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Every entrepreneur needs to know his customers and segment them to better understand their behavior, why they buy and how to get more customers like them.  For a quick and easy definition on customer segmentation, look here.  For more advanced marketers, the following article lays out some important guidelines.

Charged with extending their unit’s product lines and boosting top-line growth over the next three years, product managers at one global consumer goods company wanted to identify the most attractive customer segments to target and how best to reach them. So they turned to their market research department for guidance.

And why not? The market researchers at the company—we’ll call it ProdCorp—were world class and skilled at using the latest tools in demographics, psychometrics, and statistical analysis. Every two or three years, they would field an ambitious research project that pinpointed large, attractive customer segments and lots of tantalizing “white space” where the company could expand its offerings.

Yet for all their rigor and reach, these initiatives yielded few insights the product managers were able to translate into offerings that tempted these legions of hypothetical customers into becoming the real thing. Time and again, ProdCorp would quietly bury its latest segmentation scheme after efforts to build marketing programs and product development upon it fizzled. Once the memory of failure faded and a new crop of product managers sought room to grow, the company would mount yet another new, expensive segmentation project.

ProdCorp is certainly not alone. We’ve seen this pattern play out in many companies in many industries. In fact, when Bain & Company recently surveyed executives about their experiences with customer segmentation, 81% said it was a critical tool for growing profits, but fewer than 25% believed their companies used it effectively. Flawed segmentation stunts profit growth. Our analysis shows that, over a five-year period, businesses that successfully tailor product and service offerings to desirable customer segments post annual profit growth of about 15%. By contrast, companies that fail to connect the right value propositions to the right customer segments realize annual profit growth of only 5%.

Why do so many segmentation programs fail to deliver on expectations? Like ProdCorp, some companies are so dazzled by the apparent precision of sophisticated analytical tools that they lose sight of their capabilities to design and deliver value propositions and, hence, chase after potential customers that they’re not actually well equipped to serve. And many companies set goals that are too ambitious. In a drive to conquer large prospective customer groups, they overlook the many smaller clusters of loyal customers that they understand best—and who are already their most enthusiastic and most profitable fans.

Our research shows that companies that get the most value from their segmentation efforts excel at two practices:

1. Identifying lucrative Design Targets.

A Design Target is a group of customers whom a company can serve better than anyone else can. The Design Target is not the segment to pursue; rather, it’s the core of that segment. As such, it’s the sweet spot of a larger consumer population that shares many of its attributes and makes similar purchasing decisions.

2. Rigorous self-examination.

Companies that undertake an unflinching assessment of their own capabilities are able to evaluate the insights generated by segmentation projects with their operational strengths firmly in mind and focus on the customer groups they know how to serve best.

In each of the two case studies below, you’ll read how a company’s sharp focus on one of these practices resulted in significant growth. But first we’ll take a closer look at Design Targets: what they are and how your company can identify the ones that will deliver profitable growth.

Who really, really likes you?

Every marketer’s dream is to discover some huge untapped or underserved customer segment and develop a killer offering for it. But segmentation strategies often fail because marketers cast their nets too wide and try to capture overly large, amorphous customer groups. The result? In trying to satisfy very many customers, companies end up satisfying very few.

A better approach is to focus marketing and product development efforts on one or more Design Targets. A Design Target is a group of customers that your company understands so completely that when you design products and services for them, they say: “This is absolutely perfect for me.” They’re the customers most likely to be profitable for you to serve year after year.

Of course, a group so distinctly and narrowly defined may not be big enough to be attractive by itself. But the Design Target is the bull’s-eye of a larger population of customers who share many of their attributes—and who will thus be attracted to many of your company’s offerings, too. To identify promising Design Targets, we recommend looking for the overlap in two customer sets:

1. Current customers who are profitable promoters of your products and services.

2. The conceptually attractive customer segments turned up by your market researchers.

Promoters, as their name suggests, are those customers who not only buy from you but also urge their friends, colleagues, and family to do the same. How do you find them? Just ask your customers to mark their response to the question “How likely are you to recommend our company’s products or services to a friend or a colleague?” on a scale of zero to 10. Here’s what the scores mean:

• 9 or 10: These are your promoters, customers whose enthusiasm for your company and its products or services effectively makes them your volunteer marketing corps.

• 7 or 8: This limp handshake of a score comes from passives, lukewarm, at best, about your company. Don’t count on them to drive profitable growth.

• 6 or less: Meet your detractors, the customers you wish you didn’t have. They’re dissatisfied with your company, vocal about it, and driving potential new customers away.

Profitable promoters are simply those promoters who buy the most from you; of all your customers, they’re the most likely to be receptive to new offers directed their way. Your market researchers should learn as much as they can about your profitable promoters at the same time they scan external market data to identify potentially attractive customer segments. When they find a slice of a customer segment that shares many of the attributes of the profitable promoter group, they’ve hit a Design Target.

American Express: A focus on Design Targets delivers a charge to profits

American Express is one company that developed hit products by focusing its marketing and product-development efforts on highly attractive Design Targets.

