The Art and Science

of Customer
Segmentation

Brought to you by Target Marketing, a Target Marketing Group Publication.

www.targetmarketmag.com
 The Art and Science of
Customer Segmentation

Smart customer segmentation is the bedrock of every successful marketing program.

It can be as simple as sorting buyers by ZIP code or as complicated as layering behav-
iors, demographics and attitudes to produce deeper insight.

Alan Weber, principal of Data to Strategy Group, wrote in a past issue of Target Mar-
keting that, “Housefile segmentation fits into a strategy to grow the customer base,
increase loyalty and grow share of customer. In some ways, it drives the strategy; in
other ways, it reflects the strategy. For example, an organization with a goal of rapid
growth would look more at lifetime value and future sales than an organization with a
goal to maximize cash flow today.”

By answering some fundamental questions, marketers gain insights from database

research that allow them to formulate effective segmentation plans with corresponding
marketing tactics attached. Weber breaks down the key areas:

To know who should be contacted, marketers need to be able to predict three

basic behaviors:
> How likely is he to respond?
> If he responds, how much is he likely to spend?
> Is he likely to continue to respond in the future?

To construct unique offers for different segments requires an understanding of

the needs and behaviors of each segment. It leads to testing and defines reasons
to test different offers:
> Is the average order substantially different among segments? Should buyers spending
$50 each purchase get a different offer than buyers spending $500 each purchase?
> Are different segments buying different things? Are “best buyers” simply buying expensive
items, and average buyers buying cheaper items?
> Are different segments buying more types of things, while some buy only one or two
things? In general, customers who buy a greater variety of items are more valuable.

Knowing which customers have the potential to become more valuable helps to
grow loyalty within the housefile. Here are some of the things you need to look
for to spot a target ready to move up to a more valuable segment:
> Does the customer look like—demographically, or firmagraphically in B-to-B— a “best
customer”?
> If she is buying only one or a few items, could she be sold a greater variety of items?
> If you have only one contact name, or no contact name (not unusual in B-to-B), would
reaching more people in the organization increase sales potential?

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 The best timing of offers often varies substantially between segments. To know
when to test, the marketer should understand:
> How seasonal is the market by segment? Typically, seasonality takes on two components.
Best customers tend to buy more regularly, and often less seasonally, than occasional
customers or first-time buyers.
> How often do customers buy? The more often they buy, the more appropriate it is to
contact them frequently. The less often they buy, the less appropriate it is to contact
them too frequently.
> How soon do they buy again after a purchase? For most consumable goods and
services, customers are more likely to return sooner rather than later. A quick follow-up
offer generally is effective.

To devise a strategy to most effectively increase best customers, the marketer

needs to know:
> Are best customers moving up in the database, or just dropping in from outside?
> Is enough emphasis placed on keeping customers, or are current customers being
ignored while the organization chases prospects?
> What is the right balance of marketing efforts between prospecting and retention?

To understand which triggers are most effective, marketers need to look for
specific customer behaviors that correlate with high or low spending. Typical
differences include:
> Average order. Some customers make many small purchases; some make a few large
purchases. In general, average order is a more effective segmentation tool than total
monetary value (overall spending). A recency-frequency-average order segmentation
usually will be substantially more effective than a recency-frequency-monetary
segmentation.
> One item vs. many. In general, the greater the variety of things customers buy, the
greater the likelihood they are to return. By contrast, a large customer who buys only one
item often has a high likelihood of defecting.
> Time on file. New customers often behave differently than customers who are set in
a pattern. New customers often try many different things; they are ripe prospects for
cross-selling.

To pursue the most appropriate media mix, ask:

> Does a combination of media produce better results?
> Do some customers prefer one medium over another?
> Does general media, like magazines or radio, produce good prospects or inquiries?

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 One Is Not Enough
With today’s society so fragmented with respect to media consumption and demo-
graphics, marketers will see better results from segmentation efforts when they layer
various segmentations. Don Ryan, senior partner at iKnowtion, pointed out in an issue
of Tipline that building relationships with customers, as opposed to promoting prod-
ucts, “means understanding customer characteristics, attitudes and behaviors. And
no one segmentation scheme can depict all that.”

He referred to the example of a financial institution that combined attitudinal, demo-

graphic and behavioral segmentations, using information on the resulting customer
subgroups for its “long-range planning process and to inform its service model, cus-
tomer experience and direct marketing programs.”

