Evaluating market segmentation approaches

Evaluating Market Segmentation Approaches Thomas

V. Bonoma

Benson

P. Shapiro

This article is concerned with managing and monitoring industrial market segmentation. The economics of market segmentation are overviewed, and an attempt is made to relate the segmentation tool to costs incurred. It is recommended that managers employ more economical methods of segmentation before using more costly parts of the marketing mix. A monitoring scheme is presented with two components that helps managers assess how well their segmentation strategy converts customers to the firm, meets market needs, and represents an efficient allocation of resources.

Though a wide variety of segmentation schemes have been proposed since Smith [lo] first argued for the advantages of market segmentation, managers have not been offered guidelines for how to choose segments, analyze serving costs, or monitor resulting customer groups in a way that allows simplicity of choice and clarity of results. Consequently, in many businesses only the most simple and intuitive segmentation attempts are made (e.g., [ 131); in other, more sophisticated ones, management has little idea if its segmentation expenditures are effective (cf. [ 141). Address correspondence to: Thomas V. Bonoma, Graduate School of Business, Harvard University, Soldiers Field, Boston, Massachusetts 02163. Indusrrial Marketing Manu~ement 13, 257-268 0 Elsevier Science Publishing Co., Inc., 1984

52 Vanderbilt

(1984)

Ave., New York, New York 10017

The purposes of this article are to discuss some aspects of managing segmentation strategies in practice, and to propose some guidelines toward increasing their efficiency. We take, as a conceptual basis for our work a new segmentation strategy model proposed for industrial marketers because its breadth allows a wideranging discussion of the relevant issues. SEGMENTATION

STRATEGIES

In a recent book, Bonoma and Shapiro [2] proposed a “nested model” of segmentation that combines traditional macro- and micro- approaches to market partitioning on the basis of the intimacy and directness of management knowledge required to approach the market. Five “nests” are proposed as an interlocking set of segmentation strategy tools. Each successive “nest,” as in nested computer program subroutines, requires increasingly intimate and detailed customer knowledge for effective use. Segmentation costs, of course, rise with intimacy of knowledge. Of the five segmentation levels listed, the demogruphic is the outermost, for it requires little intimate knowledge for management to discern prospects’ location or industry. The operating nest requires somewhat more 257 0019-85011841$03.00

intimate knowledge of prospective buyers, because this level references preferred production technologies and other general “ways of doing business” variables not easily gleaned from indirect sources. The third and fourth nests require moderately intimate and direct contact with prospects. To assess either prospects’ habitual purchasing approuch or the relevant situational factors impinging on purchasing behavior requires direct and frequent vendor contact. Finally, knowledge about the inner-most level, individual buyers’ personal churacteristics such as risk proneness, is only gleaned through deep familiarity with prospects and customers. Unlike some other models, this “nested” one offers a coherent and managerially understandable set of strategies for segmentation. We argued in our book that marketing management, for cost and other reasons, should start its segmentation process with the cheaper, outer nests, and work inward only until a “good enough” segmentation scheme is found. However, the meaning of “good enough’ ’ in this and in other (e.g., [S]) segmentation models is not entirely clear. How does a manager know when ‘ ‘good enough’ ’ segmentation has been achieved? What monitoring methods allow a careful, realistic assessment of this judgment over time and changing market conditions’? This article is also concerned with the development of segmentation monitoring rules. We look first at some differences in how segments are chosen, next at the interaction of marketing tools with segment approach, third at segmentation economics, and finally at the creation of monitoring methods to determine segmentation efficiency. CHOOSING

SEGMENTS

There appear to be two different general approaches toward segmentation. One is based upon customer needs and works conceptually from the customer backward toward the vendor. This approach is similar to benefit segmentation [5].

