What is Market Segmentation

Contents

1 Introducing Market Segmentation
- 1.1 Formal Definitions of Market Segmentation
2 Why Use Market Segmentation?
3 Choices of Segmentation Bases

Introducing Market Segmentation

Market segmentation is the first step in defining and selecting a target market to pursue. Basically, market segmentation is the process of splitting an overall market into two or more groups of consumers. Each group (or market segment) should be similar in terms of certain characteristics or product needs.

Market segmentation is a critical and important component of developing a marketing program, as it is the stepping-stone to identifying and selecting target market/s for the firm.

Its prime purpose is to split an overall market into related sets of consumers (known as market segments), based upon similarities of their individual characteristics, purchase behavior, and/or other relevant aspects of consumer behavior.

The eventual goal of undertaking market segmentation is select one or more of identified segments to be the firm’s target market/s, in order to implement a more precisely designed marketing strategy and marketing mix tactics.

As a result, market segmentation is usually grouped together in the three-step sequential process of:

Segmentation
Targeting
Positioning

This process is referred to as the STP process. In a few marketing textbooks, it is also referred to as the STDP process, where the D stands for differentiation (which is technically a component of effective positioning).

A good way of thinking about market segmentation is that we want to effectively create smaller and more defined markets from the overall market (that is, end up with several mini-markets, rather than one overall market).

Formal Definitions of Market Segmentation

The concept of market segmentation was first identified by Smith back in the 1950s. He was one of the first to recognize the importance of market segmentation, as shown in the following quote:

“Market segmentation is based upon developments on the demand side of the market and represents a rational and more precise adjustment of product and marketing effort to consumer or user requirements.” (Smith, 1956)

To clarify this statement in simple language, he basically saw market segmentation being an important tool to enable marketers to better meet customer needs. Since that time, market segmentation has become a widely accepted and used marketing approach. Here are some more recent definitions of what is market segmentation:

“Market segmentation is the process of splitting customers, or potential customers, in a market into different groups, or segments, within which customers share a similar level of interest in the same, or comparable, set of needs satisfied by a distinct marketing proposition” (McDonald & Dunbar, 2004)

“Market segmentation involves aggregating prospective buyers into groups that (1) have common needs and (2) will respond similarly to a market action.” (Kerin, 2011)

Both of these definitions highlight that market segmentation is designed to split customers into similar groups. They also indicate that market segmentation is simply a step in the process of identifying and evaluating potential target markets, which is best achieved by breaking the overall market into smaller, related groups of consumers. Therefore, an alternate definition provided by this market segmentation study guide is:

Market segmentation is the process of splitting a market into smaller groups with similar product needs or identifiable characteristics, for the purpose of selecting appropriate target markets.

Why Use Market Segmentation?

As discussed, mass-marketing is a largely ineffective approach for the majority of firms.

By using market segmentation, resulting in more precise target markets, we able to construct a better marketing mix offering to better meet the needs of these more defined consumers = which means we should make more money!!!

The main advantages of market segmentation (and subsequent selection of target markets) are:

greater understanding of customer needs
great insight and understanding of the overall market
ability to target gaps in the marketplace
helps provide the choice to attack/avoid main competitors
can provide a competitive advantage through innovative segmentation
generally able to closer to the target customer (connection and engagement)
a more defined marketing strategy and marketing mix
a much stronger fit to consumer needs
preserves limited company resources to focus upon key target markets
improves the customer journey and experience, through tailored processes
simplifies strategy choices, as the company is more focused
simplifies product mix decisions
enables more relevant market research, from target consumers only
enables clearer positioning, as the company/brand is focused
helps build a stronger brand with targeted consumers

When we put all of these benefits together, it should mean that the company is far more profitable due to:

clear strategic focus,
increased market share of targeted consumers,
enhanced brand loyalty, greater protection from competitor activities,
while running a lower more efficient cost structure.

The Market Segmentation Trade-off (or Are We Giving Up Potential Customers?)

