WHITEPAPER 10 Secrets to Segmentation Success MARCH 2007 Marcy Riordan | Vice President, Consulting Services 35 CORPORATE DRIVE, SUITE 100, BURLINGTON, MA 01803 T 781 494 9989 | F 781 494 9766 WWW.IKNOWTION.COM PAGE 2 10 Secrets to Segmentation Success Some customer segmentation approaches last, many don’t. Some have driven entire organizational structures, marketing strategy, and financial success, while others were barely actionable upon arrival. What is the secret to segmentation success, and how can you avoid the pitfalls? This article outlines the 10 critical steps required to develop and implement a successful customer segmentation scheme. Customer segmentation initiatives are usually launched from a simple yet valid premise: “not all customers are created equal.” Of course this is true, but does it matter, and should you care? The answer is a resounding yes, but only if you are able to segment your customers in a meaningful and actionable way - a way that can truly make a difference. Segmentation approach and function can vary, and while there are many ways to differentiate customers, the focus here is primarily on behavioral segmentation, given its ability to be applied uniquely to each customer and appended to a database for marketing purposes. While behavioral segmentation is a highly actionable approach, it is not the only alternative; it can integrate well with, and is often influenced by, attitudinal and/or needs-based segmentation. Figure 1 Segmentation can take on many forms, each uniquely able to support varying business objectives It is important to keep in mind that segmentation is much more than a statistical exercise. Bringing customer data together and running it through a statistical package in an undirected manner is not only a potential waste of money, it could represent an enormous missed opportunity. Often times you will only have one chance to persuade the skeptics, or perhaps even persuade yourself, that investing in a segmentation scheme is worth it. PAGE 3 10 Secrets to Segmentation Success Segmentation can be a huge endeavor, with operational implications (such as householding, data purchasing, ongoing scoring) and organization hurdles (establishing new goals, objectives, reporting, roles / responsibilities). If done right, it’s a significant investment that could reap even greater rewards. The 10 Secrets to Segmentation Success - Checklist Clearly define the business needs Identify the profit levers Determine a methodology that aligns with both the business goals and user requirements Explore alternatives Vet through multiple constituents Bring the segments to life through extensive customer profiling Identify how the segmentation can be used in conjunction with other analytic tools Identify quick hits where the segmentation can make a difference to gain near term traction Invest in a well thought-out segment development plan as the foundation of long term strategy Proactively identify measures of success in order to quantify the benefit Step 1: Clearly define the business needs. This may be the most important step; one that is too often overlooked. While high level business goals, such as increasing sales, improving retention, or raising profits are generally well understood, the key is to go one step further. Push yourself and the key stakeholders to address the question, “How could segmentation get me there?” Think about what could practically and realistically be accomplished, armed with a segmentation. What tactical objectives or current processes could be improved? How? For example, one way to increase sales may be to develop targeted cross-sell and up-sell strategies. Understanding different customer groups, their buying behaviors, and their value potential through a segmentation - and developing targeted strategies based on those insights is an achievable way to reach broader sales goals. The reason this step is often overlooked is that what seems straight-forward on the surface really isn’t. Each key stakeholder will likely have a different take on how segmentation could be used to help achieve overarching business objectives. Ample time must be spent with key constituents contemplating segmentation objectives and applications. If this doesn’t happen up front, your segmentation will likely be off the mark. Step 2: Identify the profit levers (business and marketing), then draw a connection between customer attributes and differences across those profit levers. Once you have clearly established goals and objectives, the next step is to identify the levers - that is, the customer behaviors that drive business results and can be influenced by marketing actions. For example, your goal may be to drive profitability, and there are several ways to do that: increase purchase frequency, shift purchases toward higher margin goods, cross-sell new products, or decrease costs. Come up with a short and manageable list of those profit levers. The best segmentation solution is one where there are distinct differences in the profit levers across segments, and there is real potential to improve on profit- producing performance. PAGE 4 10 Secrets to Segmentation Success Consider a retailer of consumer goods, where four key levers are identified: transaction activity, product margin, product discounts, and incremental sales potential. A lifestyle and demographic based segmentation might be the