The central theme in customer-driven segmentation is that the vendor must implement a separate marketing strategy to provide the products or services that deliver uniquely sought benefits to each market segment chosen as significant for serving [4]. Each segment, therefore, is an aggregation of customers and prospects sharing a common set of needs different from the needs of other segments. The advantage of this “needs/benefits” approach, obviously, is that it drives segmentation through its most important variable-customer needs. That is, after all, the basis on which the buyers make their choices, and the bedrock of marketing decisions. But, benefit segmentation is not always easy to implement, and in some cases is impossible to implement. For instance, in markets prone to rapid change, such as office automation, buyer needs may only develop in interaction with new technologies (and the marketing of those technologies) which expand buyer opportunities in unexpected directions. While almost all managers may feel they “need” the information freedom brought with personal computing power, for example, a significant segment have bought such machines only to learn that they did not need the obtuse software, keypunching requirements and interfacing difficulties current generation machines exact for the promised benefits. Buyers, in short, may be incompletely aware of their needs in a novel area until faced with a concrete method to clarify and satisfy them. Ease of implementation is the major characteristic of the second segmentation approach. It works outward from the selling firm, and segments the market disaggregatively on the basis of prospect identifiability and accessibility to the seller. All members of each segment constructed using this approach can be identified through the same criteria (geography, etc.) and are accessible in the same manner (publications read, etc.). In this approach, buyer characteristics are assumed to be associated with underlying need. Buyers who attend a particular trade show, for instance, might be defined as a segment of convenience from an identifiable/accessible

Management often faces segmentation tension between the theoretically desirable and the managerially possible. 258

segmentation approach. Certainly they are identifiable through virtue of their presence, and accessible through the same means. But, it is likely that they do not share the same specific needs, nor seek the same benefits. Clearly, the benefits-oriented approach is the more attractive in the theoretical sense (e.g., [6]), but most difficult for managers to implement [ 131. The identifiability approach provides readily-definable customer groupings, but can claim no causal relationship to sought benefits. Sometimes the two approaches can be made to coincide. For example, prospects are easily identifiable through coastal/noncoastal plant siting, and such information easily is available to vendors to corrosion-resistant steels. Here the needs (corrosion resistance) and identifiability/accessibility (location) coincide. But often management and researchers face an interesting “segmentation tension” between the theoretically desirable and the managerially possible. Figure 1 summarizes these two approaches to segmentation, and the area of “fortuitous overlap” where “identifiable means” meets “need differences”. The most useful means of segmentation involve this area of overlap; that is, segmentation management tools must be forged which encourage sound (i.e., needs-based) and implementable (i.e., external criteria driven) schemes. But, the occurrence of such an overlay is not independent of the marketing tools used to approach customer groups. Segmentation

Approach

and Marketing

FORTUITOUS OVERLAP IDENTIFIABLE/ ACCESSIBLE

NEEDS/BENEFITS OR!ENTA’l-‘lt~M’ / / ...*.l

Method

Different marketing tasks seem to be tilted toward needs-oriented or identifiathe serving either ble/accessible segmentation approaches. Table 1 shows marketing tasks along with a an array of “standard” judgment of the applicability of each to the needs/benefits or identifiable/accessible segmentation approach. As can be seen from the Table, those marketing tasks most conceptually sympathetic to creation and manage. ment of the product concept-product policy, pricing and to a lesser degree, market selection-can make especially good use of needs/benefits segmentation. Setting a price, developing a product, or selecting the customer base is

\-7

II FIGURE 1.

‘BUYING COMPANY

I

Two approaches to segmentation.

TABLE I Marketing Tasks and Segmentation

Bases

Basis of Segmentation Needs/Benefit Segmentation

Task Associate Professor THOMAS BONOMA and Professor BENSON SHAPIRO are in the Marketing Department at the Harvard Business School. They have written extensively on industrial marketing and segmentation. This article is a companion to “How to Segment Industrial Markets,” published in a recent Harvard Business Review. Both articles were drawn from their recent book, Segmenting the industrial Market (Lexington: Lexington Books, 1983).

