Customer Segmentation process would be studied in details. The
milestones of customer segmentation will be introduced while the notion would be
considered with its questions, types, methods and experimental results. Here, it
would be presented several examples of customer segmentation applications
especially from banking, finance, and retail sales sectors. Additionally, the IT
solutions for customer segmentation would be explored and knowledge management
principles for correct applications would be précised.
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Thirdly, the task would go deep into the extensive approaches for customer
knowledge management. Further studies proved that customer segmentation would
have deeper impact on business profitability if the management of the consumer is
more scientific and advanced. Therefore, the advanced steps of customer
segmentation and their impacts on business strategies would be defined in that
section.
Lastly, the final section concludes.
CUSTOMER RELATIONSHIP MANAGEMENT (CRM)
For today’s customers having choices is not a luxury. Thus, even for the legendary
firms which are the mental monopolies in the consumers’ minds it is hard to conserve
that reputation, psychological market share and competitiveness in the today’s fierce
business life with many players. Because of the increasing importance of conserving
the acquired consumers and being able to reach to newer ones, firms pay more
attention to what consumers expect from them, their behavioral patterns, and the
interaction between the firms and its target consumers. All the set of these modern
business essences is called customer relationship management (CRM). In brief CRM
is an enterprise-wide business strategy (Fayerman, p.58) to maximize customer
lifetime value instead of maximizing profits from discrete transactions with customers
(Verhoef &Langerak, p.70). That is, exploring more customer information, then
matching all his needs and by the way keeping customer more in the firm’s
transactions create a long-term management process of firm-customer interaction
and lead to high long-term profits upon the acquired customers.
Truly, CRM is more than a customer database management. A marketing strategy
built on customer database lacks an important issue that is covered by CRM
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strategy, which is customization of marketing. The consumers identified by the data
collected could be classified according to certain segment criteria but these steps of
database marketing might not be ended by the customization of transactions
according to feedback got from the customer database. CRM, mainly focuses on that
customization step in order to let marketers learn more about the customer
preferences and then derive future offers of products, packaging, delivery,
communications or even invoicing processes tailored accordingly (Fayerman, pp.5859). Then it is obvious that CRM is a one more further step of database marketing
requiring more complex organization, knowledge management and communication
systems administrated by effective and talented managerial notion.
CRM contains three departments in its ecosystem. First, operational CRM integrates
the different departments of firms under a unique aim defined by customer oriented
business strategy. From the front side departments such as sales department to back
side ones like financial service or human resources, all business steps should be
gathered under the principles of operational CRM. Secondly, the information
gathered by all departments should be analyzed and it should be developed a
panoramic view of consumer. This is called analytical CRM in which statistical
decision supportive tools are heavily utilized. Lastly, there comes collaborative CRM
which is the interaction between customers and the firms via e-mail, voice response
systems, direct mail, or web portals (Fayerman, pp.62-63). That CRM department
carries another requirement for a CRM tool called interactive communicative
techniques (Verhoef and Langerak, p. 70). All these CRM departments clarify the
necessity of enterprise-wide automation since the data collection, analyze, feedback
and responsive actions according to given feedbacks are matters of a knowledge
management system. Generally, firms targeting to develop more intensive customer
relations heavily invest in IT projects and demand positive short-term results.
However, CRM is beyond automation, it is a deeper understanding of customers
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(Fayerman, p.65) and a software construction without a customer-oriented
organizational mentality would never yield short-or long term returns.
Failed CRM projects generally caused by missing organizational culture and some
general misconceptions about CRM. CRM projects aim to increase customer loyalty,
maximize customer life-time value and expand firm’s profitable areas over the
matched needs of acquired customers. Firstly, however, CRM could not be the sole
strategy of a firm since it should be enforced by a customer acquisition strategy
because there would always be a drop in number of current customers. Secondly, it
should not be forgotten that loyal customers are more price and quality sensitive.
Moreover, they could easily be irritated by insisting communicative demands of the
firms (such as long phone queries, everlasting questionnaires etc.) Then more gentle
treatment and correct communicative actions are crucial during the relations with
loyal customers. Thirdly, firms should be aware of consumers having a higher profit
potential in the future while they are insignificant currently. Generally, CRM projects
forces firms to go deep into consumers creating more returns for the main time and
to ignore the potential hidden entirely. So trying to maximize the interactions of
currently less valuable consumers can be more profitable than the efforts to
maximize life-time values of currently valuable consumers (Verhoef and Langerak,
pp70-74). Correct selection of target consumers is surely a matter of correct
knowledge management enabling interpretation of consumer’s potential.
