A Paper Company's Segmentation Story

A paper company took this approach in developing a new offering (product plus services) for its North American customers. The company makes packaging material and is one of several such firms in the market, some of which are tiny shops while others are enormous global companies.

Historically, the paper company segmented based on customer size—small, medium, and large. But several functions, including sales and customer service, had routinely pointed out this segmentation was not actionable. For example, some of the largest customers only needed the most basic features and were willing to pay less as a consequence, while others needed fully featured offerings. To make matters worse, many small and medium-sized customers valued features such as support services that had only been offered to large customers. What's more, many customers of all sizes complained delivery was too slow and needed to be “just in time.” Other customers, those with large warehouses that could stock plenty of paper, didn't care about just-in-time delivery. They could just pull it from their warehouses.

So in thinking about how to design its new product and service offering, the paper company realized it would have a failure on its hands if it continued with the status quo segmentation.

So the paper company went back to the drawing board. It needed to identify the right segments. The firm surveyed about 200 customers. (The firm used the methods we described in Figure 4.3 in Chapter 4, including most–least and purchase simulations/conjoint analysis.) The foremost goal of the validation was to answer two questions: What features and services really mattered most to customers, and what were they willing to pay for them?

You can see the results of this research in Figure 5.1.

The research showed that on average, from the customer perspective, price was the most important aspect of the paper company's offering. Technical service was the least important factor. However, the company was surprised to learn that customers valued service programs that increased the efficiency of their operations—so much that they were willing to pay for this feature. The firm was shocked. Before conducting the research, they regarded this feature as a cost center, not a potential source of revenue.

But the biggest insight from the research was something different: There were significant differences on what was valued across customer groups. The firm's packaging customers could be segmented in four very different ways, each with distinct needs and WTP for features that met those needs:

1. A “want price only” segment. These customers primarily cared about getting a low price. Tech service and delivery terms were unimportant, and they were not willing to pay extra for them. And in terms of product quality, as long as the product met their minimum requirements, they were fine.
2. A “want it now” segment. This group was largely interested in speedy delivery. Because their own customers often needed packaging in a rush, this segment depended on suppliers that could respond quickly, and thus they were willing to pay for fast delivery.
3. A “want product only” segment. This segment coveted product performance and quality above all other features. Service, delivery, and speed were least important.
4. A “want the best” segment. This was the least price-sensitive group, and it emphasized quality and service features. They had a high WTP because their customers demanded high quality themselves. What's more, reliability and just-in-time delivery were more important than price.

This shows how useless and misleading averages are in segmenting customers. The sales team was right: Dividing customers simply by their size didn't shed light on what they really needed from the paper company and how much they would pay to fill those needs. Before segmenting its market this way, the company didn't understand what customers really needed and what they'd pay to fill those needs. The research upended earlier assumptions. In fact, each of the four new segments had a mix of customer sizes. The sales team was right: Dividing customers simply by how big they are didn't shed real light on what they really needed from the paper company.

With this new way of segmenting its customer base, the product development team went to town. They saw new possibilities—with both product and services—to meet the needs of the four new segments. They developed solutions—products plus services—for each segment. And in constructing the portfolio of products and services for each segment, the product developers had a good idea of how much they could charge for them. They knew what customers were willing to pay. We'll say more about that in Chapter 6.

Typical Pitfalls of Segmentation

The paper company used segmentation to drive the way it designed new products based on the needs, value, and willingness to pay data. Is that what you're doing? Probably not. Most businesses do segmentation, but many are ineffective because of these three pitfalls:

1. Segmenting too late.

   Many companies start out with a one-size-fits-all approach to product development and use segmentation only to determine their marketing and sales messages. But if they don't design offerings to suit the needs of each segment, they run the risk of creating products no segment gets excited about. For example, if you have two customer segments and you design offerings for the “average” customer across both segments, you end up building a product neither group is fully happy about. You can try to repair the damage through sales and marketing segmentation fixes—essentially, tailoring messages that appeal to each segment. But it's too late by that point. You still have only one product to suit a range of diverse and sometimes incompatible customer needs.

2. Segmenting only by observable characteristics.

   Remember Prince Charles and Ozzy? The simple rule for product design is to base segmentation on your customers' needs, value, and WTP for features you are developing. Period. Revenue size (for business-to-business), age (for consumer segments), ethnic background, and other observable characteristics are often purely uncorrelated to what matters the most in product design.

3. Having too many segmentation schemes.

   Letting your managers create different segmentation methodologies for marketing, promoting, and selling the same product in addition to your product design will lead to confusion. Ideally, your company will settle on one segmentation scheme used by all your firm's functions so you have a unified approach to servicing your customers. Worst case, you must reduce your number of segmentation schemes. If you have more than three, you are headed for organizational confusion.

What Best-in-Class Companies Do

To do segmentation right in designing new products, remember this golden rule: You can act differently. (See Figure 5.2.)

