This article is based on excerpts from Kotler on Marketing, by Philip Kotler, an American marketing author, consultant, and professor, and Kellogg on Marketing, edited by Alice Tybout and Bobby Calder.

Below are the key insights from these books related to customer segmentation and targeting:

Marketing Management

Marketers see the marketing management process as five basic steps:

Research

Research is the starting point for marketing. Without research, a company enters a market like a blind man. Good marketing involves careful research into the market opportunity and the preparation of financial estimates based on the proposed strategy indicating whether the returns would meet the company’s financial objectives.

Segmentation, targeting, and positioning

Research is likely to uncover several customer segments. Management should target segments to which it can bring superior “firepower”, by checking its competencies against the success requirements in each segment. The company must then position the company’s offering so that target customers know the key benefits, differentiation and other reasons potential buyers should buy their brand.

Marketing mix

The company must then set the tools of the marketing mix that will support and deliver the product’s positioning: Product (the product, packaging, and services the buyer would acquire), Price (the price of the product along with other charges for delivery, warranty, etc.), Place (the arrangements to make the product readily available), Promotion (the communication activities, such as advertising, sales promotion, direct mail, publicity to inform, persuade, or remind the target market about the product’s availability and benefits).

Implementation

The company, having engaged in strategic and tactical planning, must now produce the designated product, price it, distribute it, and promote it. Many issues can arise, e.g. with R&D, manufacturing, or sales and marketing (failure to presell the sales force on the product’s specialness or price, poor execution of advertising, failure to deliver service or customer experience at the promised level, poor linkages among product management, field sales, and customer service).

Control

The company must then collect feedback from the marketplace, audit and evaluate results, and make corrections designed to improve its performance.

Segmentation

• Segmentation involves dividing the market of potential customers into homogeneous subgroups. These subgroups may be distinguished in terms of behavior patterns, attitudes, demographic characteristics, psychographic profile, and the like.
• Once segmentation is complete, targets are selected by prioritizing the subgroup(s) whose needs can be better served by the company versus its competitors. Although it may seem counterintuitive, segmenting the market and tailoring the marketing strategy to a subgroup of potential customers may prove to be more profitable than attracting a broader customer base.
• Because customer preferences for products and services in most categories are heterogeneous, firms often find it difficult to attract everyone with a single marketing program. This is where segmenting becomes important, allowing a company to tailor marketing efforts toward subgroups of consumers who are likely to be most responsive to their offerings, resulting in maximized profits. A successful segmentation strategy is one that yields a target(s) for which the firm can develop a compelling positioning and meet its growth goals.
• Many managers find this task daunting. One reason is that the list of potential ways to segment a market is seemingly endless, making it difficult to decide where to begin. Further, once the segmentation analysis is complete, many or even all of the subgroups may appear to be attractive targets, making it difficult to set priorities for allocating resources.

Usage-based segmentation

Users and nonusers

• The first step in usage-based segmentation is to divide the market into users and nonusers of the product category.
• Nonusers must be persuaded to use the category, users of competing brands must be persuaded to switch, and users of the firm’s brand must be persuaded to remain loyal and expand their usage.
• Nonusers may be unaware of the category and its benefits or believe that the category does not fit their needs. They also may be ineligible to use the product. Marketers must overcome these barriers when targeting nonusers.
• Category users are familiar with and (presumably) find some value in consuming within the category. Thus, the task is to sustain and perhaps expand their usage. Usually marketers further segment users on the basis of brand—do they use your brand or a competitor’s brand? Consumers generally choose a particular brand because they believe that it provides a benefit that is different from (and presumably better than) other brands. Thus, current customers are likely to be more receptive to the firm’s marketing efforts. Further, a firm typically can obtain more detailed data on its customers versus competitors’ customers. This data may allow more efficient, customized marketing activities directed at current customers.

Level and occasion of use

• The basic segmentation of customers into nonusers, brand users, and competitor-brand users is often further refined by considering the level and occasion of use.
• These variables help identify customers who differ in their value to the firm. Use occasion and brand loyalty may be associated with the level of use; heavy users may use the brand across multiple occasions and may be highly loyal.

