The Reality of Segmenting
Grouping clients by profitability and service level.
PART 1
The model of segmentation
Targeting specific markets by segmentation is not a new concept to marketing professionals and many firms concentrate on specific groups of clients that they want to invest time in. Re-evaluating market segments is especially significant when faced with economic uncertainty. Segmentation involves grouping clients that share similar characteristics, like buying behaviour and needs. These segments often cross over industries and services, though there may be a high proportion of a specific industry within a segment. By segmenting by those charactistics rather than by industry or services, firms can help ensure that marketing strategies are more effective.
Focusing on groups of comparable clients, instead of viewing all clients homogeneously, supplements businesses with a comprehension of the needs of the segment. Competitors may not be as pragmatic and have a limited understanding of segment needs, providing attentive firms applying the necessary actions a competitive advantage. There is potential to gain a greater market share through segmentation.
Most marketing professionals will agree that not all clients are alike. Targeting specific markets or segments provide the focal point necessary to increase the interest level of potential clients and avoid reaching those customers that are not of interest to the firm. For example, organizations selling to consumers may focus more marketing dollars on mass advertising vehicles like television or radio as their market includes a broad range of individuals. However, organizations selling to other businesses may focus their marketing spend on specific sponsorship or advertising mediums, like a trade publication, as their target audience is much narrower. Further to segmenting to attract clients that have interest in the services of the firm, there is a need to distinguish between clients that are profitable to help determine the service level required for each client.
Part 2
What do profitable clients look like?
Discerning the profitability of clients provides a coherent strategy for discerning existing clients, as retaining clients that are actually unprofitable may cost more for firms than acquiring new clients. Companies that know which clients are most profitable, tend to be rewarded with clients that require less service, or higher service at a higher fee, and these clients may have longer-term relationships with their service providers. Questions remain though when looking at the financial figures, is the company truly unprofitable, and if so, should an organization expel the unprofitable client or service them differently?
Ascertaining the profitability of clients is not an easy task. The revenues produced from clients is relatively straight-forward, however, the costs associated with building and maintaining the client relationship is not a simple calculation. Aspects of a client relationship not easy to measure include the cost of marketing or selling to that individual client, the value of referrals from the client, as well as in the business relationships between individuals. Even as the profitability equation of existing clients is drawing nearer to realization, the element of future clients’ profitability is an even more daunting task for marketers. Not only is it looking at profitability of existing clients but predicting profitability through similar characteristics of the existing clients and qualifying the potential clients.
The financial services industry (i.e. banks) are likely in a favourable position to determine the profitability of clients as these institutions have access to technologies and customer information that others in different industries do not. Companies need to invest in software to enable the integration of the financial information of clients with other information like usage and loyalty, to position themselves capable of segmenting their clients by profitability. There are examples in companies that there is a correlation between retaining the best clients and an overall increase in profits of the firms. Building relationships with profitable clients and implementing retention strategies is clearly important to overall gross profits. However, not all organizations have the depth and breadth of expertise in database analysis or fiscal aptitude to invest in the necessary software to take advantage of segmentation by profitability.
An alternative approach to software for assessing client profitability, is a process referred to as the customer value management (CVM) cycle.[i] Companies do not require the technology and analysis favoured by certain industries to understand client profitability. By following five steps, profitability of segments is concluded. The steps in the CVM cycle include: managing client segmentation; measuring client margins; measuring client lifetime value; measuring client impact; and managing client profitability. This article will not go into details of the CVM cycle, however, the suggestion of determining client profitability through this process is one that is relevant to firms that may not have the technological advancements to analyze databases.
An important aspect that should be mentioned is understanding the profitability of the client segment over the lifetime of the client. Relationships with clients should not just focus on a specific period of time that reveals margins, but should be viewed as an investment, from attracting the client to retaining the client. Understanding the lifetime value of a client provides marketing professionals with useful information in managing long-term relationships of those that are profitable.
[i]Epstein, M.J., Friedl, M., & Yuthas, K. (2008). Managing customer profitability: Determine which customers are most valuable to your organization, Journal of Accountancy, December, 54-59.
Serving clients
Realistically, organizations will never completely remove unprofitable clients and will need to continue to serve them. However, reducing the service tactics to increase the profitability of the low profitable clients is a strategy worth considering. An assumption is that high purchasing clients are profitable, however, in firms there are cases that they are often unprofitable as they require higher level of service and greater fee discounts. To increase profitability, if a price increase is not an option, then service level reduction or purging of the client is necessary with these high purchasing users. For example, a large organization renegotiated contracts with some of their recently discovered unprofitable customers and stopped serving those that were unwilling to allow an increase in fees to serve them so that the profit margin for the provider was reasonable. Clients that demand an increased service level may be open to a fee increase resulting in the client having an increased profitability to the provider.
Professionals can not service every client effectively unless they reduce the number of clients. Making sure that the client segment is profitable and increasing client profitability through price or service level strategies offers a winning situation for the service provider and potentially increases the service levels for profitable clients.
Part 4
Barriers to change
There are barriers to segmenting by profitability and service level in organizations. The obvious barrier is whether certain firms have the technology or experience for the essential analysis of their client base. Other barriers may include cost for technology, leadership’s appetite for change, and the organizational culture as a whole. Additional challenges include discovering whether unprofitable clients may increase their value through variables like referring work to the company. The ideas presented may provide marketers with the tools to involve leaders in the process of segmentation and increase the ability of eliminating or reducing the barriers.
Part 5
Why segment?
Segmentation provides marketers with the ability to concentrate attention on a homogenous group of potential buyers. Profitability rather than industry or services segmentation facilitates the substantial understanding of the buying behaviours as they vary within the industry or services group. Choosing to delve into this typical marketing definition of segmentation may lead to a competitive advantage that is worth exploration. Though barriers to segmenting by profitability may exist, a variety of processes along with tools that marketers have access to can aid the implementation of the segment strategy. Neglecting to explore possibilities for segmenting may be a lost opportunity not only in increased profitability but also in the best clients not being served properly.