1 i

Market Market Product Pricing Personal

analysis selection policy selling

Advertising Distribution

policy

Difficult but important Applicable Applicable Applicable Applicable after interaction Applicable in some situations Applicable

Identifiable/Accessible Approach Easy Sometimes applicable Not applicable Not applicable Applicable for initial call Applicable Applicable

259

done best with a clear sense of sought benefits from a group of users. Those tasks, on the other hand, which relate generally to communication-advertising, some aspects of distribution policy, and the initial stages of personal selling - can make good use of the identifiable/accessible approach, since communication’s occurrence requires identification more than need awareness. I Personal selling and distribution, however, are hybrids in that they make good use of both segmentation approaches in their application to market penetration. It is useful to look more deeply at these two “hybrid” tools. On the first sales call personal selling is much like advertising. Selling at this stage is aimed at a target audience which may or may not be in the appropriate needs segment [3, 91. Management can, however, select an identifiable and accessible prospect group toward which to target salespeople. After initial contact, salespeople can separate prospects (and existing customers) on the basis of need. One advantage of personal selling as a communication medium is that the salesperson can segment the market at the most disaggregate level, i.e., that of an individual buying influence. Personal selling thus undergoes a metamorphosis from employing the identifiable/accessible approach initially to using the needs/benefits approach over repeated visits as the selling process moves from prospecting through qualification toward close. Distribution is a different situation. Distributors perform a variety of functions which relate to communication, pricing, and product policy [ I I]. These include communication (display, personal selling, etc.), inventory support (product policy-related), physical distribution (also related to product policy), credit (pricing), and postsales service. When choosing distributors, managers might naturally make use of the identifiable/accessible segmentation approach. A firm might, for instance, use a particular distributor to reach its Wyoming customers. Or, management might consider using distributors for orders under $100, while it services the larger orders directly. But, because distribution also affects aspects of product policy such as time and place utility for buyers, management must also consider distribution networks from a needs/benefits point of view. The two basic segmentation approaches work differently in the exercise of various marketing tasks. A management that uses primarily product formulation and product line extensions for post hoc segmentation, for ‘Whether recipients’

260

the communication

needs.

will be effectwe,

of course, is affected by the

instance, probably is doing an effective job meeting different segment needs but has a difficult time discriminating segments on grounds other than those of product bought. Thus, management may be satisfying customer needs inefficiently - it may miss the opportunity to target new segments for increased sales. Managements that segment mostly through the use of advertising or other market communication tools like trade shows probably have a pretty good idea of who prospect groups are, but may not know what they want. Managements that use distributors or their own sales forces to foster segments (e.g., national versus other accounts) probably have a better idea than most about who the prospects are and what they want, but at some additional marketing costs. Of course, no management uses one of these tools in isolation from others; but, the marketing mix seldom is understood in terms of its powerful, differential segmentation effects. The task is to pick a mix that not only satisfies customer needs, but which encourages efficient resource allocation and effective monitoring. It is the thesis of this article that whether segmentation efforts result in the “fortuitous overlap” depicted in Figure 1 or are misfocused on one approach or the other depends on the marketing mix tools management uses for segmentation, and perhaps most of all, the presence of monitoring methods to diagnose the goodness of the segmentation strategy. We look next at some economic relationships between marketing tools and segmentation results, and then at an integrated monitoring scheme. THE ECONOMICS SEGMENTATION

OF MARKET

Market segmentation is an expensive process. There are definite costs involved in obtaining necessary data, and in developing a multiplicity of plans to serve each resultant segment effectively. In fact, some have argued that segmentation costs are now so high it may pay some firms to deliberately not segment their markets 171. Two specific questions about segmentation economics can be raised: 1) how does the amount of segmentation affect the cost of segmentation, and 2) how does the market mix tailored for each segment impact the economics? A third element, how the special characteristics of chosen segments impact the economics of doing business, will be taken up in the monitoring section. Impact of Number of Segments

