The Limits of Traditional Segmentation

The Limits of Traditional Segmentation

The idea of identifying homogenous groups of customers, assessing these segments for size and responsiveness, and then more precisely creating offerings and marketing mixes to satisfy them is not new. Traditional segmentation is most effective when it leads to more precise targeting that results in higher revenues or responsiveness to marketing programs. However, traditional segmentation is not typically grounded in knowledge of the different profitability of segments. 

To build and improve upon traditional segmentation, businesses have been trying to identify segments--or, more appropriately, profitability tiers of customers--that differ in current and/or future profitability to a firm. This approach goes beyond usage segmentation because it tracks costs and revenues for groups of customers, thereby capturing their financial worth to companies. After identifying profitability tiers, the firm offers products, services, and service levels in line with the identified tiers. The approach has to date been effectively used predominantly in financial services, retail firms, and business-to-business firms because of both the amounts of data existing in those firms and the ability to associate data with individual customers. 

One example of an innovator in the field is Bank One, which recognized that financial institutions were grossly overcharging their best customers to subsidize others who were not paying their keep. Determined to grow its top-profit customers, who were vulnerable because they were being under-served, the Bank implemented a set of measures to focus resources on their most productive use. The company used the data resulting from the measures to identify the profit drivers in this top segment and stabilized their relationships with key customers.(n10) 

In another example, First Commerce Corporation knew that customer segmentation could improve the effectiveness of all of its operations. After dividing clients into mutually exclusive groups of individuals based on demographics, the company then identified the reasons for profitability swings (including balances, product mix, and transaction behavior). The firm then defined three unique segments: the smart money segment, the small business segment, and the convenience segment. Tailoring its marketing efforts differentially to those segments made the company's programs far more effective.(n11)