Whenever a company focuses on one or more a target markets it will, by necessity, need to rule out certain segments which it will exclude from its marketing focus. This means that our marketing efforts will be primarily focused upon a smaller group of related consumers.

As a result, there is a clear a trade-off involved of – focusing upon a target of a smaller proportion of the market versus providing a broad offering to the entire market.

There are some people who may see this as “leaving money on the table”, as we are deliberately scaling back the size of the market that we serve.

But keep in mind… we can target more than one market segment. So, by choosing a target market, we are not ignoring the rest of the market, but instead we are tailoring an effective marketing offering for that segment.

And if there are other attractive segments that fit our strategy and resources, we can also target them with an alternative marketing mix – either now or in the future as we become more successful.

More Customers is NOT Always Better

Marketing students sometimes start their studies by thinking that “more customers are better” – this is not always the case.

As an example, let’s consider a law firm. Let’s assume that they focus on providing specialist advice to large corporations.

But what is they pursued more customers and considered expanding by providing a wide variety of legal services to individuals? Would this help them become more profitable? Probably not.

Why? Even though expanding their services to everybody would dramatically increase the size of their target market and their number of customers substantially, it would most likely lead to a reduction in their overall profitability.

This is because they would have the additional costs involved in providing these services to (relatively) small-value individual customers, while simultaneously damaging their reputation/brand as a specialist corporate legal provider, leading to reduced corporate clients.

How do we Construct Market Segments?

While conceptually quite straightforward, constructing an effective market segmentation approach is often quite challenging. And, of course, we need access to suitable customer data – usually from our customer database and/or from market research survey results and/or from third-party data.

It takes time and requires analytical trial and error – this means that we will usually need to consider multiple variations before we identify a suitable segmentation outcome.

Even large companies will spend some time in analyzing the market forming different approaches to market segmentation. This indicates that there are multiple approaches to segmenting the SAME market for the same firm.

And by looking at the marketplace in different ways, this can be an effective and powerful way to understand the market and gain market insights.

In the marketing classroom, it is common to construct a market segmentation from guesswork, or from using simplistic data. However, in practical terms in the business world, marketers are looking for greater depth, insight, and a competitive advantage from their construction of marketing segments.

While segmentation guesswork might be suitable in business for simple decisions or scenarios in a planning day, it is not suitable for a company to base their entire marketing efforts on what management thinks are the market segments.

The best data sources for market segmentation will include:

the customer database, containing an array of information about each customer
market survey results, ideally with a mix of purchasing, attitude, demographic, and media preference information
analysis of publicly available information, such as census data and industry reports
third-party data = consumer data collected by other firms and surveys
review of commercially available segmentation approaches, such as VALS

Once we have suitable consumer data, we then look for similarities and patterns in relevant characteristics and consumer behavior. Marketers may employ various statistical techniques, such as cluster analysis or other analytical approaches to classification of consumers into segments.

Why Not Use Mass Marketing Instead?

The main approaches to a target marketing strategy are:

Mass-marketing = one marketing mix offer to all consumers
Product-variety marketing = lots of choices (size, flavor, color, etc.) of similar product lines, but with no distinct segments in mind
Market segmentation and the choosing a target market = as we will discuss in this article
Niche marketing = a targeting very small segments, with a specialized marketing mix
Localized marketing = targeting local consumers (such as the local hairdresser or accountant)
Individualized marketing = tailoring products to customers on a one-on-one basis

Mass-marketing is where we try and appeal to everyone in the market through the SAME marketing mix offering – that is, same product/s, same price, same positioning, and so on.

Mass marketing was a highly successful technique in the 1900-1950s era, where large-scale manufacturers were able to obtain a cost advantage and sell products at a relatively low price. Good examples of these firms/brands were Henry Ford (Form Motor Co.), Gillette (razors), and Kellogg’s (breakfast foods).

While some firms are still able to be mass-marketers today (let’s think Apple and Google), it is generally not a viable approach for the MAJORITY of businesses.