A
METHOD FOR CUSTOMER UNDERSTANDING: BASIC CUSTOMER
SEGMENTATION
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To match the different needs of different consumer types is an important issue for
CRM projects. Monitoring consumers’ behavioral patterns and then figuring out how
to treat them requires a prior classification of consumers according to several criteria.
Basic Customer Segmentation is the grouping of consumers according to
demographic, behavioral and psychological similarities.
Customer Segmentation is a tactical tool for CRM projects. By the help of that tool, it
could be grouped the consumers, and then it is easy to develop suitable business
opportunities matching different groups, pricing strategies, and optimum delivery,
finance and after-sales options. In fact, segmentation is not a new business tool; it is
simply utilized by monopolistic price discrimination theories in which consumers were
classified according to their willingness to pay. Price discrimination actually has
demographic links since willingness to pay is directly related with consumers’
income. Furthermore, current business theories focuses more on behavioral and
psychological patterns than the demographic ones and build their consumer
segments on the question “ what they expect from my firm”. Each consumer is
characterized by an ultimate opportunity that he seeks from a good or service,
therefore segments formed according to expectations of the consumers would be
more successful in monitoring and responding consumers’ needs.
The ultimate aim in segmentation is to ensure that “better” consumers are separated
from other consumers (Jonker, Piersma, Van den Poel, p.3). That is consumers not
only differentiate in their consumption patterns but also in the value return that they
create or are able to create. According to Pareto Principle, for a firm, in general, 80
percent of the sales are made to 20 percent of total consumers. This 20 percent
segment is the crème de la crème of a business and should be well-treated and
forced to increase their incentives to consume. Thus, identifying and targeting that
segment is the essence of all CRM projects and customer segmentation efforts
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(Jonker, Piersma, Van den Poel, p.3). In the identification process there are several
methods which are listed below:
1- Demographical: This the traditional segmentation type in which customers
are classified due to their age, gender, income and other demographic
definitions. However, demographic segmentation is not a currently preferred
method since behavioral and psychological segmentation methods override
demographic segmentation in terms of efficient marketing results. On the
other hand, demographic definitions are mainly used in labeling the created
segments. This could be easily understood by the examples in following
pages.
2- Behavioral: This method is based on RFM variables. RFM variables are
Recency, Frequency and Monetary Value. These variables measure
consumer behavior firstly by asking how long it has been since the customer
has last responded, then finding out how often the customer responded and
finally computing the Monetary Value created by the customer (generally
monetary value is equal to the sales revenue from the customer) (Jonker,
Piersma, Van den Poel, pp.7-8).
3- Preference: Any single consumer seeks an ultimate opportunity from a good
or service. Preferences are the answers of what a consumer expect from a
transaction, what are the incentives to consume, and which transaction
channels are preferred by consumers. Preference as an important
determinant of consumer demand plays an equally important role in
identifying customer segments.
4- Perception:
The last segmentation type is about the consumer’s
psychological patterns, his attitude, prejudices about and awareness of
certain goods and services and his ability to receive messages sent by firms.
Each firm represents an image in consumers’ minds and each image blocks
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or eases the relationship with a consumer. Therefore, consumers could be
classified due to how they perceive the firm’s image and marketing strategies
can be built accordingly.
At that point an example would be helpful for better consideration. Let’s take a
coke brand called Fancy Coke for what firm managers would like to segment the
consumers and choose a target consumer segment. Firstly, it is considered the
ultimate expectation of consumers from any coke brand which could basically be
refreshing and tasting a sweet aroma. This is preference segmentation and
Fancy Coke’s ultimate opportunity offers to the consumer are a refreshing drink,
or a delicious taste. Secondly, firm managers could think about what a coke
brand could bring to people’s mind? It could be a fresh air on a sunny beach, or a
symbol of energy in a sport activity, or just an enjoyable drink which is never
lacked in refrigerator. Up to here, managers classified consumers into five
segments according to consumers’ psychological patterns. Now, these segments
could separately be used in the construction of a consumer value pyramid with
using RFM measures, such as the consumers rarely, often or frequently
consuming Fancy Coke, and the monetary value that they create. When the
segments and the pyramid are built then managers of Fancy Coke can reach up
to a final definition of each group of consumers by examining common
demographic features such as age group, gender, occupation etc. Table 1
shows a simple customer segmentation study for Fancy Coke. Here there are
four customer segments defined by a single key pattern and ultimate expectation.
