Segmenting industrial markets

Segmenting Industrial Markets Rodney L. Griffith Louis G. Pol This paper investigates the use of demographic

data as a basis for segmenting industrial markets. Current literature on industrial market segmentation is explored to ascertain what demography means in an industrial context. A demographic-based segmentation scheme is applied to the market for an industrial product sold to retail store chains in an effort to measure a manufacturers penetration across market segments. The information generated from this application has provided the impetus for changes in marketing strategy.

INTRODUCTION Segmenting industrial markets is generally a more complex process than segmenting consumer markets. Industrial products often have multiple applications; likewise, different products can be used for the same applications. Industrial customers vary greatly from one another, and it is frequently difficult to discover which differences are important and which are irrelevant. In some industrial contexts, the degree of diversity is such that a common theme seems not to exist [l].

Address correspondence to Louis G. Pal, College of Business Administration, University of Nebraska at Omaha, Omaha, NE 68182-0048. The authors thank Jackie Lynch for her assistance in the preparation of this manuscript.

Industrial Marketing Management 23, 39-46 (1994) Q Elsevier Science Inc., 1994 655 Avenue of the Americas, New York, NY 10010

The goal of segmentation in an industrial setting is the same as that in a consumer product environment- that is, to divide large markets into smaller components that are homogeneous with respect to their response to a marketing mix. The objective is to have members of a given group more like each other than firms outside of the group [2]. Two different segmentation approaches can be taken: either aggregate individual customers into groups, or disaggregate a larger market into subgroups. In order to benefit sales managers, the disaggregation process must end up with individual customers so that they can be targeted [3]. In other words, “micromarketing” is essential in industrial markets where distribution channels are short and direct contact between the manufacturer and the ultimate user is commonplace [4]. Unfortunately, some of the benefits of segmentation have not been realized by businesses due to the difficulty of “upfront” segmentation and the tendency to segment markets after they have been established (at which point management becomes descriptive and reactive rather than prescriptive and proactive). On the positive side, segmentation by demographic characteristics of both businesses and the marketplace is relatively easy, quite useful, and inexpensive. And when combined with traditional segmentation factors such as product use, demographic data provide a much clearer view of the market. Segmentation using demographic information in the early stages of market development allows managers to be proactive. 39 0019-8501/94/$7.00

Demographic segmentation relatively easy. According to Bonoma and Shapiro [2], the demographic segmentation component primarily consists of three factors: industry type, company size, and location. Determining industry type, at various levels of detail, provides a general understanding of customer needs and purchasing situations. The size of the customer segments, measured in ways specific to the purpose at hand, has an impact on which customers a firm decides to serve. Geographic location is particularly important to sales force deployment and plant/warehouse location, among other factors.

DEMOGRAPHIC

SEGMENTATION

Although most research findings on MDSS (Marketing Decision Support Systems) conclude that systems should contain demographic information about customers and prospects, little detail is provided concerning what these demographics should consist of [5-71. The list suggested by Bonoma and Shapiro [2] provides a good beginning framework, though these variables are somewhat narrowly defined, particularly when “traditional” demographic variables and processes found in business demography are considered [8]. In particular, much more demographic information is required about targeted businesses as well as competitors. Data on size of the business (e.g., revenue and number of employees), how long the business has been in existence (i.e., age), number of competitors, proximity to competitors, and characteristics of the organization other than its size (e.g., occupational structure and size of management team) can prove valuable in setting and implementing strategy. Although customer characteristics are seen as valuable information in consumer markets, the charac-

RODNEY L. GRIFFITH is Manager of Marketing Administration at Kiewit Construction Group Inc., Omaha, Nebraska. LOUIS G. POL is Kiewit Professor of Marketing University of Nebraska at Omaha.