But why? The main weaknesses of being a mass-marketer are:

The firm competes against every other firm in the market = intense competition
The firm’s products are a “reasonably OK” fit to the needs of most consumers, but a strong fit to very few consumers
More specialized competitors take market share from mass-marketers by targeting a small segment of consumers, but with a much better fit to their needs.
They are more prone to the risk of environmental change, as they are committed to one prime offering and business model

As a simple example, let’s compare a local restaurant that offers “all the foods of the world” in an attempt to appeal to all consumers. But their competitors choose to specialize and down the street there are multiple competitors including, Chinese, Indian, Japanese, steak/barbecue, vegan, French, and Mexican restaurants.

What will happen? Most likely is that the consumers will perceive these latter restaurants as specialists, or they will be a better fit to their needs/tastes, as well as the first restaurant as being perceived as “good at nothing in particular”.

Another example is traditional TV channels. They are mass-marketers with their one channel trying to meet the needs of all consumers with news, movies, sports, comedies, dramas, and so on. But they only offered one show at one time.

Then along comes YouTube, Netflix, cable/pay TV, Disney, Amazon TV (and the list goes on) – with each of these platforms being a better fit to consumer needs as they offer on-demand flexibility, making the one-show-at-a-time approach of traditional TV obsolete.

And if we go back 50-100 years – back then the kings of retailing were major department stores. But now consumers prefer specialist retailers and department stores generally struggle with profitability.

As we can see, over time generalist firms (mass-marketers) progressively lose market share to specialist operators who fragment the market into smaller segments – effectively splitting the battle ground and breaking the mass-marketers hold on the market.

Key Requirements (Criteria) of Market Segmentation

Obviously with segmentation we tend to focus upon ensuring that there are similarities between the consumers placed into each segment. However, that is only one of the criteria for deciding upon an appropriate segmentation approach.

Remembering that this is primary a stepping stone stage in the STP process, we need to ensure that the resulting segmentation structure is suitable for targeting, position, and then marketing mix development and implementation.

There are several key criteria for segmentation (which tend to vary by textbook), but when we split consumers into small market segments, we need to ensure that the final segments are:

Clearly identifiable – we know the type of consumer who is in each segment (that is, the characteristics that have resulted in them being classified into that segment)
Easy to measure – we can measure the size and growth rate of the segment
Large enough to be profitable – the likely sales and revenue will be sufficiently profitable for our firm
Mutually exclusive – consumers tend to logically fit into one segment only
Unique behavior – from a marketing perspective, consumers in each segment act relatively differently (in terms of purchases), relative to the other segments identified
Reflective of consumer behavior – the segments provide clear insight into how these consumers behave with purchasing and/or their response to marketing mix tactics
Workable as target markets – in this case, “workable” means that we can reach them through communications, that we have the capacity/resources/access to channels etc.
Informative – segments should provide the marketer with helpful (and even predictive) information about the consumers in the market
Strategic fit – segments that work well in our strategy and business objectives
Logical and easy to communicate – the segments make sense to us as a business, and they are easy to communicate to relevant staff and management

How Many Segments Should We Have?

Ideally, most businesses would be best to look at 3 to 5 segments when dissecting their markets. If we only have one segment, then we have not engaged in market segmentation, as this is the entire market. It is not until we get to around three segments, that we are starting to see clear differences in behavior that is valuable for marketers.

However, unless we are very large firm, once we get past six or seven segments, this creates two main problems for us.

The first problem is that each segment is getting quite small, which will substantially reduce its viability to us as a business.

And the second problem is that we may wish to target multiple segments, and with a complex segmentation, it is possible to end up with four – five potential target markets, making our overall marketing program more complex than it needs to be with multiple marketing plans required.

As a rough rule of thumb, if we can choose 1-2 target markets from a segmentation of 4-5 market segments, that usually negates the concerns listed above.

Choices of Segmentation Bases

Segmentation bases are the variables that we can use to segment the market. A variable is any descriptive or behavioral piece of information that we have for a consumer.

For example, if we have a customer database, then we might know the following pieces of information: residential address, frequency of purchase, types of products bought, possibly age, possibly marital status, and so on (pending on the firm and industry). These pieces of information are all variables and are potentially useful for market segmentation.