Approaches

The more a market is segmented, the more expensive it is. This easy truism, however, masks great differences

in the rate at which the marketing cost components change. If segmentation costs are broken into “direct” and ‘ ‘indirect’ ’ categories, direct costs include those incurred obtaining and analyzing data on each new segment, as well as the management time and effort needed to make sense of the data and repartition the market. Our own sense and that of the executives with whom we work convinces us that this very visible component of segmentation costs, mistaken for the main component in many analyses [ 121, does not rise very quickly with additional segments analyzed. This is not to say that the costs of such analysis and interpretation are not substantial in large firms serving heterogenous markets; indeed, they routinely run into the tens of millions of dollars. It is to say, however, that if analysis of any sort is ongoing, it is relatively easy to add another segment for analysis or planning without major cost increases. The group of costs thought of as “segmentation overhead” rises very quickly when the decision is taken to serve an additional segment. These are the “indirect” costs of making and especially implementing the specialized plans, product line extensions, price schedules, advertising programs, and perhaps even specialized sales forces (or at least sales programs) necessary to serve the incremental segment. A fungicide advertisement aimed, for example, at citrus market usage will not be appropriate for stone-fruit growers in terms of diseases prevented, suggested dosages, or timing of applications. Indeed, products that meet the needs of one segment are likely to be largely inappropriate for the needs of another. The same thing holds true for other marketing programs. Very quickly, the incremental market strategy and implementation requirements of added business can strain both personnel and budgets. Though seldom cited by marketers, the same kind of cost increases from additional segmentation occur in the factory, often to a much greater degree. Sometimes, each segment must have its own product line with attendant duplication in facilities and effort. Managing the scheduling of multiple product “customizations” for many

segments is a nightmare even when separate production lines are not needed. Furthermore, administrative costs and those incurred from low economies of scale can be substantial. The benefits of segmenting in terms of additional sales volume, resulting scale economies, and marginal profits must justify these added segmentation costs. As the number of segments approached increases, administrative costs probably increase more quickly. The exact shape of the cost and revenue curves, of course, will depend a great deal on the nature of the production process, the degree of component standardization, and on marketing and sales “slack capacity” to deal with not just more customers, but with difSeerent customer groups. One large company, for example, segmented its market into 10 industry segments. The vice president of marketing believed strongly in a “democratic” model of staff and budget allocations to each segment, since on the face of it, he didn’t think there was any reason that one segment should use more of his resources than another. However, after 3 years under this approach, sales costs had reached the unacceptable level of 2 1% of revenues, and a decision was taken to “look at the numbers.” As the simple-minded ratio analysis in Table 2 (the numbers have been disguised) shows clearly, there were strong differences in the returns each segment provided. Further, some of the worst returning segments were the most expensive to serve, and generated the least amount of sales force commission. While this firm did not feel it had the option of abandoning any segment, two actions were contemplated on the basis of the results. The first (see the monitoring section below) was to drive sales statistics and routine reports toward a contribution to fixed costs statistic in order to get a single management yardstick on what each segment returned. The second was to be freer about reallocating people and expenses away from the currently under-performing segments and toward those in which incremental profits might be generated for the extra staff and money allocated.

The cost of segmentation is related to the type of response the marketer chooses to effectively serve the segment. 261

TABLE 2 Results of a Major Utility’s Segmentation

Strategy Segment

Total Rev. Opportun.a

New Salesb vs. Total Revenues

I

6

2 3 4 5 6

5 9 4 2.5 2.5 I 8 I I@

1.5 4 5 9.5 1.5 3 8 Y IO

Seg No.

I 8 9 10

The Nature of the Segmentation

New Sales/ Staff

I(

“Rank-order, a tied rank, e.g., bThe company generated two current sales.
I I 5 8 3 4 6 2 Y IO’

New Sales Dollar Expense 4 I I 8 6 2 5 3 Y IO’

Number on Staff

No. of Accts

3 Y

I0 2 I 8 4 I 5 6’

2.5, is expressed halfway between the two ranks tied. kinds of revenue: ongoing revenue from past sales and new revenue

Y 6.5 6.5 1.3 1.3

I0 1.3 5 x 41

from

10th of IO segments in total revenue opportunity. 1”’ in new sales revenue person and per sales dollars expended, but 6”’ in number of staff assigned and