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at the

is

teristics of businesses in industrial markets can be just as useful. Traditional thinking about demographics in the industrial marketing context must be expanded. General demographic information, which provides data on the three key variables, industry, geography, and size, usually can’be obtained without entering the customer’s premises by using government and commercial sources. In addition, the repackaging of these data by vendors in formats such as floppy diskettes and CD ROM make them electronically accessible. Even though external data are easy to obtain and analyze, business marketers often have difficulty linking them with their customer data bases. In addition, external marketing data bases often do not provide detailed information about business-to-business customer buying habits [9]. Some business list brokers attempt to compare a client’s customer list with their data base, however the “hit rate” (i.e., percentage of the client’s list that matches up with the external data base) is often no better than 50%. This is due to a number of factors, such as variations in the company name, complex subsidiary/division relationships, and so on. Some of the problems may be overcome by using a common identifier for a given company, such as a DUNS number (provided by Dun and Bradstreet), or tax I.D. number, as a key. The Federal government’s Standard Industrial Classification (SIC) system is the industry classification scheme used by the U.S. Census Bureau’s economic censuses, and the County Business Patterns series. SIC codes give a relatively complete, but somewhat static and aged, picture of products and industries. There are two assumptions which cause difficulties when attempting to use SIC codes for market segmentation [2, lo]. The system assumes that: 1. All establishments with the same code engage in the same activities. 2. All establishments in a given category account for a large proportion of activity in that category. These assumptions may be valid for some industries, but they are clearly not for others. For example, in some retail trade categories, less than 60 % of the total output of busi-

Traditional thinking about demographics must be expanded. nesses in a given category is devoted to the product that defines the category [2]. A good example of this occurs in the Grocery Store classification (SIC 5411). As can be easily observed by patronizing today’s giant “superstores,” supermarkets sell much more than just grocery items. This cross-merchandising trend has definitely made the “grocery store” category less homogenous by including pure grocery establishments with those having a product mix of, for example, 75 % groceries and 25 % hardlines. In spite of these shortcomings, the SIC system, when used by a marketer who understands the system and his customers, can go a long way toward a first cut segmentation. Other classification schemes employed by publishers of industry guide books, telephone companies, and list brokers, may in fact be more appropriate than the SIC classification system, depending on the nature of the market. Location can be based on the site of the buying office (sold-to), the location where products are received (shippedto), and/or the location where products are used. The first factor is of concern to sales management, the second to logistics managers, and the third to field service people, installation crews, and the like. There is also a second tier of location demography which exists within a company. The second tier accounts for type of location (i.e., size and relationship to other geographic units) and proximity to other locations. For example, a retail store chain of 50 stores can be of a completely different character than another 50store chain in the same business. The former may have primarily metropolitan locations in low growth areas in its location portfolio, whereas the latter may have primarily suburban sites in higher growth areas. Company size can be measured in a myriad of ways. Among them are total size, size by division, or the size and number of individual branches. Absolute size can be measured by sales or some other type of economic activity, asset value, or the number of employees. In many environments such as capital equipment markets, expected purchases of the product in question is probably the best measure of size, provided that reasonable estimates can be obtained. The industrial salesperson is often the best source of these estimates, and many industrial firms include mar-

ket research and sales forecasting as a key part of an industrial sales person’s job [ll].

PRACTICAL APPLICATION OF INDUSTRIAL DEMOGRAPHICS IN A RETAIL EQUIPMENT MARKET Background The balance of this paper presents work done to segment the market for a specific type of equipment sold to large retail chains, and individual stores. The large chains (numbering in the hundreds), however, buy in excess of 80% of the total sales of the product line offered, which makes segmentation by micro aggregation necessary and practical. Throughout the 1960s and early 197Os, Lightsell, whose name is disguised to protect its confidentiality, grew rapidly, riding the wave of chain store expansion. The recession of 1974-75 hit the company hard. Except for a minor leveling of sales in 1981, growth between 1976 and 1990 had been steady, with the company relying on its core product line for over 80% of its sales (in spite of the addition of a number of new product lines since then). Company sales began to turn downward in 1990, and this trend is likely to continue throughout most, if not all, of 1993. Management at all levels was concerned that a considerable company downsizing might be required just to insure survival. The primary cause for this downturn, other than the current recession, is the fact that some of the firm’s largest customers experienced sales declines unrelated to the recession, and they curtailed expansion. Although the firm has gained a number of significant new accounts, it has not been able to make up for the decline in orders from older accounts along with the demise of some accounts. Of particular interest at this time is specific information on market penetration by industry and region. The company is in the process of reassessing marketing efforts and requires information on which to base changes in marketing strategy.

