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 Ümit ÖNER 2 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. Ümit ÖNER 3 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 Ümit ÖNER 4 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 Ümit ÖNER 5 (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 Ümit ÖNER 6 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 Ümit ÖNER 7 (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 Ümit ÖNER 8 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. Ümit ÖNER 9 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. Ümit ÖNER 10 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 Ümit ÖNER 11 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. Ümit ÖNER 12 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 Ümit ÖNER 13 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 Ümit ÖNER 14 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 Ümit ÖNER 15 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. Ümit ÖNER 16 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 Ümit ÖNER 17 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. Ümit ÖNER 18