Approach

The cost of segmentation is closely related as well to the type of response the marketer makes to achieve effective segments. Some parts of the marketing mix are cheaper to use for segmentation purposes than others. Figure 2 reflects our best sense of direct cost differences for four marketing tools. The cheapest implementation of segmentation is achieved through market selection: “declaring” a segment, as it were, available for serving. After the data related to segmentation are collected and analyzed, marketing management decides to approach some segments and avoid others. The direct costs of so doing are fairly low, and involve mostly executive and administrative functions. Such costs do not, of course, include the opportunity costs of neglecting a segment which might be highly profitable. The next more expensive segmentation tactic consists of tailored communication approaches, in particular advertising approaches. It is fairly inexpensive to develop and execute a specialized advertising campaign for different market segments. More expensive, but still relaare specialized sales programs, or tively inexpensive, even specialized sales force deployment. In most industries such tools are less expensive than segmented price policies or product designs. Specialized price policies are very hard to administer, particularly when large product differences are not present. They mostly, however, are expensive in terms of the margin given up through price cuts. Such costs, when 262

Rankings

maintained over time, are more substantial then the added costs of even a special sales force. By far the most expensive segmentation tool is a specialized product line. It costs large sums of money to develop, test, and introduce specialized products. Such specialized lines additionally wreak havoc in the production facility forcing short runs, constant retraining of labor, hand work, increased inventories, and general disorganization. But, on the other hand, customers with unique needs are most responsive to the unique benefits of the customized line. Following the latter logic, Figure 2 may also be read to reflect the potential impact of different marketing tools on segments. All other things equal, we would predict communications, especially advertising, to have the lowest direct sales impact and specialized pricing and product policies the greatest. To this point discussion of the distribution function has been consciously avoided, because its unique aspects as a segmentation tool require an understanding of the remaining tools first. Figure 3 shows four marketing tools, selection, communication, price and product as possible “segmentation levels” for management application. The thesis for this approach to segmentation through marketing tool application is that managers should, where possible, use the least expensive or outermost tool possible for segmentation. Thus, if a segment can be approached adequately with a specialized advertising program, then specialized pricing policies should not be necessary. The

PRODUCT

PRICE

COMMUNICATION

MARKET SELECTION

SEGMENTATIONMETHOD FIGURE 2.

Direct cost of market segmentation.

SELECT A GROUP OF CUSTOMERS

IN ONE OR MORE MARKET SEGMENTS

-1 DEVELOP A SPECIALIZED

COMMUNICATION

PROGRAM

FOR EACH SEGMENT

DEVELOP A SPECIALIZED

PRICING PROGRAM

FOR EACH SEGMENT

DEVELOP A SPECIALIZED PRODUCT

OFFERING

FOR

wGuRE3. Segmentation implementation nests.

263

marketing executive can move from the outside to the inside of these segmentation execution “levels” as justified by the expected rewards of such a policy versus its certain higher costs. The Figure also provides a context for discussing distribution. Distribution cuts across selection, communication, price, and product policy all at once. It can be used as a response to special segment needs at all three different levels, although the levels often come as a package. Thus, if the marketer employs distributors for segmented communication purposes, he may be forced to segmented pricing and product policies as well. Because a particular form of distribution tends to define more than one level on Figure 3, distribution has been drawn as a tool crosscutting several areas. MONITORING SEGMENTATION IMPLEMENTATION Given the interaction between segmentation strategy, marketing tools, and segment economics, it seems clear that if a company is to be effective at approaching a market in a segmented fashion, management must determine the profitability of each group served. Particularly problematic, of course, is deciding which currently unserved segments to add to the target list.