first logical choice, because there is such an intuitive connection to product preference. However, when demographic groups are measured by spend behavior (or “RFM:” spend recency, frequency, and monetary value), results are often flat. Thus, there is little actionability for that segmentation approach beyond creative tailoring. In this case, a behavioral segmentation could be a far superior solution, because it would reveal the strongest differences across the levers, while making it much easier to craft differentiated offers and strategies - not only by varying creative, but by varying offers, communication cadence, and segment-level objectives. Step 3: Determine a methodology that aligns with both the business goals and user requirements. After devoting sufficient time to addressing the business needs and segmentation drivers (i.e., the profit levers), it is time to identify the methodological approach. This is another critical step where a wrong turn could spell disaster. If at all possible, ignore any “demands” from the business to let the segmentation approach be entirely data driven or statistically based. Segmentation schemes must be directed at some level to ensure they have impact on the business. Detractors from this philosophy may argue that a guided approach will force a foregone conclusion without letting the data speak for itself. While it’s true that an undirected analysis may help uncover unexpected patterns in the data, human intervention is absolutely critical. The best solution is an iterative process that starts with hypothesis-based EDA (exploratory data analysis), and allows the developer of the segmentation to identify key differences across groups that can be influenced and are actionable. In my experience, I have observed a predictable (and avoidable) outcome of purely data-driven (i.e., undirected) segmentation: the creation of the “Average Joes” Segment. What is a marketer supposed to do with a segment labeled “average?” One shouldn’t stop there. It is advisable to keep working through the data until segments are uncovered that are all distinctly different in some way and represent unique marketing opportunities. Step 4: Explore alternatives. Before arriving at a final solution, think broadly and test several possible alternatives. Identifying a solution early on (perhaps due to artificial time constraints) and sticking to it without adapting as you learn is likely to result in a sub-standard compromise. Keep exploring for a while! Meeting a short-term deadline is much less important than finding the right long-term solution. If your solution is a good one, it will far outlast the next marketing campaign or board meeting. On the other hand, if time is truly of the essence (often a business practicality that can’t be overlooked), and as a good practice overall, plan for annual review and evolution of the segmentation so it reflects the current dynamics of the business. Step 5: Vet through multiple constituents. Another essential element for success is the right level of communication throughout the project before locking in the final solution. The user community and key stakeholders throughout the organization can provide invaluable perspective and insights. Their participation early in the project will ensure commitment and buy-in. PAGE 5 10 Secrets to Segmentation Success It will also ensure that decisions are aligned with business needs and important details are not overlooked. Before the project even begins, outline a plan with project checkpoints and updates, along with an opportunity for stakeholders to contribute. This will ensure adoption. Of course, fostering too broad of a steering committee and/or allowing highly frequent user input can be dangerous. The misguided stakeholder may want to force groups that meet only individual objectives or conflict with observed data trends. Similar to the management of directed versus undirected approaches, this is an area that must be carefully balanced. Step 6: Bring the segments to life through extensive customer profiling. Once the segments are defined, an absolutely critical step is running extensive profiles of the segments. This is the only way to “bring the segments to life” and explore all of the business potential that each group represents. Make sure to provide descriptive profiles that include demographics (available through data overlays) such as lifestage, age, income, presence of children, and lifestyle interests. Also include all of the key behavioral metrics, particularly customer value components (that is, the revenue and cost elements of the value equation, such as product margin and marketing costs), and a summarized customer value measure. If possible, a future value projection for each segment is extremely useful at this stage. One additional component that could be added here is a historical segment migration analysis. Typically, the segmentation is “rolled out” to the key stakeholders in a formalized presentation, which should include detailed findings from this profiling study. This is the beginning of the indoctrination process. Stakeholders within the organization will relate to the segments and be able to identify the marketing opportunities only if the segments are adequately described and easy to understand. Catchy but intuitive segment names are also an important part of this process. If done well, they will