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The retail market is becoming over-stored and fragmented. Current Market for Equipment

Used by Retailers

The retail equipment market is a mature one, and one that has historically relied on the continuation of mass merchandising. There is growing evidence that many of the mass merchandiser retail chains will not be in operation by the end of the decade [12, 131. Some even predict the demise of over one-half of these companies. It is clear that to survive and prosper, any company selling to or through retailers will need to watch each chain carefully to ensure that the survivors are among its customers. The dramatic rise of chain stores, or multi-unit companies as the U.S. Census Bureau now labels them, has its roots in the development of the supermarket, which was based on a number of post World War I events, some of which were demographic, some social, and some technological [14]. Other types of retailers-discounters, hardware/building materials dealers, to name a few- began to embrace the supermarket concept and found that economies of scale could be had with multi-unit arrangements. Most types of multi-unit stores (defined as companies that own and operate three or more stores) increased their share of the retail dollar. In general, the retail market is becoming increasingly over-stored and fragmented. In many markets, there is more retail space than can be profitably supported. In others, developers are building even larger malls, which is further fragmenting retail businesses. Many strong, well-managed retailers are expanding beyond their regional bases and are reconfiguring competitive conditions, often at the expense of existing retailers [15]. Some researchers are predicting the demise of the Discount Department Store, since it is the paradigm of mass market retailing, and the continued strengthening of category killers. Consider the rise of Office Depot, Toys ‘R Us, and Victoria’s Secret, as examples. Add to this the wild card of electronic shopping, which has been touted as the wave of the future, not to mention the rapid increase in direct mail and video shopping, both of which do not require retail store equipment [16]. The inescapable conclusion is that a considerable shakeout among retailers is un-

42

derway, with the poorly run, poorly positioned companies bearing the brunt. Those firms which are mindful of demographic trends in their particular markets, and of the increased splintering of consumer demands, will likely win out. Firm’s Current Market Penetration Retail Category

by

In order to gauge penetration in various markets, the firm’s 12-month sales history was coupled with estimates of total store equipment purchases by both customers and noncustomers (as determined by the firm’s sales people). Sales history data were available in existing company records and were quite easy to access. A specific dollar cutoff was chosen which allowed the capture of over 85 % of the actual sales. A list was compiled of several hundred customers large enough to make the “cut,” and the data loaded into a Lotus l-2-3 spreadsheet for analysis. The classification scheme used for retail types (in other words, industry) roughly mirrors the SIC codes. However, some groups were subdivided or combined to acknowledge the more up-todate definitions used by Chain Store Guide [17]. The types were : . Automotive Supply Dealers (SIC 5531) . Catalog Showrooms (part of SIC 5311) . . . . . . . . . . .

Department Stores (SIC 5311) Drug Stores (SIC 5912) Discount Department Stores (part of SIC 5311) Food Stores (SIC 5411) General Merchandise/Variety Stores (SIC 5331) Hardware/Home Centers (SIC 5211 + 5251) Other Retailers, not classified elsewhere (mostly specialty merchandise retailers) Office Product Stores (SIC 5943) Sporting Goods Stores (SIC 5941) Toy/Hobby/Craft Stores (SIC 5945) Unclassified

Retailers that could be classified in more than one group, such as general merchandise/grocery combo stores or

TABLE 1 Summary of Store Equipment

Sales and Potential

by Retailer Type: 1990 Total Market Equipment Purchases l

Company

Equipment Sales ($000)

Retailer Type Supermarkets and convenience stores Automotive supply dealers Catalog showrooms Department stores Drug stores Discount department stores General merchandise/variety stores Hardware/home centers Other retailers (mostly specialty) Office supply stores Sporting goods stores Toy/hobby/craft stores Unclassified Total product *Salesperson

22,595 2,070 515 2,583 8,450 9,250 2,072 2,120 1,780 650 817 3,210 310

Food Auto Cat.Shw Dept Drug Disc Gen.Ms Hard Spec Offi Sport Toylcrft Unclass

56,422

line sales to large customers

($000)

Company

Market Share w

74,084 20,677 5,568 28,699 56,041 71,155 12,933 36,659 17,792 8,098 3,480 15,911 1,360

30.50 10.01 9.25 9.00 15.08 13.00 16.02 5.78 10.00 8.03 23.48 20.17 22.79

352,457

16.01

estimates.

hypermarkets, were classified according to where the majority of their sales were. The resulting data are summarized in Table 1. Company sales totaled over $56 million in 1990 as compared to the industry total of $352 million. As can be seen, the greatest sales (nearly $23 million) came from supermarkets and convenience stores, followed by discount department stores

($9 million) and drug stores ($8 million). Together these three retailer types represent 71% of the company’s sales. With regard to the total market, the top three retailer types are supermarkets, discount stores, and drug stores, the same ordering as Lightsell. In addition, the table shows that the firm’s market share is about 16%. Figure 1 also shows that market share by retail type varies from a low of less than

34 32 g

30

Ill 28 2

26

Ill 24 a

22

z

20

RETAIL

CATEGORY

TOTAL MARKET SHARE FIGURE 1.