Customer

Conversion

Analysis

Figure 4 shows an inverted triangle. The triangle suggests a scheme for evaluating current segments, or computing the attractiveness of prospective ones. The control measures to be computed on each segment include density, access, qualification, trial conversion, and customer conversion. The top of Figure 4 starts with a group of prospects or customers that management believes to comprise a valid segment. Choices about which segmentation variables to employ have already been made and decisions have been made on how to approach each segment (e.g., communications, product modifications, etc.). Customer conversion analysis begins with a calculation of density. Consider the example of a producer of small safes. The president of the company said that he “didn’t care whether the customer is a small business with critical records or an old person with a photo of a dead spouse to protect-we want to sell to everyone.” Of course, it might not be equally profitable for this safe company to pursue certain segments of the market for small safes. Clearly, the density of potential customers who need or want a small safe (and for whom the safe produced by this particular company is a good “match”) differs among possible segments. The “little old people with photos” segment, though its total size is a massive

Management must determine the profitability of each segment served. We will not review the information and control literature here. Much of it is at least indirectly applicable to segmentation (e.g., [ 11). However, the remainder of the article describes two major segmentation control processes and illustrates specific control procedures within each. The first, customer conversion analysis compares various segments on the basis of their customer yield. In the context of the preceding sections, it serves as a check on customers returned eflectively, given a marketing mix of any type. The second category, segment profitability analysis, concerns the quality of each customer generated by management’s strategies in terms of profits generated per marketing dollar expended on the segment. It is a measure of the efficiency of management’s moves. 264

16.1 million (these figures are hypothetical), provides a very poor density of only 100 prospects per 100,000 individuals. On the other hand, professional corporations provide a high density of 500 good prospects per 100,000, even though the absolute size of this segment is much smaller than that of the first. The objective of density computation is to seek segments with the highest possible density. A percentage measure should be used to control for different absolute numbers in each segment. The next step in customer conversion analysis is computing the ability of the vending firm to access the potential prospect list. This measures how many of the total possible prospects (some call them “suspects” at this early marketing stage) can be reached per unit marketing

IDENTIFIED/ACCESSIBLE MARKET GROUPS1

A NVMBER

OF PROSPECTS

PER

“NIT

PER

“NlT

ACCESSIBLE

NUMBER PER “NIT

POTENTlAL

MARKET TCTAL

DEi:SI-V

PROSPECTS

OF BUYERS ““ALlFlED

TRIAL

REPEAT

CONVERSION

CONVERSION

/

CUSTOMERBASE

FIGURE4.

Customer

conversion

analysis.

cost. Prospect efficiency can be expressed as a ratio, or more qualitatively as involving “low,” “medium,” or “high” marketing costs per prospect accessed. In a personal selling situation, the location of the prospects will be a major factor in determining the sales force costs incurred to reach each prospect. The next measure is an estimate of how many accessible prospects can be “qualified” for the purchase. In many businesses, qualification is not an issue. But in others, such as in selling business jets, it is of maximal importance. Though many companies in the United States rightly might be thought of as prospects and most of them as accessible prospects for a business jet, a much smaller percentage (less than 10%) will be qualifiable. Major qualifying variables include the geographical “spread” of the prospect’s operating facilities, ability to pay, competition from scheduled airlines, and other factors. The essential difference between the “density” measure at the top of the triangle and the “qualification” one discussed here is that qualifying a prospect probably will require some customer contact to assess the buyer’s interest and ability to buy. Density is the rough screen of buying possibility; qualification the finer one of buying probability. “Trial conversion” refers to the percentage of qualified prospects that can be persuaded to try or buy the