From 1958—when the company introduced its first charge card—through 1990, the card market grew rapidly, but American Express introduced only a handful of different card products. As competition intensified in the 1990s, the company set out to reenergize its product line. Through segmentation analysis of its customer base, American Express marketers identified various customer groups by income, spending, travel frequency, shopping preferences, lifestyle characteristics, and so on. They decided to focus on several groups of deeply loyal customers who were very high spenders and very profitable.

Although American Express already had a strong position with these profitable promoters, the marketers recognized that it was possible to serve them better and tap significantly more spending from them. At the same time, the marketers’ scan of the external market indicated that there were plenty of potential customers out there who shared many of the profitable promoters’ attributes.

One Design Target the company identified was “points junkies”: business executives and management consultants who loved to accumulate frequent flyer and hotel guest points. For these people, American Express created the Rewards Plus Gold Card in late 1994. Though it had a higher annual fee (initially, $125) than the standard Amex Gold Card, it was particularly appealing to this customer group because it was bundled with the Membership Rewards Program and awarded double points on all spending with partner airlines and hotels in the first year, and one and a half times the points thereafter. Cardholders could get up to five free supplemental cards to give to their spouse or use separately for personal spending to maximize points. Customers who signed up for the Rewards Plus Gold Card also enjoyed other Gold Card benefits, such as the Global Assist hotline, which provides information about inoculations and visas and helps travelers with medical and other emergencies on the road.

The Rewards Plus Design Target was a very attractive but narrow group. Because mass marketing couldn’t efficiently reach this group, American Express promoted the Rewards Plus Gold Card by offering upgrades to current customers and relying on word of mouth to attract new ones. These efforts succeeded far beyond the company’s expectations, as Rewards Plus became one of American Express’s most popular and profitable products.

Besides the Rewards Plus Gold Card, American Express created additional card products, such as the elite card and the new Blue credit card, for specific Design Targets, and freshened up older products such as the basic Green and Gold cards to appeal to yet other Design Targets.

American Express believes its clear understanding of its Design Targets enabled it to create the very best products for them and credits this for delivering a significant chunk of its increased share of the consumer card market. As customer loyalty has climbed and defections to competitors’ cards have declined, card usage across the board has grown. Spending by individual and small-business card members grew by more than $2,000 and $9,000 per account, respectively, from 2002 to 2005, during which time the company added more than $104 billion in charge volume.

An investment bank identifies its strengths— and the customers who value them

Identifying appropriate Design Targets is only half of the growth equation, as one global investment bank we’ll call Premier InterCapital (PIC) found. Just as important to a growth-focused company is to undertake an unflinching inventory of its own capabilities and what value different customer groups attach to them.

Otherwise, marketers and product developers might succumb to the temptation to chase after customer populations that the organization simply is not well equipped to serve and thus will never truly satisfy. Segmentation-savvy companies evaluate their customer insights with their organization’s operational advantages firmly in mind and focus on those that they have the best shot at developing into robust new platforms for growth.

An industry leader, PIC served both large and small corporate customers across a wide spectrum of industries. But the bank’s relations with some of its largest and most profitable customers were strained, while other big clients prized PIC’s services quite highly. The bank’s senior directors couldn’t agree on what accounted for the discrepancy or what to do about PIC’s smaller clients, many of which generated decent profits but absorbed a large amount of senior executive time. In short, the bank was having trouble deciding where to place its bets when it geared up to solicit new business.

To help clarify these issues, PIC first segmented its clients to identify promoters, passives, and detractors. It then subdivided each category according to profitability. Analyzing the results, PIC’s bankers discovered that many of its profitable promoters were large, complex companies operating in multiple countries. They also found these profitable promoters often were in heavily regulated industries and had highly complex financing needs. Interviewing key contacts at these clients to learn what they most valued in PIC’s services, the bankers found that the contacts spoke glowingly of the depth of PIC’s technical expertise and capabilities, and valued the probing questions PIC’s bankers asked.

By contrast, conversations with detractors revealed that these companies—large and small—generally did not face very complex financing challenges. Qualities that for profitable promoters were major positives (“confidence,” “expertise”) were characterized by detractors as negatives (“arrogance,” “condescension”).

Armed with these insights, PIC decided to pull executives off unprofitable detractor accounts to focus on potential customers that shared the profitable promoters’ distinguishing attributes and their more extensive advisory needs. Recognizing that some customers highly valued PIC’s mastery of regulatory matters, the bankers set out to convert passives into promoters by emphasizing PIC’s expertise in solving complicated issues of capital structure.

PIC’s strategy is paying off. A sizable number of profitable passives have become profitable promoters, and the bank has achieved greater penetration into a category of largecompany accounts where the bank had low share. Though still in its early days, this new program has begun to raise PIC’s number of promoters overall and increased its revenues among this targeted group.

As the experiences of American Express and the investment bank show, successful segmentation programs are dynamic, are grounded in hard data, and engage the passions of real flesh-and-blood customers. Companies that learn to enlist their own profitable promoters to develop their next-generation products and refine organizational skills that continue to delight these A-list customers will be best positioned to recruit many more like them.

By: Rob Markey, Gerard du Toit, and James Allen

Source: Harvard Business Publishing