Segmentation & Targeting

Segmentation & Targeting 1 Segmentation & Targeting Key Concepts market segmentation process market segmentation strategies calculate the value of current customers with RFM & ABC accounting estimate the future value of acquiring new customers with CLV Segmentation Market segmentation Process of dividing the total market into well-defined slices of relatively homogenous groups using factors such as demographics, psychographics, geography, and behavioral considerations The goal is to create a market segment that consists of a group of customers who share a similar set of needs & wants relative to the solutions you provide. This intra-group homogeneity should result in meaningful intergroup heterogeneity when segments are compared to each other

Segmentation & Targeting 2

Segmentation & Targeting 4 climate Psychographic values attitudes lifestyle personality Demographic age family size family life cycle life stage gender income occupation education religion race generation nationality social class Behavioral Considerations Behavior needs/benefits sought decision rule usage occasion usage status

Segmentation & Targeting 5 usage rate loyalty status buyer-readiness stage Segmentation Variables Geographic Divide the overall market into groups based on geography. most products derive the majority of their sales from a very small number of regions Demographic divide consumers into groups based on gender, income, age, occupation, race, religion, education etc Psychographic potential buyers are divided into groups on the basis of psychological / personality traits, lifestyle, or values Behavior Divide buyers into groups on the basis of their knowledge of, use of, or response to a product. Unlike descriptive characteristics, this segmentation base employs actual behavior to segment the market many marketers believe variables related to actual usage behavior are good starting points for constructing market segments Effective Segmentation Criteria - Select Segments to Target A segment must meet the following 5 criteria to be effective the segment is measurable segment is conceptually differentiable & is unique in its response to marketing mix elements & programs segment must be reachable thru promotion & distribution segment must be profitable segment must be relevant to the firm’s mission, objectives, & resources

Segmentation & Targeting 7 everyone is a customer one (maximally large) market segment Economies of scale for production, distribution, and advertising Differentiated Marketing A market coverage strategy in which numerous products are offered to different segments through differential use of the 4Ps Currently the most common strategy Pros higher per capita sales (vs mass mktg) higher shares of segment stronger position within each segment Cons Concentrated / Niche A market coverage strategy most often used by small firms that directs the firm’s efforts toward serving a very small segment 1 to 1 Also called customized marketing, it’s an extreme version of differentiated marketing, where the company strives to meet the needs of very small segments by customizing its offering to fit the individual customer’s need where many of today’s firms are headed Targeting with the Help of CLV From segmentation to targeting Calculate the value of current customers with RFM & ABC accounting Estimate the future value of acquiring new customers with CLV

Segmentation & Targeting 8 Evaluating Current Customer Recency Frequency Monetary Value (RFM) Analysis A method for rating customers based on 3 key purchase characteristics Process for an RFM analysis (emphasizes revenue ) A coding system is created that is relevant to the firm & its category context Weights are assigned to each component Individual customers are coded & assigned a single overall RFM score

Segmentation & Targeting 10 Some Customers are More Costly to Serve Than Lose Study Industry Result Niraj, Gupta, and Narasimhan (2001) B2B: Wholesale/Distribution 32% of customers from sampled firms, including some of the largest customers, had negative gross margin Helm, Rolfes, and Günter (2006) B2B: German Mechanical Engineering 17.5% of respondents claim that 50% of their customer base is unprofitable. Storbacka, Strandvik, and Grönroos (1994) B2C: Swedish Retail Banking It is not uncommon for 50% of a retail bank’s customers to be unprofitable in Europe Kumar and Shah (2009) B2C: Retail stores 30% of the customers are unprofitable. Examples of Customer Firings & their Performance Companies Events Reasons Results First Chicago (NYT, April 27, 1995 ) It introduced $3 teller fee on its 3% unprofitable customers Unprofitability It made an adequate return on 44% of customers, vs 33% beforehand Bank One (WSJ, Jan 7, 2001) It dropped 33% of its customer loan portfolio Unprofitability It saved $1 billion