vendor’s product or service once. This does not make such buyers customers, but only “trial users. ” For example, word processing stations cost $7,000 to $15,000 each and have semicustom software. The preferred way to evaluate such machines in major corporations is to outfit one department or division with a vendor’s offering for test purposes. Thus, an initial purchase of 5 to 100 machines is often made. Yet, the vendor has not converted the entire corporation to a loyal user. Finally, the astute manager will measure conversion or the percentage of users who become regular customers. The higher this percentage, obviously, the more attractive the segment for pursuit. Each measure will need minor tailoring to make it suitable for the particular industry and company employing it. For instance, industrial suppliers with few customers may wish to measure the percentage of a customer’s total business they get versus their competitors, rather than using a pure “repeat buying” ratio for the last item on the triangle. Cereal companies will be much more comfortable with straight trial and repeat measures. Customer conversion analysis yields useful segmentation diagnostics. If density is found to be abnormally low among some current segments, it may mean poor market selection. If access is lower than desired, the manager can examine the market communications methods currently employed to reach prospects, the marketing and sales force allocations, or the “mix” of prospects identified to determine the source of the inefficiency. If the qualification percentage is unsatisfactory, either market selection or qualification procedures are called into question, or worse, selling tactics themselves. If trial conversion is not at desired levels, the manager might look to the selling efforts, the product or service delivered, or price to assure that all are adequate and offer desired benefits. And, if repeat conversion is low, the selling effort, product/service/price and post-sale services are possible culprits. However, the critical diagnostic provided by customer conversion analysis concerns whether the “identified, accessible” groups input by management actually comprise a needs/benefits segment. Customer conversion analysis allows this determination by providing management with a series of diagnostic indicators and suggestions for tactical fixes when such indicators do not meet desired levels. Given that all such tactical fixes have been made, and key indicators on the triangle still do not “read within expectations,” management is forced to the correct conclusion that it has not found a 265

needs segment, but only a group that appears to be a segment. For instance, if density, access, qualification, and trial use are all high but repeat conversion low, and no obvious marketing implementation problems exist, management may rightly suspect that its products or services do not meet the needs of the segment sought. In this case, segmentation strategy must be reformulated.

ble, and six electrical boxes.” This small quantity, wide variety order may be the backbone of the local industrial distributor’s business, but is the bane of the larger distribution company which primarily wholesales to other distributors but maintains counter service to contractors as well. Desirable order sizes and product mixes depend not only on marketing costs, but on production technology, the distribution system, and other variables. For example, in a continuous processing industry such as a paper mill, low demand specialty items are undesirable in periods of high demand because the changeover time interrupts the mill’s long runs which generate a limited variety of product in higher volumes but higher dollar profits per hour of machine time. In tool and diemaking, where a specialty job shop atmosphere prevails, a conceptually similar but opposite problem can be encountered with regard to order size. Ambitious firms that have sold diligently to obtain large, batch-type orders have found that they could not deliver such orders at a profit because their marketing, production technology, and other systems were developed to deal with low-volume, shortruns. Regardless of the particular conditions, every business

Segment Profitability Analysis It is not enough

to find segments that generate high customer conversion ratios. The customers obtained must be serviced at reasonable cost, maintained without excessive marketing expenditures, and hence, contribute a high margin to fixed costs and profit. Figure 5 presents an upward-pointing triangle that contains notions about controlling segment profitability. The input to the top of the triangle is a market segment. The first two sections of Figure 5 deal with order size and product mix. If the customers attracted provide orders that cannot be filled profitably, or if their product mix results in suboptimal utilization of resources, the desirability of serving the segment is questionable. For example, small electrical contractors, called “basket contractors,” often buy “three fixtures, 100 feet of ca-

ORDER /DESIRED

SIZE\

ACTUAL

MIX

DESIRED

TO

MIX

/

CUSTOMER

SIZE

PRODUCT

MIX

\

CONTRIBUTION

HARGIN

PERCENTAGE

/

\

CoNTRIBUT1oN MARGIN

CONTRIBUTION RETURN SEGMENT

l

CONTRIBUTION

PER

DOLLAR

INVESTED

\ Segment

profitability

analysis.

ON

INVESTMEN

/ FIGURE 5.

