Managing Customer Segments
by Arthur Middleton Hughes and Paul Wang

 

The goal of mass marketing is to create a massive demand for products. This is followed by mass production and mass distribution. It works. It creates profits and intense competition. In the last forty years, it has brought prices down and quality up. It has produced an ever growing number of excellent products and services which American households just have to have.

For some companies today, however, the game is changing. Using database marketing, we have altered our methods. We are no longer looking only at the products we are selling, we are looking at the customers we are seeking to serve. The goal of successful database marketing is to acquire and retain profitable customers. As we develop databases for the first time, we are able to use them to see customers as distinct individuals, rather than as a part of an amorphous mass market. We see their differences.

Some customers are very profitable and loyal. Some customers are unprofitable and fickle. We are beginning to discover that we can increase our profits by studying these variations, and by using this newly acquired knowledge of our customer base to market differently to each discernable profit group.

Airlines have led the way. Establishing frequent flyer programs, complete with unique ID numbers and databases which record each flight and accumulated miles, airlines have been able to provide super services to their best customers. Even more important: they have been able to incentivize their next-to-best customers to get them to make extra efforts to reach Gold status.

Let's provide a personal example.

Although he had accumulated miles on American Airlines for ten years, Arthur had never attained Gold status, which requires 25,000 miles in a single calendar year. Last Christmas, he called American to learn how many qualifying miles he had.

"You have 24,600 miles, Mr. Hughes"
"You're going to give me Gold, aren't you?"
"I'm sorry, Mr. Hughes, you have to have 25,000 miles."
"Can't I pay you for the missing 400 miles?"
"No. You have to fly them."

So Arthur bought a ticket from Washington to Raleigh-Durham for $44, flew down there at 7:00 AM, turned around and flew back, and was in his office by 11:00 AM. He has been Gold ever since. What does this mean for Arthur? It means that he gets to fly first class on most flights without having to pay for it. He accumulates bonus miles. He gets to get on the planes first. He feels like a privileged person. What does this mean for American? They have Arthur hooked. He will arrange his schedule so that he flies American rather than some other airline whenever he can. He is loyal. This loyalty is worth more to American than the benefits that they have to give Arthur to keep his loyalty. It is a win-win situation.

American, and other successful database marketers are managing their customers. They have learned that customer management is more profitable than product management. Lets provide another example.

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One of the traditional mass marketing techniques of increasing sales volume is to offer discounts: coupons, sales, cash back. While discounting can be effective in building sales, few mass marketers are able to see what it is doing to the loyalty of the customer base. The above diagram offers a picture of what is going on. As the discounting continues, regular customers learn that they are chumps if they pay full price. They learn to think about the product in terms of it's price, rather than it's usefulness. If the discounting ends at some point, the company may find itself with a massive drop in sales. Regular customers, trained to seek bargains, switch to the competition. The company is worse off than it was to start with. Let's look at another example:

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Customers are not alike. Some are high value: they are loyal and buy a lot. Some are low value: they are inconstant and don't buy very much. By looking only at total customer acquisition, a company can, without realizing it, lower the profitability of its customer base, moving from a situation in which one third are high value customers to one in which these good customers represent less than 5% of their buyers. The methods whereby the value of the customer base is destroyed vary by company and product. Without a database that measures customer value, however, many companies have no clue as to what is really going on.

Using customer marketing databases which record transactions, companies are able to compute customer lifetime value tables which distinguish types of customers. They can see what is happening as a result of the strategies which they have chosen to implement. Marketers are beginning to understand the differences in their customers, and to visualize meaningful customer segments. With this knowledge, they can:

  • Assess the lifetime value of customers in each segment
  • Adjust marketing and communication investments to each segment
  • Manage each segment recognizing the differences in the needs and behaviors of the segment's customers.

How can the segment lines be drawn? There are a large number of methods, each of which may have uses in categorizing segments which have common purchasing behavior:

  • Geographic: North, South, Urban, Rural
  • Income: Rich, middle class, poor
  • Industry: SIC code, annual sales, number employees
  • Age: Newlyweds, Families with children, Empty Nesters, Senior citizens
  • Product End Use Wholesalers, Retailers, End Users

Behavioral Segments

Each of the above classifications reflects who customers are, rather than what customers do. They represent obvious categories which any marketer, having just created a customer marketing database, will use to profile his customer base. In many cases, this type of segmentation may be all that is available. If we examine customer behavior, however, we can often discern significant customer behavioral segments which can be used to design specialized marketing strategies for each segment which provide satisfaction to the customers of each segment and profits to the company. One such method uses two measurements of factors that influence product purchase decisions: relative price and relative service.

In traditional economics, these two factors are assumed to work in the same direction. As the level of service goes up, the theory goes, the price goes up -- and vice versa. In fact, there are market situations in which they work in the opposite direction, with service being greatest when the price is lowest. By arranging these factors on a graph, it is possible to define at least four identifiable segments:

  • Program Buyers
  • Relationship Buyers
  • Transaction Buyers
  • Bargain Hunters

Let's discuss each segment separately.

Bargain Hunters are customers who have tremendous market power. Wal-Mart is an example. Here is a customer who demands -- and gets -- the absolutely lowest prices in the market. Wal-Mart is in a position to make massive purchases at rock bottom prices. At the same time, they can demand -- and get -- a very high level of service from their suppliers. Wal-Mart makes their suppliers provide daily shelf restocking. The goods are placed on Wal-Mart shelves on consignment so Wal-Mart has little investment. In some cases, the suppliers must clean up the sales areas when they get through. Few other retailers can get such services from their suppliers.