In general, there are four top-level approaches to segmentation, which are:

Geographic segmentation
Demographic segmentation
Psychographic segmentation
Behavioral segmentation

Geographic segmentation

This is segmenting on where the consumer lives. When using geographic segmentation, we are looking for similarities that will impact consumer behavior and purchase preference.

The key underlying assumption for geographic segmentation is that their location impacts their behavior, preferences, and purchases as a consumer.

Therefore, what we are looking for in geographic segmentation is uniqueness in purchasing due to location. For example, different climates will generate different needs for clothing, housing, sports/activities, foods and beverages.

In many Scandinavian countries, which have colder climates, their consumption of coffee is quite high, especially as opposed to countries/regions in hot climates.

As another example, the local terrain (very hilly or very flat) of a region would influence the choice of cars/transport, shoes, some clothing, sports, and so on.

Some of the common segmentation variables used for geographic segmentation include:

Climate
Terrain
Urban/suburban/rural
City size
Population density
Region/city

Benefits of Geographic Segmentation

Using geographic segmentation also provides valuable cost and efficiency advantages for a marketer.

In particular, it is very effective for use of media – where we can focus upon advertising to a particular geographic area, through billboards, transit advertising, local TV and radio stations, local newspapers.

It also is very cost-effective for logistics, especially if we are marketing a physical good which we sell into local retailers (or wholesalers).

Geographic segmentation is also helpful approach for international marketers with strong global brands, as most countries and regions are potential growth opportunities for them. By using a segmented approach, they can identify which countries they can group together and utilize a combined marketing mix approach.

Within the same country, geographic segmentation is more effective when there are diverse regions and lifestyles. For example, in Canada the population is split between English-speaking and French-speaking, and their lifestyles and consumer behavior also differs, resulting in two broad subculture market segments.

The other main advantage of geographic segmentation is that it is very simplistic, easy to define, easy to measure, and clearly determines who is in/out of the target market.

In summary, geographic segmentation would be most helpful for:

small/local businesses choosing to engage in local marketing only
major retailers selecting new location for market expansion/development
international brands/firms selecting new countries/regions for their market expansion
firms operating in diverse countries with multiple distinctive regions
highly logistically dependent firms (manufacturers, wholesalers, transport)

Concerns with Geographic Segmentation

Geographic segmentation has a number of limitations, which may make it a less effective form of segmentation. These include:

relies upon the assumption that geographic location impacts consumer behavior
relies upon the assumption that all people in a location have similar needs and behaviors
provides limited insight into consumer motivation
provides limited information on consumers’ needs and preferences
is a very simplistic approach
can be “outperformed” by more segmentation savvy competitors, choosing to have a deeper level of market segmentation and gaining a better understanding of the market as a result

Demographic Segmentation

Demographics are measurable aspects of a population, such as age, gender, occupation, and so on.

The key goal of demographic segmentation, like any other segmentation approach, is to look for how those variable impacts consumer behavior and to form an overall view of the market, in order to frame our marketing strategy and implementation.

Demographic segmentation is a very common segmentation approach in the business world, primarily because it is simple, easy to understand, low-cost, and can be constructed quickly and precisely from government sources, such as Census data.

And often marketing students will use demographic segmentation because it is the only data that they have access to outside of a company. This creates a habit that students may carry into their business careers, again reinforcing the use of demographic segmentation.

As a result, demographics are often the “go-to” segmentation approach for small/medium size businesses.

Like with geographic segmentation, we are reliant upon an underlying assumption that there are similarities between demographic variables and purchasing/consumer behavior. In other words, all 30-year-olds have similar consumer behavior, or all females have similar purchasing habits, or all retirees have similar views to brands.

Obviously, we understand that this is not going to be the case. However, demographics may provide a good starting point to segmentation, especially if we can combine several of the segmentation variables. For example, thirtysomething females, married with children, working part-time – are more likely to share similar consumer behavior patterns.