To increase consumption incentives of each group managers define marketing
mixes consisting TV campaigns, sponsorships, competitions, and other marketing
tools. According to the frequency shares of each segment firm managers could
decide on which segment the marketing strategies should be focused. Actually,
every frequency interval would show a respective sales revenue level.
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Recalling from the first section of that task, ignoring the bottom level consumers
is not a true marketing strategy since they are the lost share of the market and
should quickly be captured. Here firm managers might choose to focus on the top
of the pyramid, to acquire the bottom part or both. In fact, while the aim of the
customer segmentation seems like to separate better consumers from ordinary
ones, the ultimate aim however is exactly to choose correct marketing mix to
maximize the profit (Jonker, Piersma, Van den Poel, p.5).
In customer segmentation, another important issue is the Customer Performance.
Customer Performance consists the Life Time Value of a consumer, his
openness to the innovations, his leadership, and cost magnitude of a consumer.
Life Time Value of a consumer is the current profitability, the potential profitability
of a consumer and total loyalty period. Secondly, if a consumer easily accept the
innovations in the products or could produce effective feedback to the firm
enabling it to innovate, that consumer is might be considered as a valuable one
although he is not profitable. Thirdly, a leader and example consumer who lead
others to the products that he uses would rank at the top of a value pyramid.
Finally, a profitable consumer with high frequency and sales revenue rates may
produce equally high after-sales costs and so ranked at a lower level.
Briefly, consumer segmentation has two legs, strategically segmentation which
are built upon ultimate opportunity offer, value pyramid and customer
performance;
tactical
segmentation
for
which
demographic,
behavioral,
preference and perception criteria are the measures. Strategic Segmentation is
used in the strategy making process and a back bone for tactical segmentation
which is used in customer-centered campaigns.
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Identifying and targeting the consumer segments and then communicating with
them are not a very smooth way. A complex and comprehensive knowledge
management system should be utilized to gather and store qualified knowledge,
to build correct segments, to re-engineer the information flows in order to
maintain effective fill-in to the defined segments and eventually end up with a
feedback that will enable firms to get in touch with correct consumer in a right
manner and yield maximum profit. Next section of that paper would explain the
importance of knowledge management, the application methods and probable
results.
INFRASTRUCTURE OF CRM: KNOWLEDGE MANAGEMENT
A simple CRM path could be defined in three steps. First it is collected
information about the consumers, second efforts paid for making consumer
happier, and lastly departing from the happy consumer it is created more
business. Surely, CRM is a project work to make business more profitable while
investments on customer satisfaction through data collection and smooth returns
to customers enable firms to figure out new business opportunities. However,
collection, tracking and analyze of the data within the frame of CRM is much
more a hi-tech task (Bose and Sugumaran, p.3) than a mass generalization of
characteristics upon the given data. Then, effective knowledge management
methods (KM) which allow firms to one-to-one marketing are not just a
requirement but a necessity.
A KM system would be basically responsible from tracking and analyzing a range
of customer actions and events over time. Then the results of the analyze should
be composed and delivered in order to construct a single, unified and
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comprehensive view of consumer, his needs and preferences across all business
functions, point of interactions and audiences (Boses and Sugumaran, p.4).
A KM infrastructure would consist four parts (Boses and Sugumaran, pp.5-6):
1. Knowledge Identification and generation: It is the determination of relevant
consumer, process and domain knowledge, and monitoring the customer
behavior and other related industrial events
2. Knowledge Codification and Storage is the process during which the
knowledge is converted into machine readable form and stored.
