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Customer Analysis: Segmentation

MKTG 613 Prof. Suresh Ramanathan

Customer Analysis and the STP-Process

Market Segmentation Targeting Product Positioning

1. Identify 3. Evaluate the 5. Identify possible

segmentation attractiveness of positioning
variables and each segment concepts for
segment the each target
market segment
2. Develop profiles 4. Select the target 6. Select, develop,
of resulting segment(s) communicate the
segments chosen
positioning

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Customer Analysis: Segmentation Lecture Overview

• What is segmentation and how do we use it?

• How do we profile market segments?
– Descriptive approach
– Behavioral approach

• Cluster Analysis

Market Segmentation -- What is it?

The process of subdividing a market into distinct groups of

consumers with similar needs, so that a subset or subsets
of the market may conceivably be selected as a target
market to be reached with a distinct marketing mix.

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Credit Card Portfolio Segmented by FICO Score

Net Portfolio Yield by FICO Risk Score

10
36% of Accounts
5 26% of
Accounts
0

-5

-1 0
Yield
-1 5

-2 0

-2 5

-3 0

-3 5
2 4 6 8 10 12 14 16 18 20 22 24 26 28 32 36 38 42 44 48 52 56 60 74 96

Risk Score

5
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Why Do We Segment Markets?

• Reduce risks
– Avoid “if I build it, they will come” blunders: “You have to get someone to buy your product before you get
anyone to buy it.” (Haley)
– Avoid being misled by data aggregated over many segments

• Customer heterogeneity
– Differences in needs and responses

• Increases probability of match

– Ability to stay ahead of competitors

• More informed allocation of resources

– Better return on marketing investments
– Targeted communication

• Improved efficiency of marketing action

– Leads to greater satisfaction and loyalty

• Pragmatism
– Can’t be all things to everyone

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Evolution of segmentation practice

1) Emphasis on accessibility: Geographic and demographic segmentation

based on characteristics

2) Emphasis on past behavior: Volume or Recency-Frequency-Monetary

3) Emphasis on prediction of future behavior: Benefits segmentation

+
One-to-one marketing, mass customization

Segmentation: The Descriptive Approach

• Segment consumers according to descriptor variables

– Consumer markets
• Location: geography (country, city, zip code, …)

• Demographics: age, gender, ethnicity, education

• Socio-economic characteristics: income, wealth, family status

• Psychographics: lifestyles, values, personality

• Media patterns: usage levels of different media, times of use

– Industrial markets (Shapiro and Bonoma)

• Location

• Industry
• Firm size
• Technology employed
• Method of buying (components, systems, auctions)

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Ethnic differences in consumption

Product African Hispanic Asian

American American
Decaf Coffee 19% 20% 13%
Toothpaste 92 95 93
Frozen Vegetables 40 21 17
Canned Soup 53 32 36
Toilet Paper 95 95 93
White Rice 73 89 90
Potato Chips 52 36 41
Peanut Butter 54 31 51
Condoms 16 9 12

Elvis lives!

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Segmentation: The Behavioral Approach

• Segmentation based on behavior or response
variables that describe consumer behavior with
respect to the product
– For the marketer, are descriptor or behavior variables more
useful basis variables for a segmentation scheme?
Behavior variables
o Benefits sought
Descriptor variables
o Attitude towards product
o Zip code
o Likelihood of purchase
o Age, family size, …
o Price sensitivity
o Income, education
o Purchase volume
o Asset ownership
o Loyalty – retention rate
o Lifestyles
o Customer lifetime value
o Media patterns
o Media response
o Need for service

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Segmentation: The Behavioral Approach

• Behavioral segmentation captures those differences across consumers that
are ultimately of interest to the marketer
• Segmentation method:
– Choose relevant behavior/response variables
– Form segments

– Use the descriptor variables to build profiles of the segments

Behavior Descriptor
Variables Profiling Variables

• A segment profile describes the typical (average) location, demographics,

lifestyles, media patterns, etc., of the customers in the different behavior
segments
• These profiles aid delivery of the 4 P’s to the target segments.

13• Is behavioral segmentation useless without profiling?

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Two segmentation approaches:

Descriptive vs. Behavioral

Descriptive
Start here any pattern here ???

ACCESSIBILITY PREDICTIVE
OF SEGMENTS OF BEHAVIOR
Segmentation criteria

any pattern here ??? Start here

Behavioral
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Behavioral

• Examples
– Occasions, user status, user rate
• fairly easy to measure
• fairly easy for competitors to measure
• highly predictive of sales

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Behavioral

• A good place to start

– Existing Customers – Retention
• Exclusive buyers (loyal?)