Segmentation & Targeting 11 Companies Events Reasons Results Nationwide and Allstate Insurance (WSJ June 5th, 1996) They dropped 35,000 and 95,000 homeowner policies in Florida Fear of losses from future hurricanes Allstate’s stock price surged 5.7%. They received lots of criticism from govt agencies and activist groups Sprint Nextel (WSJ, July 7, 2007) It fired 1,000 unprofitable customers Unprofitability It got lots of bad WOM and its stock price dropped by 2% CLV: Estimating a Customer’s Future Value The net present value of all future streams of profits that an individual customer generates over the life of his her business with the firm Focuses on an individual customer’s profit over the long term Can be used to quantify how much our total customer base is worth Can distinguish profitable segments from unprofitable segments Helps determine the max dollar amount we should spend to acquire a new customer and retain/serve existing customers A forward looking projection of customer value How should we value customer loyalty (ie repeat purchases) from a particular customer Gross margin = price - unit variable cost Asics GM = $100-30=$70 Running shoe purchases going forward 5 years Accounting for the TVM i = interest rate used for discounting Note that in this CLV formula, we assume profits are booked at the beginning of each time period $70 + Y 1 $70 + Y 2 $70 + Y 3 $70 + Y 4 $70 = Y 5 $350 + (1+ i ) 0 gm t + (1+ i ) 1 gm t +1 + (1+ i ) 2 gm t +2 + (1+ i ) 3 gm t +3 (1+ i ) 4 gm t +4

Segmentation & Targeting 13 my retention rate = 1 - 8% = 92% t = year % still with Asics in Year t 1 100% 100% 2 92% 92% 3 92% 85% 4 92% 78% 5 92% 72% New Customers Don’t Grow on Trees p = conditional purchase probability given that I was a customer in year t-1 t r = unconditional purchase probability year t t −1 p t r t −1 .92 (1−1) .92 (2−1) .92 (3−1) .92 (4−1) .92 (5−1)

Segmentation & Targeting 14 AC = Acquisition Cost For a given segment, this is the per capita cost to earn the business of an individual customer $A = $ amount spent directly on the acquired prospect a = % of a prospect becoming a customer (yield rate) AC = $A If Asics needs to spend $100 (per group of 10 people) to reach a 10% yield rate (a) for the segment to which i belong, then my AC is $100 (even though my $A was only $10) ie AC = $10 / 10% yield = $100 & my 5 year CLV for Asics = What is the most Asics should spend to acquire my business $253.16 ≥ AC A ≤ $253.16 *10% yield $A ≤ 25.32 Estimating Acquisition Cost aka Custom Acquisition Cost AC = → AC = CLV: Quantifying the Value of Customer Segments $253.16 − $100 = $153.16 a $ A the % of a prospect becoming a customer the dollar amount spent directly on the acquired project Number of new customers acquired Total costs attributable to attracting 1st time customers

Segmentation & Targeting 16 = $132.09 compared to $153.16 without coupon Sample Problem with Retention Expenses Ruth Langmore manages the Missouri Belle casino, located in the state’s Ozark region. She is wondering whether the Missouri Belle should target a potential new customer named, “Mr. Navarro.” If he becomes a customer, she thinks the Missouri Belle should offer him free transportation to and from the airport during each of his visits (at an estimated annual cost of $300) in the first two years (i.e., during the t = 1 and t = 2 time periods). Based on the following, what would Mr. Navarro’s three-year CLV be to the Missouri Belle if he were given this free transportation incentive? Would this be a justifiable expense?

Segmentation & Targeting 17 5000 annual revenue * 20% gm = $1000 CLV Sample Problem: Bonobos Andy Dunn is the Chief Marketing Officer at Bonobos, an e-commerce-driven men’s apparel company. He is trying to determine which market segment to target with his company’s fall clothing line. He has narrowed potential customers down to two segments: (1) fashion-forward city-dwellers that buy clothing often but exhibit little brand loyalty (“Blue Jays”) and (2) style- conscious young professionals that live in the suburbs and exhibit intense brand loyalty (“Cardinals”). Based on the following projections (assuming an infinite time horizon), which customer segment should Bonobos target? Under what circumstances will one segment be preferred over the other? [ + 1 (1000−300) ∗1 t + 1.1 (1000−300) ∗.50 ( t +1) ] − 1.21 (1000−300) ∗.25 ( t +2) 1200

Segmentation & Targeting 19 Bc CLV is the maximum benefit an organization derives from a customer over their life, it can be used to establish customer acquisition cost limits CLV is not static. Organizations can improve customers’ CLV by understanding the factors that drive CLV. Increasing customer retention has a major impact on CLV bc customers stay longer & provide more profits to the firm CLV helps make investment decisions. Allows you to link customer satisfaction / relationship management programs to retention rate