Purchase motivation

• The purchase motivation or purpose of a product or service should also be considered.
• Purchasing may be motivated by features of the product, such as its price, performance, or convenience, or by how the product makes the purchaser feel or appear to others when using it.
• Knowledge of the primary motivation for purchasing is useful when deciding how to position a product.
• One factor that influences the motivation for purchase is the role that the targeted individual plays in the purchase process, which is sometimes called the “buying center”.
• Buying center roles include the influencer, decider, purchaser, and user.
• The astute marketer understands that the motivations of those playing different roles in the decision process vary and thus focuses the marketing effort on the person in a household or company whose motives are best served by the firm’s brand.

User characteristics

• Having initially defined segments based on behaviors and motivations for behaviors, the firm can turn to questions about who exhibits these behaviors.
• Demographics. In consumer markets, usage segments are typically described in terms of demographics such as gender, age, marital status, life stage, education, occupation, income, cultural background. Identifying customers in terms of demographics serves several purposes: (1) The profile can be applied to census data to arrive at a rough estimate of how many people share the demographic profile of the current customers, (2) Make product design and pricing decisions (market research reports often include data on the behaviors and consumption patterns of people with certain demographic characteristics), (3) Select media that cost-effectively reaches targeted individuals while avoiding nontargeted people, (4) Design communication content and message presentation (self-paced media is likely to be more effective than externally paced media when targeting older adults, women tend to be communal, considering both themselves and others in decision-making; likewise, people from Asian cultures tend to be more interdependent and thus more likely to consider multiple benefits and perspectives).
• Firmographics. This approach is equally applicable to business-to-business markets. In these situations, potential customers can be initially divided into groups based on the usage characteristics we outlined previously (e.g., user/nonuser, user of Brand X versus Brand Y). As with consumer usage segments, business-to-business usage segments may then be further characterized in terms of distinctive descriptive characteristics, which are sometimes termed “firmographics”. The most commonly used descriptive characteristics are industry/SIC code and firm size because information on the number of companies in these categories is publicly available, allowing a firm to estimate how effectively it has penetrated a segment, as well as the growth potential associated with targeting a particular segment. These characteristics are useful not only because they are easily available, but also because product and service needs often vary by industry and firm size. Most industries have their own publications and conferences, enabling firms in particular industries to reach these communities efficiently. Finally, the buying process may vary as a function of industry and firm size. For example, the decision process is likely to be more complex and formal when selling to the government versus private industry and when selling to a large versus a small firm.
• Geography. It can be useful to describe both consumer and business segments in terms of their locations, because where customers live and work may influence their preferences and behaviors. Geography is often correlated with economic status, or cultural orientation, and may have implications on advertising (e.g. in regions where customers are widely dispersed, billboards are not seen by enough customers to justify the expense).
• Psychographics. It is also useful to characterize segments in terms of general psychological or personality traits and lifestyle. SRI Consulting Business Intelligence offers a tool for psychographic classification known as VALS.

Profitability and growth potential

• A detailed description of the usage-based segments provides the foundation for the next step, which is assessing the current and/or potential profitability each of these segments might provide.
• When a firm has an established customer base, this analysis begins by scrutinizing the revenue and costs associated with serving current customer segments.
• Typically, data reveals that some segments are more profitable than others.
• Sometimes a detailed examination of current customers identifies subgroups that are actually unprofitable.
• However, in many instances, customers who might seem unprofitable in the short term become more attractive if the value of a relationship over time is considered.
• When examining the profitability of a segment, it is important to begin by calculating Customer Lifetime Value (CLV).

Setting targeting priorities

Established brands in existing categories

• When a brand is established in a product category, there are three options for growth.
• Growth may be achieved by:
  1. Targeting current customers and convincing them to increase their spending on the brand.
  2. Targeting competitors’ customers and persuading them to switch their purchasing to the firm’s brand.
  3. Convincing non-category users both to consume in the category and to choose the firm’s brand when so doing.
• Companies should follow the “path of least resistance” in targeting:
  1. Begin by exploring the opportunity to grow by increasing the revenue from current customers through increased loyalty or expanded purchasing.
  2. Then attract new customers who are similar to current customers, perhaps by stealing them from competitors.
  3. Then target nonusers.