3. Knowledge Distribution process is the dissemination of knowledge throughout
the organization and handling request for specific knowledge
4. Knowledge Utilization and Feedback
With all four parts explained above, a KM infrastructure should posses some
capabilities which are practically crucial. First of all, personalized presentation of
data is highly required since it enables a user to access the exact data he needs,
and assures that the user would not be drawn in the unnecessary data. Secondly,
the system should participate to the business process. Thirdly, there should be a
platform for publishing and distributing the knowledge where all users could
conduct an integrated search during which data overload is reduced, and
usefulness of search results is increased. Fourthly, effective management of
knowledge categories and healthy share of organizational knowledge among all
users are the final essences of a KM system (Boses and Sugumaran, pp.7-9).
Figure 1 shows a KM system with its fundamental departments.
As it is
observed from the figure, four steps of a KM infrastructure are very clear:
Collection of Data, its management and storage, its analysis and finally the
automation of the business according to predictive models.
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Fundamental customer segmentation mainly depends on the seek for profitable
consumer. Thus, revenue ranking is the main method for CS.
Developing
business world, however, requires more extensive approaches to customer
understanding and because of that several segmentation methods are developed
upon the basic ones.
ADVANCED CUSTOMER SEGMENTATION STRATEGIES
Main aim of customer segmentation is the acquisition of different consumers.
Basic segmentation was the first breakthrough innovation in customer acquisition.
Actually profiling methods defined in the previous section are the results of that
primitive wave. After all, more practical solutions started to be delivered, such as
predictive modeling and multi-dimensional trade offs (Rohde, p.2). First is the
scientific modeling (or it should be said statistical) which is fed by the mass of
customer data collected by the business databases. Here, it is tried to forecast
the behavioral patterns and changes in consumption trends. Multi-dimensional
trade off structure is one further step of modeling. By that method, it could be
possible to match different consumer segments in common and unique
opportunities. By the multi-dimensional studies, departing from a matrix of
customer segments it is aimed to focus on the most profitable match. Up to here,
by segmentation firms just target the most profitable and fastest growing group of
consumers (Grover, p.3) a basic axis study where profit ranking is vertical axis
and growing rate is the horizontal one drives the researcher to the combination of
best consumer segments.
A final advance in customer segmentation is achieved by the Strategy Science
concept (Rohde, p.2). This concept is revolutionary since it does not only
consider the consumers’ behaviors or choices but also the content of offers
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presented to them. Moreover, it is a responsive system since certain dynamics
are taken into account. And finally it is reinforced by the accelerated learning from
the firm-consumer historical background and reform firm’s strategy accordingly.
STRATEGY SCIENCE CONCEPT
Primitive strategies driven by segmentation used traditional tools such as
campaign management and personalization (or customization) usually related
with consumer tiers based on current profitability (van Everen, p.1) Day by day,
however, monitoring and managing consumer himself is getting much more
crucial. Monitoring consumer certainly means more investment on human capital
especially for skilled salesmen and agents who will continuously be in touch with
valuable consumers. Moreover, it is an extensive customization which can be
defined by the motto, “for every customer, the appropriate service” (van Everen,
p.2). Although, these new tools for strategy making are effective, they are not
enough solvent to manage customer response which is highly complex. At that
point Strategy Science concept comes fore scene.
Strategy Science first asks certain questions to understand the target:
1- Who is the target consumer
2- What is the optimum way for his acquisition
3- What is the relevant offer for the defined acquisition way of the targeted
consumer (Rohde, p.2)
Truly, such a deeper study requires an advanced knowledge base by the help of
which a decision modeling system would work on. The main structure of a
knowledge management system was described in the earlier sections. Decision
modeling would go deeper to the interactions of the prospect consumer and the
offer and build a statement which includes the response dynamics, the activation
dynamics, the utilization dynamics and then the longer term profitability and loss
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metrics (Rohde, p.2). For different prospects, the unique offer would certainly
yield different responses; therefore a decision tree would be formed after the
examination. Finally, the history of prospect dynamics would generate an
accelerated learning for the business and by the way a strategically behaving firm
could re-engineer its offering schedule.
CONCLUSION
The sales business of these days require more than traditional tools such as
direct selling, advertising, unique services like packaging, delivery and
promotions which ignore the customers’ own preferences. In fact, customization
is the core of the issue in today’s business life. Adjusting the product
development, pricing, marketing and delivery process of each business yield
higher returns in the long run since it enables firms to possess a crucial asset
which is called the confidence of consumer. Briefly, consumer is more of a target;
he is now a partner of our businesses. Then he should be treated as a partner
whose preferences, behaviors and psychological patterns form the strategic
decisions of firms. Being aware of consumer is what Customer Relationships
Management means.