Store Equipment

Sales: Company Versus Total Market

43

RETAIL CATEGORY

COMPANY SALES FIGURE 2.

6% (Hardware

q ITOTAL MARKET SALES

Store Equipment:

Stores) to a high of over 30% (Supermarkets). Clearly, there are some retailer types that are “overrepresented” in the portfolio as well as those that are “underrepresented.” Figure 2 focuses on the company-to-total market sales comparison. There is a great deal of uncaptured business in all categories, though the high market penetration in food stores is again worthy of note. The high penetration in this category accounts for the fact that the firm made its first inroads into this market, and has maintained dominance. This market is further analyzed because Lightsell felt that this market was vital to its prospects for growth. These data alone prove valuable in the evaluation of current marketing strategy. If growth is to occur, or decline is to be averted, the business portfolio must reflect a mix with adequate representation in growth categories. After comparing Lightsell’s market share with projected growth by SIC/store type, managers concluded that a change in portfolio mix was needed. Once the decision was reached to change the mix, then marketing/management strategies had to be developed to produce the desired change. Plans were put in place to alter the current mix so that it would “fit” the desired mix thought necessary to kindle growth. Company resources were reallocated and the marketing

Market Share by Category

department strategy.

was reorganized

to best carry out the new

Supermarket and Grocery Chain Segmentation by Geographic Location For the second part of the analysis, data were gathered on the top 200 Supermarket/Grocery chains in the U.S. This analysis was conducted because more information was needed regarding the store type category where Lightsell had the largest market share. On one hand, heavy reliance on this category insured that performance had to remain strong. On the other hand, over-reliance on one category could mean that the company was overly at risk to forces outside its control. A balance in the mix was sought. Multiunit companies comprise only 19.4 % of the stores by number, but 82.9% of the retail dollars sold in SIC 5411 [18]. Over 69 % of the chain-owned stores are owned by the top 200 companies, so tracking these companies individually accounts for the vast majority of the market for the firm’s product. In this part of the analysis, the firm’s internal sales data were linked to information provided by chain store directories [17]. The difficulty here, as it would be in many firms, was to sort through the distribution network. On the firm’s

side, data were captured based on the “sold-to” name on the books (in other words the invoiced customer, not the ultimate user chain). In reality these sold-to entities were a collection of sales through dealers, distributors, buying groups, as well as direct sales to the chains. In particular, the smaller chains purchased through wholesalers, or voluntary/cooperative buying associations, thereby masking who really purchased the merchandise. To account for this complexity, the firm’s sales to Distributors, Wholesalers, Voluntaries, and Cooperatives were included as if they were sales directly to SIC 5411, even though their actual SIC code is in the Wholesale category. At this point consideration of the ship-to location was critical in determining whether a particular chain bought or not. Another difficulty encountered was that the firm tended to bill to individual divisions of the chains, whereas the directory listed only totals for some chains. This tended to taint the “sold-to” geographic analysis. Table 2 shows the firm’s penetration in the Food Store category in the nine Census Bureau Divisions designated. The geographic location assigned was based on the buying office location, not individual store locations. The analysis shows that while overall penetration is over 30 % , regional penetration varies from a low of 14% in the New England states, to a high of 47% in the Mountain states. The East South Central, West South Central, and Middle Atlantic states are also being penetrated below the “norm.” This information was unknown to company managers and they were forced to re-evaluate the company’s position in each of these markets. In light of these hard data, marketing strategies that were “thought” to be effective emerged as needing significant change. At the same time, some marketing activities that were initially regarded as suspect emerged as sound. The analysis was extended. In order TABLE 2 Supermarket

to estimate overall purchases of the particular product, the supplier currently selling to each chain was noted. The resulting information provided a current picture of the company’s position and a measure of competitor presence in each market. This information brought about a x-e-evaluation of marketing strategy. Lightsell’s impression of the strength of various competitors across markets was altered. Some competitors are now viewed as more vulnerable. Armed with information on industry-specific penetration, regional strengths and weaknesses, and an estimated competitor’s customer list, the company is now able to refocus marketing efforts in ways more consistent with an objective assessment of current conditions. For example, the promotions manager is using the above information to guide him in the placement of magazine advertisements. Marketing expenditures are being redistributed among the geographic divisions based on the knowledge of market share, market potential, and desired market position in each of the nine by census divisions. The data are also being used in the consideration of product development and the allocation of company resources. More sound decisions are being made when allocating resources between markets where penetration is high and markets where penetration is low. Moreover, a time-series dataset is being developed. This will allow the company to assess the impact of changes in the marketing mix that might be implemented and provide additional direction in the formulation of strategy.