266

MARGIN

will have some optimal order size and product mix. We suggest periodic review to insure that either 1) customers are meeting order and mix criteria, or 2) there has been a conscious management decision to serve customers who do not meet the criteria. For example, a company may choose to service customers who individually do not meet the order size criterion, but who as a group generate a desirable product mix portfolio. The third part of customer profitability analysis turns from customer serving costs to customer maintenance costs, recognizing that continuing business ordinarily requires additional marketing resources and that customers differ in the resources required per dollar of revenue generated. There are many ways to measure marketing expense-to-revenue ratios, including the costs of communication, price promotion (discounting, etc.), and other costs per customer. Nonmonetary measures also exist, such as total selling days per customer account (which is useful if customers are large and the sale is project oriented like major power plant construction). Regardless of the particular measure chosen, the objective is to compute the marketing costs involved in customer maintenance for each account, and in each market segment. Order size, product mix, and marketing expense-tosales revenue measures all help to determine the percentage contribution per revenue dollar for each segment. This measures the amount of contribution left for covering fixed costs and providing profit after direct production, distribution, and marketing expenses. This analysis can and should be performed by account or market segment. But, analysis should not stop here. Contribution margins must be related to the investment. Often, marketers throw up their hands at the prospect of allocating investment to segments because of the difficulty. Yet, it has been our experience that for larger segments or key accounts, it is usually possible to get a good sense of the investment intensity required. If this can be done for the firm’s major segments, it is possible to compute a rough but useful marketing return-on-investment ratio, which is the most sophisticated measure in the control system we propose. It is not quantitative rigor that supplies management with the ability to assess and control its segmentation efforts, but rather the discipline of the process. If ROI cannot be computed, can contribution? If this cannot be computed exactly, can segments be scaled on a “more” to “less” qualitative rubric? In many instances, such information is all that is needed to permit sound segmentation decision making and tight segment control. Though data

such as these would be thought to be readily available to almost every manager in today’s data-oriented companies, they are not. Indeed, it is the rare and exceptionally able manager who has been able to defeat the accounting system’s obfuscations in order to determine the “back-of-the-envelope ratios” suggested here.

Integration of the Measures It is no accident that the customer conversion triangle in Figure 4 is downward pointing and its companion in Figure 5 upward. The entire process of segment control requires first exploring the downward triangle of customer conversion analysis, and then continuing to monitor customers obtained through profitability analysis. Thus, segmentation control can form an “hourglass model” of a) tracking the costs of getting customers, and b) the return they deliver. Though the triangles can be implemented separately, optimum application comes from using them together.

CONCLUSION Much has been written about the strategy of segmentation (e.g., [2]); little about its implementation, control, and management. We find two general approaches to segmentation; a needs approach that is theoretically “right,” but very difficult to implement, and an identifiable/accessible one that is easy to implement but not generally tied to customer benefits. A way was sought to encourage a “fortuitous overlap” between these approaches. The logic suggested here attempts this integration by relating segmentation approach to marketing tools, marketing tools to segmentation economics, and all three of these factors to segment controls. Management is not asked to abandon finding identifiable customer groups for depth psychology studies of benefits, for those are often unimplementable in practice. Rather, it is recommended that managers 1) understand the difference in philosophy between what is recommended (benefit segmentation) and what frequently is possible (identification/accessibility segmentation); 2) note that different marketing tools seem to implement one or the other of these concepts more directly; and 3) understand the relationships between segmentation strategies and segmentation economics. The central innovation, though, is the construction of the control system which may be simple and qualitative if lack of data dictates, but which accepts segments at one end of the “hourglass” and returns two central decision 267

aids to management. The first (customer conversion analysis) comments on the effectiveness of management’s isolation of these prospective or current segments, and thus returns a rough judgment on the adequacy of the segmentations strategy. Where customer conversion is low, and after implementing the tactical “fixes” of selling presentation and the like, management is faced with the inescapable reality that the segment it has identified and accessed may not be getting its needs met by purchasing its products. Thus, the customers’ responsiveness to the firm’s marketing moves itself is used as a check on need satisfaction. The second (segment profitability analysis) uses rough contribution and profit pictures not only as a test of management’s efficiency in serving the segments it has elected to approach, but as a proxy measure for management’s efficiency at meeting the needs of the segment it has elected to serve.

3. Churchill, Gilbert, Ford, Neil, and Walker. Orville. ment Homewood,

4. Corey, E. Raymond. Harvard

Planning,”

5

Haley, Russell I., “Benefit Tool.”

6.

Journal

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