In that task it is aimed to explore an important issue of CRM, which is called
Customer Segmentation (CS). CS is the customization of business due to the
demographic, behavioral and psychological patterns of different customer
segments in order to maximize long-term profits of a firm. That customization
includes the product development in order to customer needs, pricing strategies
conquering consumer surpluses, and after sales services increasing consumer
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satisfaction and loyalty which can be defined as a virtual market share of a
business since loyalty and satisfaction enable firms to preserve current market
shares and expand to higher rates.
CS is actually resulting of a very systematic management of customer
knowledge. To precise customer needs and requirements, it should first gather,
store and manage current customers’ information which can be in a wide range of
identity information up to different modeling figuring out the customers’ behavioral
patterns. Truly, this is a hi-tech process. Collection, storage and filtering of
knowledge demands an advanced knowledge management system which is
described in details in previous sections. Briefly, a Knowledge Management
infrastructure consists of four departments, knowledge acquisition during which
consumer knowledge is collected via invoices, queries, questionnaires and other
basic business transactions; filtering during which knowledge is fill the defined
sets of databases; utilization in which related users access the data for modeling,
forecasting and for other purposes and finally diffusion in which the feedback is
distributed to related departments of the business. That four-step infrastructure
increases the level of creative criticism and value-adding feedback.
A well integrated system of knowledge management would certainly increase a
firm’s long-term profits. At that point the phrase “long-term” matters since all the
IT investments and strategic organizational developments done under the
curriculum of CRM and CS are exactly hard tasks which would not yield profits
soon. Reaching to a certain level of customer knowledge and being able to
generate profits from that feedback is certainly a long and hard path. But without
any doubt the one waiting at the end of the path is nothing but higher returns.
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Secondly, IT investments are solely nothing. A business vision which is
customer-oriented and willing to be aware of her prospective business partners
should strongly required for the success of a CRM project.
Thirdly, segment analysis should not lead the firms to have a single aim such as
preserving top consumers. It should never be forgotten that the zero consumer
class has always a higher business potential than the top class of consumers.
So, firms should equally pay attention to customer acquisition as customer
loyalty.
Finally, it is important to state that the business life evolves. Therefore business
strategies should evolve, too. Developing business world continuously requires
more advanced methods for strategy making. Customer is not a profit generator,
but a very complex combination of decisive, behavioral and psychological
patterns. Therefore, the responsive dynamics of customers upon product offering
of the firms is as important as their demographical patterns or life-time values. A
true strategy for customer acquisition should certainly frame its target, relevant
offer, the way to present it and its consequences. This is what a real marketing
strategy is.
References:
 Fayerman, M., 2002, “Customer Relationship Management” ,New Directions
for Institutional Research, 30:113, pp. 57-67
 Langerak, F. and Verhoef, P.C., 2002 , “Eleven misconceptions about
customer relationship management”, Business Strategy Review, Volume 13,
Issue4, pp.70-76
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 Bose, R. and Sugumaran, V. 2003, “Application of knowledge management
technology in customer relationship management”, Knowledge and Process
Management, Volume 10, Number 1, pp.3-17.
 Koç Topluluğu, “Bambaşka bir Koç müşterisi”, Bizden Haberler, 313, Nisan
2004
 Peppers, D., 2002, “Alınlarında Yazmıyor, Birebir pazarlamada dünyanın en
başarılı uygulamaları ve yeni eğilimler”, pp.6-79.
 Langerak, F., and Verhoef, P.C, 2003, “Strategically embedding CRM”,
Business Strategy Review, Volume 14, Issue 4, pp.73-80
 Jonker, J.J, Piersma, N. and Van den Poel, D.,2003, “Joint optimization of
customer segmentation and marketing policy to maximize long-term
profitability”, University of Gent Release, Netherlands
 Rohde, F., 2003, “The appliance of science”, Credit Risk International,
crimag.com, pp. 2-4.
 Van
Everman,
D.,
2002,
“Customer
Segmentation
Strategies”,
www.line56.com/articles?ArticleID=4055&ml=2, pp.1-3.
 Grover, B.R,2002, “How to segment customers: think of your customer list as
an investment portfolio”, NAW Publications, pp.1-4.
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