• Multi-brand buyers

– Potential Customers – Acquisition

• Exclusive competitor buyers

• Multi-brand competitor buyers

• Not buying in category at all

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Customer Retention
Impact on Profit

80
Profit from price premium
60 Profit from referrals
40 Profit from reduced cost
Profit per Profit from increased
customer
20 purchases
0 Base profit

-20 0 1 2 3 4 5 6 7

-40 Acquisition
-60 cost

Years
Source: Reichheld and Sasser (1990), “Zero Defections: Quality Comes to Service,” HBR, Sep-Oct.

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Attitudinal

• Examples
– Preferences, opinions, beliefs

• difficult to measure
• may predict sales
• dynamic
• can provide competitive advantage

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Behavioral Approach Example: Benefit Segmentation

• What is a product? – A bundle of benefits

• Customers often differ in the importance they attach to
different benefits.
• Useful without profiling? How to get profiling?
• Importance weights for wireless calling plan features:

Consumer A Consumer B Consumer C

Custom data
5 1 3
applications

Price 2 5 3

Can use a stylish

2 1 5
phone
Nationwide
4 2 4
coverage

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Market Segmentation: An Example

CAD System Design Components

Design Inputs Design Options

Input Mode
• Buttons With 162 alternative product-price design
• Mouse configurations … which configuration
• Tablet would best serve customer needs?
Resolution
• 640 x 480 Pixels
• 860 x 1020 Pixels
• 1024 x 1280 Pixels
Display Monitor Alternative Design Configuration
• Black & White
• Color with 8 Planes
• Color with 12 Planes
Price Level • Screen Size. . . . . . . . . . . 17 inches
• $ 7,000 • Screen Resolution. . . . . 860 x 1020 pixels
• $10,000 • Input Mode. . . . . . . . . . . Mouse
• $13,000 • Display Monitor. . . . . . . . Color w/12 planes
Screen Size • Price . . . . . . . . . . . . . . . . $13,000
• 17 inch
• 27 inch

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Market Segmentation Based on Customer Design Preferences Yielded Two

Unique Design Configurations … One for Each Segment

Market Segmentation
Segment I
Segment II • More price driven
• Places greater value on
• Less price sensitive
input mode and screen
• Puts value on
resolution size
and color display

Optimal CAD System Design … Segments I & II

Segment I Segment II
Design Input
Prefer Importance Prefer Importance
Input Mode Mouse 1 Tablet 5
Resolution 640 x 380 pixels 5 1024 x 1280 pixels 1
Display Monitor Color 12 planes 4 Color 12 planes 2
Price Level $7,000 3 $10,000–13,000 3
Screen Size 27” 2 27” 4

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Requirements for Useful Segmentation

Measurability
– The degree to which the size and purchasing power can be
measured in the segments

Durability
– The temporal longevity of the segment is sufficient to generate a
positive NPV for serving the segment

Accessibility
– The degree to which the resulting segments can be reached and
served usually by the use of descriptor variables

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Requirements for Useful Segmentation

Substantiability
The degree to which the resulting segments are large and/or profitable
enough to warrant a separate marketing mix

Homogeneousness
Within-segment differences are small, while
across-segment differences are large.

Difference response function

Segments must have different response functions to
any individual or combination of marketing decision variables

Otherwise there is no point in segmentation!!!!

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Choosing Relevant Descriptors

Relevant Descriptor Irrelevant Descriptor ?

Fraction of Customers

Low High Have No

Educatio Education Kids Kids
n

20% 80% 30% 40%

Likelihood of Smoking Low-Tar
Likelihood of Smoking Low-Tar
Cigarettes, given Smoker
Cigarettes, given Smoker

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Dealing With Multiple Basis Variables

• Often, one needs multiple bases for segmentation

– Credit card account: Average annual balance held, default risk,
number of transactions
– Digital camera: Importance of resolution, easy to use, want to
print out pictures, willingness to pay

• Suppose there are N such basis variables. Let each variable have L
levels. Then the number of possible segments is LN . E.g., 310 =
59,049 segments!

• Hence, there may be “too many” segments

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Multiple Basis Variables: Cluster Analysis

• If there are several basis variables, use a statistical procedure called

cluster analysis to group customers

• How does cluster analysis work? – Maximize variation (or distance)

across groups, minimize variation within groups

• How do we decide how many segments to have?

– In the previous example, should we retain all segments? Or reduce to
fewer segments ?
• How do we know which variables to use, and how to scale them?