Common demographic variables include:

age
gender
income
education
occupation
family size
family life stage/cycle
religion
ethnic background
and possibly social class (although this is more commonly classified as a psychographic variable, as it reflects lifestyle as well as a combination of demographics).

Let’s have a look at some of these variables and how they impact consumer behavior.

Let’s start with ethnic background. Ethnicity is likely to influence choices around food, clothing, travel choices, education of children, as well as general lifestyle and personal values.

As another example, gender has a big bearing on purchases such as cosmetics, clothing, jewelry, and even fitness centers, entertainment and possibly cars.

Ideally, what we need to look for is a clear connection between the demographic variable and our business model and its product mix. Although demographic variables are easy to obtain and split into segments, unless there is a relationship between them and consumer behavior, they are generally not powerful segmentation variables.

In addition to segmentation in their own right, demographics are often added to other segmentation approaches as descriptors, to give us more information a segment.

For example, we may define our preferred target market for our fast-food business as being “heavy users” – and by adding demographics we can see that these people are predominantly male and age 15 to 25.

Geodemographic Segmentation

Although not listed above as a core approach to segmentation, as suggested by the term, geodemographics is the combination of geographic and demographic segmentation.

It is typically used to define much smaller areas of the population. For instance, you may have been to a particular city or suburb where you have noticed distinct differences in housing as you travel through the streets.

That is, you may start in a very affluent area with big houses (indicating upper social class), and then a few streets away there is a reduction in quality of housing, indicating that lower/middle class people lived there. This means that the purpose of geodemographics is to identify these different “pockets” of consumers that exists in similar locations.

Geodemographics is usually constructed from Census data that is drilled down to its smallest level. There are multiple consulting firms that offer this data for sale and typically have constructed 100’s of segments across a large city or a country.

Psychographic Segmentation

Psychographic variables include personality traits, lifestyles, people’s activities, interests and opinions, values and mindsets. In other words, we are seeking to understand the consumer as a person first. What motivates them, what interests them, what they value, and so on?

Psychographic segmentation would also be used in the social sciences as well because it paints a picture of people, not necessarily consumers.

As marketers, we are looking to connect “what makes someone tick” to their purchases and other consumer behavior, such as brand loyalty, product usage, and so on.

As a result, we will end up have a very detailed understanding of the person, and how they live their life – “effectively getting inside their head”.

A common summary or checklist for psychographics is referred to as AIO which stands for activities, interests and opinions.

When reviewing AIO we would consider their interest in family, work, current events, entertainment choices, how they spend their spare time, travel and holiday preferences, hobbies, participation in sport, views on social and political issues, and so on.

There are multiple consulting companies that provide firms with psychographic segmentation, most commonly using VALS (values and lifestyle segments). These firms have built sophisticated analysis of consumers over many years and have constructed clear segmentation approaches, which they can match back to the needs of specific businesses.

However, please note that the breakup of psychographic segments differs across countries, as the foundational culture and lifestyle would be different. Therefore, the psychographic segmentation used in the USA is unlikely to be applicable to many other countries.

The key challenge in using psychographic segmentation is to establish a clear connection between the person’s lifestyle and their consumer behavior. We will end up with a very detailed understanding of the consumer, and then we need to identify the key factors that impact purchasing and product choice, as well as other key consumer actions.

That is the biggest challenge with psychographic segmentation. It is typically much deeper and more insightful than either geographic or demographic segmentation, but without a relevant connection to consumer behavior it lacks usability for marketers.

However, firms are getting more sophisticated in constructing appropriate psychographic segments they are becoming more commonly used in the business market because they provide a greater understanding of the customer.

With this improved understanding, firms are more able to structure effective marketing communications that tap into their motivations and mindsets. They are more able to design products that aligned to their needs and lifestyles. And they can build the supporting marketing mix elements that these customers expect.

Behavioral Segmentation

When we use the word “behavior” in marketing – we are not looking at people’s general behavior, but instead we are looking at how they behave as consumers. Which products do they buy, which brands they prefer, how price sensitive are they, how brand loyal are they?