Targeting current customers

• There are several reasons to make current customers the first priority:
  1. Current customers are aware of the brand and presumably have a more favorable disposition toward it competing brand users or nonusers.
  2. A firm is likely to have data about past purchases as well as contact information for current customers, that allows it to deliver customized products, services, and messages, in a cost-effective manner.
  3. ROI is often greater for customer retention than customer acquisition.
• The process of focusing on existing customers begins by assessing customer loyalty:
  1. What percentage of customers are retained from one year (or buying period) to the next? The more customers that are retained, the more loyal the customer base is.
  2. What proportion of customers’ category spending does the firm capture?
     • If the firm captures only a small percentage of a customer’s category spending, this suggests opportunities for growth. If retention is low or customers spread their category spending across multiple brands, the firm should implement strategies designed to increase loyalty.
     • If the reason for defection is that customers are facing tough economic times and are trading down to store brands to save money, increasing retention may require introducing a more affordable version of the brand.
     • If retention is high and the firm captures the majority of a customer’s current category spending, then growth might be achieved by identifying new use occasions for the product or by persuading loyal consumers that their needs would be better served by a more expensive, higher-margin version of the product.

Targeting competitors’ customers

• Although it is critical to target current customers for retention and growth, the long-term success of a firm requires that it also acquire new users of the brand.
• One approach is to target customers of competitors’ brands who are similar to the firm’s current customers or who have aspirations to be like the firm’s customers.
• These people are already users of the category, and their similarity to current customers increases the likelihood that they might be persuaded to switch to the firm’s brand.
• However, a word of caution is in order: efforts to steal competitors’ customers sometimes provoke a counterattack, especially if the competitors’ core business is threatened.

Targeting non-category users

• When opportunities are limited to increase category consumption through an existing customer base, firms should turn attention to attracting nonusers of the category.
• Point of entry (attracting first-time users): In many product categories there are nonusers who are likely to enter the category coincident with some life stage or life event. The goal of a point-of-entry strategy is: (a) to identify who will enter the category; (b) to determine when entry is likely; and (c) to direct their consumption to the firm’s brand. Targeting customers at the “point-of-entry” to the category is appealing because (i) these individuals have reached a point in their lives when they are particularly receptive to the category, (ii) companies can avoid switching costs, (iii) it maximizes the time period over which the product will be used, increasing the CLV.
• Building the category An alternative approach to attracting nonusers involves building the category. Category-build strategies are appropriate when managers believe that demand for the category is unsaturated and might be stimulated through marketing: (a) prospective customers may be unaware of the category and its benefits, may fail to recognize the problem for which the category is a remedy, or may desire to consume products from the category but perceive barriers to their consumption, (b) sales may be low during certain seasons. It is often difficult to know whether a category is unsaturated in the absence of data regarding the reasons for nonuse. In general, a category-build strategy is more likely to be effective when nonuse is attributable to lack of awareness, rather than to a negative disposition toward the category. Before investing in category-build strategies, the firm should assess the likelihood that it will be the primary beneficiary of any category expansion.

Targeting when launching a new product

1. When the firm has a current customer base in one category, research that uncovers unmet needs of existing customers in other, related categories may prompt entry into the new category. Focus centers on current customers, but the emphasis is on persuading them to consume the firm’s brand in a new category.
2. In other instances, entry into a new category is motivated more by the opportunity to leverage the firm’s competencies and resources to attract new customers than by a desire to serve existing customers.
3. In the case of “really new” or “new to the world” products, the firm not only launches a new product, but it also pioneers a new category. In such situations, all prospective customers are nonusers, and the firm must build the brand and category simultaneously. The firm must target nonusers who are achieving the goal served by the new product with products from a different category. It should also reflect on its distinctive competencies and the way it creates value : (a) operational excellence (focus on middle-of-the-market products at great prices and with minimal inconvenience; appeal to customers who prefer habitual consumption experiences, seek functional products, and choose brands based on logic; requires strong operating procedures), (b) product leadership (focus on developing new and better products; appeal to customers seeking both newness and the very best; requires innovation and experimentation capacity), (c) customer intimacy (focus on building strong relationships and tailored solutions; appeal to emotionally involved customers who seek self-expression in the category; requires flexible, customer-driven front-line employees).