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Cluster Analysis: Purposes

Dimension 2
Cluster analysis is a multivariate technique
for grouping objects (e.g., consumers,
brands) into unknown groups. In marketing,
it is primarily used for Dimension 1

– Market segmentation where objects are consumers

– Market structure analysis where objects are brands

Two main types of cluster analysis

– Hierarchical: to explore different ways of cluster formation; easier for a
smaller number of objects
– Non-hierarchical: number of clusters known/fixed; may be more practical
for a larger number of objects

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Example: Beer Market Structure

Brand Calories Sodium Alcohol Price

(12 oz.) (mg./12 oz.) (%) (Wholesale)

1 BUDWEISER 144 15 4.7 .43
2 SCHLITZ 151 19 4.9 .43
3 LOWENBRAU 157 15 4.9 .48
4 KRONENBOURG 170 7 5.2 .73
5 HEINEKEN 152 11 5.0 .77
6 OLD MILWAUKEE 145 23 4.6 .28
7 AUGSBERGER 175 24 5.5 .40
8 STROHS BOHEMIAN STYLE 149 27 4.7 .42
9 MILLER LITE 99 10 4.3 .43
10 BUDWEISER LIGHT 113 8 3.7 .44
11 COORS 140 18 4.6 .44
12 COORS LIGHT 102 15 4.1 .46
13 MICHELOB LIGHT 135 11 4.2 .50
14 BECKS 150 19 4.7 .76
15 KIRIN 149 6 5.0 .79
16 PABST EXTRA LIGHT 68 15 2.3 .38
17 HAMMS 136 19 4.4 .43
18 HEILEMANS OLD STYLE 144 24 4.9 .43
19 OLYMPIA GOLD LIGHT 72 6 2.9 .46
20 SCHLITZ LIGHT 97 7 4.2 .47

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Step 1: Standardization

(X - X ) Z = standardized variable X= original variable

Z=
SX

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Step 2: Hierarchical Cluster Analysis

• Goal: to group/form clusters of beers
with similar profiles (based on the
beers’ characteristics) so that
marketers can better understand which
beers compete more directly with one
another.
• Number of clusters are not known in
advance
• The formation of cluster is sequential
in nature.
• Similar to factor analysis, the
determination of clusters is also
subjective.

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Distance Measure And Cluster Method

Distance measures (between object i and j):

– Squared Euclidean distance (Dij) is used for continuous variables.
– Standardization also makes this distance measure applicable to all types of
variables (xik and xjk = variable k characterizing object i and j, respectively).

Dij = å ( xik - x jk ) 2
k
e.g., D12 = (.383-.615)2+(.008-.615)2+(.342-.605)2+(-.462+.462)2 = .492

Cluster methods:
– Centroid method - clusters are generated to maximize the distance
between the centroids of clusters (a centroid is the mean value for all the
objects in the cluster). -> as a result, objects that are similar will be
grouped together.

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Hierarchical Cluster Analysis Procedure

(Centroid Method)

A new mean value

Step 0 Obj 1 Step 1 Obj 1
representing the
group of objects is
Obj 2 Obj 2 computed

Obj 4 Obj 4
Obj 5 Obj 5
Obj 3 Obj 3

proceed with
Step 2 Obj 1 Step 3, 4 Obj 1 a “2-clusters”
Obj 2 Obj 2 solution.
You can choose a
“3-clusters”
solution here, or …
Obj 4 Obj 4
Obj 5 Obj 5
Obj 3 Obj 3

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Cluster Determination

Here are three different “cluster solutions”, with one, two and six clusters;
each is perfectly valid, depending on what the researcher is looking for.

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Cluster Analysis

Use standardized variables to bring all the

variables into the same scales

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Step 3: Determination Of Number Of Clusters

Notice that once objects are combined, they are
always together throughout the clustering process.

four clusters?

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Step 4: Re-run Cluster Analysis With

Specified Number Of Clusters

….

SPSS creates an extra column to

identify group membership.
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Within-cluster Means
• Using the mean comparison function to compares means of original variables across
clusters (Analyze>Compare Means>Means; choose original clustering variable as
dependent variables an cluster member ship as the independent variable).

How can you describe beer brands in different clusters?

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Group Description
• Cluster 1
– Description: moderate price and high calories/alcohol
– Member: Budweiser, Schlitz, Lowenbrau, Old Milwaukee, Augsberger, Strohs Bohemian
Style, Coors, Hamms, Heilemans Old Style
• Cluster 2
– Description: premium beer with moderate calories/alcohol
– Member: Kronenbourg, Heineken, Becks, Kirin
• Cluster 3
– Description: relatively low price and moderate calories/alcohol
– Member: Miller Lite, Budweiser Light, Coors Light, Michelob Light, Schlitz Light
• Cluster 4
– Description: Ultra light and cheap
– Member: Pebst Extra Light, Olympia Gold Light

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Cluster Analysis Is Key In Market Segmentation

• Customers are heterogeneous in their

– Needs/preferences
– Responses to marketing mix offerings (4P’s)

• The process of market segmentation consists of:

– Identify market of interest (e.g., car buyer market consists of
people aged 16 or older with household income of $25,000).
– Divide heterogeneous customers in the specified market into
smaller subsets of customers with similar needs and
responsiveness to marketing mix offerings.

• Key Criterion for effective segmentation:

– Customers in different segments should be homogeneous within
and heterogeneous between.

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