become part of the company vernacular. The profiling study should be interesting, with actual marketing ideas that get the audience excited about the segmentation’s potential - after all, isn’t it what they’ve been waiting for? Step 7: Identify how the segmentation can be used in conjunction with other analytic tools. Segmentation becomes even more powerful when used in conjunction with other analytic tools. Predictive models are the most logical companion to segmentation. In most instances, models are the best tool choice for targeting, because they provide the most direct way to pinpoint customers with a desired behavior. Segmentation, on the other hand, is best applied for investment allocation decisions and tailoring, because segmentation uncovers customer groups with distinct characteristics and potential. Just think of the possibilities when you can first target customers through a model, and then split that group of customers by segment. Now you are able to narrow the list to make it the most efficient, and then employ segmentation to differentiate on program dimensions (offer, message, channel, etc.) to make it most effective. There are many other tools that work well with segmentation. A marketing optimization engine will help identify how to allocate an offer budget across customer segments to achieve optimal results. A customer lifecycle also works well with a segmentation, providing marketers with a tool to aim programs at a specific objective (long-term relationship marketing versus short terms sales, for example), and then apply differentiated treatments within those broad objectives. And, it is not uncommon for two different segmentation schemes to work well together; for example, a behavioral segmentation combined with a lifestage-based segmentation. PAGE 6 10 Secrets to Segmentation Success Step 8: Identify quick hits where the segmentation can make a difference to gain near term traction. If done right, the analysis leading up to the segmentation along with post-segmentation profiling will spark an abundance of marketing program ideas. Identify the high impact, easy to implement programs where the segmentation will make a difference - either through refinement of existing programs or creation of new ones. Plotting the segments across a Segment Opportunity Grid highlights priorities and differing levels of potential. Figure 2 Segment Strategy Grid High Retain / Improve Frequency Defend and Grow Segment 1 Segment Segment 7 2 Segment Segment 4 6 Segment 10 Expected Value Monitor and Selectively Invest Retain / Improve Margin Segment Segment 9 6 Segment Segment 8 3 Low Low Purchase Frequency High Based on their characteristics and behaviors, the segments will align themselves under alternative marketing strategies deserving different levels of investment Often times, the number of marketing program ideas outpace the organization’s ability to act on them all. In that instance, a business case driven approach should be employed to help prioritize the initiatives. PAGE 7 10 Secrets to Segmentation Success Step 9: Invest in a well thought-out segment development and test plan as the foundation of a long term strategy. True segment level marketing goes beyond one-off programs. An organization that is committed to customer differentiation through segmentation will follow a long term Segment Development Plan. In this case, segmentation provides the foundation to build customer relationships “end to end” across their entire lifecycle. Remember, each segment represents diverse behaviors, interests, and opportunity. Different levers will be pulled for different segments at different times. A comprehensive plan for each segment should include segment level objectives and tactics, unique value proposition development, targeting / tailoring / testing plans, and a longitudinal contact management plan. Step 10: Proactively identify measures of success in order to quantify the benefit of a segment-driven marketing approach. As data-driven marketers, we thrive on the fact that our discipline is highly measurable. From the start, segment-level performance should be baselined against key success metrics, with goals established to improve above the baseline. Develop segment-level dashboards to communicate segment performance and track trends over time. Through a well-developed test plan, the benefits of segment-level marketing can be quantified and, ultimately, celebrated. This includes the establishment of proper control groups and results reporting at the segment level. It also helps to create test groups where segment-level differentiation is measured against a “generic” treatment. Ideally, multiple treatments would be tested across each segment in order to identify which treatment works best for which segment, without having to make that judgment up front. *** If executed properly and carefully, segmentation is a powerful tool that can improve marketing performance and business metrics. It can facilitate the development of variable offer strategies, more tailored communications, customer-specific product offers, and detailed customer insight. Follow these 10 Steps and you will be on your way to a successful customer segmentation that is sure to deliver business results. Marcy B. Riordan is Vice President, Consulting Services with iKnowtion, a marketing and analytic consulting firm located in Burlington, Massachusetts.