Behavioral variables are tangible, measurable aspects of consumer behavior. To help make sense of this, think about large supermarket chains who commonly provide loyalty cards, which they encouraged to get scanned with every purchase.

By capturing this data on an ongoing basis, the supermarkets can construct detailed information about how their customers behave as consumers.

Likewise, major banks can capture substantial behavioral information about their customers. How often they use their cards, how often they buy things, what products/deals, and so on.

Behavioral segmentation is almost the opposite of psychographic segmentation. With psychographic segmentation we have a strong understanding of the person “as a person”, but not necessarily as a consumer.

Whereas, with behavioral segmentation we have a precise understanding “as a consumer”, but limited knowledge of them as a person and their lifestyle.

By using behavioral segmentation, we can often tap into what consumers are responsive to. In many cases, we can use marketing experimentation to fine-tune our understanding of these segments.

For example, a marketer may choose to offer different prices over time and see how responsive each market segment is to the offering. Likewise, they can introduce new product line extensions and then measure which segments are likely to trial/or not the new product offering.

As a result, behavioral segmentation is often based upon detailed and precise statistical analysis. It can be used in marketing mix modeling, where a company can construct a mathematical model of a market. They will know if they have a sales promotion with a 10% discount, what the resultant sales and profits will be.

Common variables used with behavioral segmentation include

Key benefits sought
Level of brand loyalty
Degree of price sensitivity
Volume of purchases = heavy or light users or non-consumers
Occasion = seasonal, special occasion versus everyday purchase
Buyer readiness stage (or stage in their customary journey)

Some textbooks may break out “key benefits sought” into its own top-level segmentation base, as it is commonly used particularly in fast-moving consumer goods (FMCGs) industries.

However, it can also be used in a variety of industries. For example, a car manufacturer may split benefits sought into three segments of:

practicality = seeking a low-cost, reliable, car ideal for day-to-day life
environmentally friendly = seeking an electric or hybrid car to help the environment
advanced technology = wanting the latest gadgets and features and best technology
status seekers = seeking a strong brand equity (and high price) for social/peer recognition of success

If a company has access to behavioral information, then behavioral segmentation becomes a powerful to use to guide their marketing. Certain industries, such as FMCGs and banking, have access to very detailed customer behavior.

However, companies that do not have access to this data will find it difficult to construct and use this form of segmentation.

Market Segmentation versus Product-Variety Marketing

What’s the difference between market segment and product-variety marketing?

Product-variety marketing is an approach used primarily by large consumer-focused companies to provide lots of product choices. It would be common practice for snack, beverage, toothpaste, cosmetics, breakfast foods, pasta, soup – and so on – manufacturers to engage in product-variety marketing.

A well-known example would be Coca-Cola and PepsiCo, who would run 100’s of brands and 1,000’s of products in most of the countries that they operate in.

Coca-Cola, in your average supermarket, would offer multiple flavor variations of Coca-Cola, plus with/without caffeine, plus with/without sugar (diet or not), in multiple serving sizes. Therefore, this large beverage company could potentially offer 100’s of choices of soda/soft drink in the SAME store.

This approach is unlikely to be driven by detailed market segmentation but is more likely to be a form of product-variety marketing, where we provide our consumers with a broad choice of product.

There are multiple reasons why a company like Coca-Cola would choose to do this, these include:

dominate shelf space within a store
strengthen retailer relationships
reduce gaps in the market that competitors can exploit
leverage existing manufacturing and logistics capability
leverage existing brand equity
and, by a simple variety technique, meet the needs of a broad variety of consumers

Please note that Coca-Cola’s decision to introduce other product lines – such as bottled water, flavored milk, iced coffee, sports drinks, energy drinks, and so on – are based upon market segmentation. However, once they are in those segments, they then use product-variety marketing to dominate market share and reduce competitor incentive to enter the market.

Related Topics and Further Reading

What is the STP Process?

An Example of the Segmentation, Targeting and Positioning Process

A Step-by-step Guide to Segmenting a Market

External Resources

Cluster Analysis for Marketing

Rediscovering Market Segmentation (HBR article)