Taking this concept a bit further, David Vergara, director of product marketing at
SPSS, an IBM company, noted in Target Marketing the importance of adding predic-
tive analytics to segmentation activities. He explained that “the result is a better un-
derstanding of what products and services customers are likely to want next.”

As Vergara sees it, “Predictive analytics technology incorporates data collection,

statistics, modeling and deployment capabilities, and drives the entire segmentation
process, from gathering customer information at every interaction to analyzing the
data and providing specific, real-time recommendations on the best action to take at a
particular time, with a particular customer.

The following is his six-step road map to a comprehensive segmentation process

that leverages predictive analytics for more meaningful results:

1. Determine the Overall Business Objective. Get everyone on the same

path and in agreement with what you want to accomplish, such as improving the yield
on lead-generation efforts, identifying cross-sell opportunities or identifying customers
most likely to go to a competitor.

2. Capture All Potential Customer Data. Segmentation begins with gath-

ering customer data from a wide variety of resources, including data warehouses,
point-of-sale systems and loyalty programs.

A database of static customer information is valuable, but until key active knowledge
gained from feedback is applied—like preferences or motivations—there’s an incom-
plete picture of the customer.
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 Capturing feedback from any touch point—in any language—provides a clearer
understanding of customers’ needs, preferences and attitudes, and improves the
segmentation process.

3. Perform Recency, Frequency and Monetary (RFM) Analysis.

To obtain the most accurate picture of customer lifetime value, organizations first
should perform RFM analysis to classify customers according to: those who have
spent the most—the most often and most recently; those who have spent the most—
the most monetarily, but may not have purchased in a long time; those who spend the
most in the fewest number of transactions; and those who spend the least, or rarely,
and have not purchased in a long time.

4. Outline the Segmentation Process. Once an organization has identified

customers based on purchasing patterns, it then can begin segmentation analysis to
get to the core of the audience it wants to target.

Three Segmentation Pitfalls to Avoid

A couple customer data missteps that marketers want to watch out for include:

✓ Duplicate customer records: In an issue of Tipline, Mary Ann

Kleinfelter, vice president of marketing at L-com, warned market-
ers to account for duplicate names and/or addresses, which could
lead to faulty messaging. For example, a customer with two different
records—one showing a recent purchase and one with no activity for
a year—could be sent two different e-mails, one for good customers
and one indicating the marketer noticed her business had slipped.

✓ Inconsistent definitions of segments and related data sets:

What does one-time buyer mean to your organization? To produce
reliable results over time, Kleinfelter stated, marketers should ensure
metrics are consistently defined.

✓ Leaning too heavily on attitudinal or demographic data: Since

past behavior is the best predictor of future behavior, marketers
should first focus on behavioral attributes in conjunction with demo-
graphics, says Randy Erdahl, president of Clario Analytics and who
also was quoted in the same Tipline article.
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 The key to a successful segmentation program is to first define the many ways the
results can be used. A simple approach might take the following path:
> Create customer segments to enable differential marketing programs.
> Use past purchase data and demographics to construct customer subgroups.
> Isolate key performance factors linked to long-term customer value as major data
drivers for the segmentation.
> Use cluster analysis to form homogenous groups of differently valued customers.
> Use techniques such as rule induction to automatically extract the profile of
each cluster.
> Align the marketing spending priorities against each subgroup.
> Link product line or category affinity to each subgroup.
> Develop marketing plans incorporating value-based budgeting and category affinity
to make programs more relevant and efficient.

5. Auto-Segmentation. With a customer base more clearly defined through

effective segmentation, organizations then can add predictive modeling functionality
within each segment to produce greater insight that’s required to more effectively and
efficiently acquire, grow and retain the right customers, and also identify fraud and
minimize risk.

The modeling functionality in predictive analytics technology helps organizations

accurately determine which customers best match specific offers or campaigns. By
eliminating the guesswork when targeting customer groups, organizations quickly
increase ROI through more efficient use of resources and reduced spending.

6. Deploy and Share Results Throughout the Business. The final step
is to create an environment in which an organization can manage and automate its
analytical processes and easily deploy the results across the enterprise—thus improv-
ing productivity and collaboration and increasing ROI.

This includes the ability to automate the database scoring process, publish and dis-
tribute output and reports, and integrate the analytical process into other business ap-
plications. For example, when a customer calls a call center, that agent should be able
to pull up information on that specific customer and know what type of offer should
be made at that particular time.