For bargain hunters, the supplier has to meet specified requirements in order to sell massive amounts at very low prices.

Program Buyers are at the other end of the scale. Small purchasers of office supplies, for example, do not have the time or the economic incentive to shop around for the best deal. They don't have the market power that comes from volume purchases. Typically, they will buy from a nearby source one month, and shift to another nearby source the next month, without any really well thought out plan. The same is true of small investors who may buy one mutual fund this month, and six months later buy another so as not to put all of their eggs in one basket. These program buyers have the worst of both worlds. They pay the highest prices and get the lowest level of service. Their purchases are usually so small that few suppliers find it profitable to do much to attract them. They are generally unprofitable and not worth cultivating.

Transaction Buyers, on the other hand, represent a major segment of any market. These are customers whose purchases are large enough to make it worth while for them to engage in comparison shopping for every transaction. They read the ads, make phone calls, get comparative bids. For them, the past has no meaning. They have absolutely no loyalty. Never mind what the supplier did for you in the past, the question is what is your price today? They will shift suppliers of any product for a few pennies difference in price.

Such buyers get little service. Service is not important to them. Price is everything. There is not much point in trying to win their loyalty, since they have none to win. Database marketing will not work here -- only discounting. They are not profitable customers, even though they do buy a lot of product, and represent an important segment of the market. The best thing that could happen to these transaction buyers would be for them to shift over to buying from your competition. Give them the competition's catalogs and phone numbers and hope they take the hint.

Relationship Buyers are the people for which database marketing was invented. They are looking for a dependable supplier:

  • Someone who cares about their needs, and who looks out for them.
  • Someone who remembers what they bought in the past, and gives them special services as a reward
  • Someone who takes an interest in their business, and in them as individuals.

They know that they could save a few dollars by shopping around, but that if they did, they would lose something that they value very highly: the relationship that they have built up with a dependable supplier that recognizes them and takes good care of them.

By classifying your customers into these four segments, you can focus your marketing efforts on the one segment that is really profitable: relationship buyers. Your database is used to record the purchases of these buyers, and to give them personal recognition and special services. You set up Gold card categories for them. You communicate with them. You partner with them.

Classifying Customers by Segment

How can you classify customers by these four segments? Part of it is easy. You already know who the bargain hunters are. No one who deals with Wal-Mart or Sears or other giant retailers has to be told who they are.

Program buyers can almost be ignored. They make small purchases on an occasional basis. They pay full price, and seldom respond to sales offers. They, too, are easy to classify.

Your big problem lies in distinguishing transaction buyers from relationship buyers. Here's how one retailer does it. New customers are given a survey form. One question asks: "How important are the following in making your decision about where to buy this product? Rank from 1 -- most important -- to 5 -- least important:

a) Price
b) Service
c) Reputation of manufacturer
d) Recommendation of a friend
e) Company policy
f) Previous experience
g) Customer service

Those who code Price as most important are possible candidates for Transaction Buyers. All others are candidates for relationship buyers. This can be tested later in other ways.

Training your Customers

How do customers become transaction buyers? They are not necessarily born that way. They become transaction buyers through exposure to their environment and their management. As suppliers, we may feel that we have to take the world as we find it, but that is not necessarily true. We can take a group of customers who are quite prepared to develop a relationship with us, and ruin them by converting them into transaction buyers. How do we do this? By talking price to them all the time, instead of talking relationship. Look at how we do it:

A mutual fund acquires customers by pointing out that the performance of their fund bettered the market in the last four of five years. Once the customers are acquired, the fund continues to encourage customers to compare their performance with the competition. Of course, no fund always has top performance. Once customers are trained to look in the financial section of their paper every day to see how their money is doing, they are effectively ruined. As soon as the fund takes a nosedive, the customers will be gone.

What should the fund do? As soon as the customer is acquired, begin to build a relationship. Find out what their investment objectives are: retirement, children's education, building wealth, etc. Find out whether they are interested in money matters or not (some people have no interest, they just want to put their money some place safe and profitable and forget it!). Above all, never mention price or performance -- even if it is good. Become a household friend, an investment advisor. Think of yourself as the family doctor. He offers friendship, counsel, medical advice, warmth, healing. He never talks price. Why should you?

Treating Segments Differently

Once you have classified your customers, and set up a training program to woo and maintain relationship buyers, then consciously develop a program to spend your marketing dollars where they will do the most good.

  • Ignore program buyers. Don't waste money here.

  • Assign skilled salesmen to the bargain hunters. Database marketing won't do you any good here.

  • Tell your transaction buyers about your sales, if you have them. But make sure that the sales are really competitive. If not, you will be wasting your marketing dollars on these smart cookies. They know more about the market than you do.

  • Spend a lot of money and time cultivating your relationship buyers. Offer them Gold cards, recognition. Have member nights for them alone. Give them particular services that make them feel special and appreciated.

  • Buyer classification and careful marketing efforts can really pay off in the new marketing world of the new millennium.

 


Arthur Middleton Hughes is Vice President of The Database Marketing Institute. Ltd. (Arthur.hughes@dbmarketing.com) which provides strategic advice on relationship marketing. Arthur is also Senior Strategist at e-Dialog.com (ahughes@e-Dialog.com) which provides precision e-mail marketing services for major corporations worldwide. Arthur is the author of Strategic Database Marketing 3rd ed. (McGraw Hill 2006). You may reach Arthur at (954) 767-4558 .


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