Successful innovators build the right product for the right segment at the right price. They use segmentation as a guiding influence, starting with the R&D stages of an innovation. They constantly explore how customer needs, value, and WTP differ in the market, and how they can act differently to shape products and versions differently for different segments. If there's capacity to build only one product (for example, in a startup), the company prioritizes and builds that product for the segment with the biggest opportunity (either in terms of size or revenue potential), while creating a plan to introduce future products for other segments. In all these ways, successful companies avoid building a one-size-fits-none new product.

An excellent example of this is Garmin, the maker of global positioning system (GPS) devices that direct you on your journey, whether you're a driver, golfer, runner, hiker, or biker.

Hikers want to be safe, so they need a device to navigate the wilderness. Runners want to improve their performance, so they need to track distance, time, and speed. People driving cars want a GPS device that tells them where the traffic is. Golfers need to navigate a course in as few strokes as possible and choose the right golf club (to avoid sand and water). They need a device that tells them how far they are from the pin (so they can use the right club) and where the sand and water are.

It's hard to imagine one device (no matter how brilliantly engineered) that would please all Garmin customer segments. As a result, Garmin makes a variety of navigation devices. It could have easily created a feature shock product by designing a one-size-fits-all handheld or wearable GPS product. Instead, the company used sensible segmentation to develop multiple products. That approach makes total sense.

Consider the case of Mettler Toledo, a $2.5 billion global manufacturer of weighing instruments. The company's industrial customers need scales that can withstand high impact, large temperature fluctuations, and hazardous environments. Laboratories must have scales that are 100 percent accurate. Retailers need scales that are low-cost, capable of printing, and user-friendly. The underlying technology for weighing things is the same. But Mettler Toledo created different scales based on customer segment needs and WTP. Had it manufactured only one scale, it would have built a one-size-fits-none failure.

Segmentation gives you the power to serve customers better by catering to their specific needs. Segmenting in the early stages of your innovation process will help you build products that resonate with customers. Plus, your sales and customer support teams will know how to service them better. Fundamentally, you'll increase revenue, growth, and profits by serving multiple customer groups, and achieve broader adoption by offering products at multiple price points. Imagine the money Apple would leave on the table if it didn't offer so many models of iPhones. In only one flavor, the iconic phone would appeal to far fewer people.

Smart segmentation creates a win-win situation for your company and customers. Like the paper manufacturer we mentioned earlier in this chapter, you make it easier for your customers to find the right product, make the purchase, and get the right level of services from your company.

Insights, Tips, and Tricks

Most companies are familiar with the methodologies for segmenting customers (clustering analysis, for example). But to do segmentation along the lines we're talking about, keep in mind these five principles:

1. Begin with customer WTP data. In Chapter 4, we explored how to determine the WTP based on customer needs and value. By clustering individuals according to their WTP, value, and needs data, you will discover your segments—groups of people whose needs, value, and willingness to pay differ.
2. Let common sense be your guide in using statistics. Methods such as cluster analysis will give you many different options on how to segment with similar statistical accuracy. But choosing the most statistically significant outcome might not give you a segment strategy that will work in practice. Pressure-test your findings: Have you defined a customer group to which you can sell? Are there clear “fences” between segments—features one segment strongly wants but others don't? The acid test is asking a group of salespeople whether they can sort their clients into the segments you've come up with. Practicality and common sense are as important as statistical indicators.
3. Fewer is more. One important segmentation task is to decide on the number of segments. Theoretically, each customer could be one segment, which would make each segment perfectly homogeneous. The opposite extreme would be treating the whole market as one segment. The fewer segments you have, the less homogeneous and distinct they will be; the more segments, the higher the complexity. Do not underestimate the latter. Serving each new segment adds significant complexity for sales, marketing, product and service development, and other functions. Smart companies start with a few segments—three to four—and then expand gradually until they reach the optimal number.
4. Don't try to serve every segment. You're not obligated to serve every possible customer. The products and services you develop should match your company's overall financial and commercial goals. A segment must deliver enough customers—and enough money—to make the investment worthwhile. This part of segmentation is called market sizing. Market sizing doesn't mean simply counting the segment's customers. It means estimating how many of them you can acquire and keep, and at what prices—separating the attractive segments from those that don't make business sense.
5. Describe the segments so you can address them. Investigate whether each segment has observable criteria for customizing your sales and marketing messages to them. For example, if you find that your high-price segment has a disproportionate number of businesses that operate 24x7 vs. normal business hours, you can better describe your segments in your marketing. This is critical. In writing TV commercials, Internet banner ads, or any other marketing and sales messages, companies must describe their target segments as precisely as possible.

To fully monetize your innovations, you need to incorporate segmentation early in the product development process. And you should base that segmentation on customers' needs, value, and their willingness to pay for a product that delivers that value. If you do, your product development initiative will be off to an excellent start.