CONCLUSIONS As was pointed out earlier, segmenting industrial markets on the basis of demographics is only a first step toward even more useful segmentation based on benefits

Chain Data by Census Division Company

Sales

Total Market Sales

Company

Census Division

(8

Percentage of Total

(8

Percentage of Total

w

East North Central East South Central Mountain Middle Atlantic New England Pacific South Atlantic West North Central West South Central

4,050 551 3,777 2,475 657 3,179 3,585 2,290 1,490

17.93 2.44 16.72 10.95 2.914 16.46 15.87 10.13 6.59

12,037 2,454 7,932 9,841 4,679 12,336 12,824 6,196 5,786

16.25 3.31 10.71 13.28 6.32 16.65 17.31 8.36 7.81

33.65 22.46 47.62 25.15 14.05 30.15 27.96 36.96 25.74

74,084

100.00

30.50

22,595

Total Source: company

100.00

Share

sales records.

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sought, or purchasing characteristics. The firm knows, for example, that certain grocers are users of heavy types of equipment, whereas others can get by with much lighter hardware. Some get along fine with standard equipment, whereas others require more customization. Some chains bid every job, whereas others basically stay with one supplier. Still others require equipment for a number of complete stores on short notice, whereas others plan months ahead. The possibility exists a number of different demographic-based segmentation schemes will prove useful in understanding this market. Given the work that has been done on the Food Store category, the firm can now detail all the other markets, and find appropriate ways to categorize them. Moreover, the government and trade data needed to perform these types of analyses are becoming less expensive and more easily accessible. In particular, the U.S. Census Bureaus’ industry statistics are now available on CD-ROM. The 1992 Industry census was recently completed and the new data will provide up-to-date information on current markets by region and other smaller units of geography. REFERENCES Shapiro, Benson P., and Bonoma, Thomas V., How to Segment Industrial Markets, Harvard Business Review 62, 104-l 10 (1984). Bonoma, Thomas V., and Shapiro, Benson P., Segmenting the Industrial Market, D.C. Heath and Co., Lexington, MA, 1983. Maier, Jens, and Saunders, John, The Implementation Process of Segmentation in Sales Management, Journal of Personal Selling and Sales Management 10, 39-48 (1990).

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4. Fine, Seymour H., Buyer and Seller Psychographics in Industrial Purchasing Decisions, The Journal of Business and Industrial Marketing 6, 49-58 (1991). 5. Shaw, Donald R., Glitch-Free 58-61 (1990).

System Startups, Business Marketing, June,

6. Mentzer, John T., and Gomez, Roger, Evaluating a Decision Support Forecasting System, Zndustrial Marketing Management 18, 313-323 (1989). 7. Meredith, Lindsay, Developing and Using a Data Base Marketing System, Industrial Marketing Management 18, 245-257 (1989). 8. Pal, Louis G., Business Demography: A Guide and Reference for Business Planners and Marketers, Quorum Books, New York, 1987. 9. Eisenbart, Tom, After 10 Years of Marketing Decision Support Systems, Where’s the Payotl?, Business Marketing June, 46-51 (1990). 10. Hill, R. M., Alexander, R. A., and Cross, J. S., Industrial Marketing, 4th ed., Richard D. Irwin, Homewood, Illinois, 1975. 11. Slatter, Stuart P., The Salesman’s Job in Competitive Bidding Situations, Industrial Marketing Management 16, 201-205 (1987). 12. Darden, William R., Cutting Edge Research in Retailing, Journal of Business Research 21, 177-178 (1990). 13. Pinto, David, Industry to Undergo Big Changes, 7, 1 (1990).

Mass Market Retailers

14. Bates, Albert D., The Extended Specialty Store: A Strategic Opportunity for the 1990’s, Journal of Retailing 65, 379-388 (1989). 15. Levy, Walter K., The End of an Era: A Time for Retail Perestroika, nal of Retailing 65, 389-395 (1989).

Jour-

16. Simon, John, Retail Survival in the ‘90’s: Part 1, Visual Merchandising and Store Design Jan., 48-51 (1991). 17. Warne, Christopher, ed., 1990 Directory of Supermarket, Grocery, and Convenience Store Chains, 45th ed., Business Guides, Inc., New York, 1989. 18. U.S. Bureau of the Census, 1987 Census of Retail Trade, Subject Series RC87-S-3, Merchandise Line Sales, 3-8 (1987).