Introduction and Preliminary Analysis

Customers are like friends. You learn to choose them wisely. When I was child my mother counseled me to choose my friends carefully. She taught me that I could not play on equal terms with everyone. Some kids were smarter than I was; others more athletic. “If you spend your time chasing after friendships with these kids, you would always feel inferior. Your natural talents would not emerge,” she said. There were other groups of kids, she advised me to avoid. “Stay away from the arrogant children, the selfish, and the trouble makers. They will ask you,” she told me, “to do things you should not do.” If I were wise, I would find those kids who were like I was. I would find a group where I could succeed as a valuable member. They would encourage the natural development of the gifts that I brought to the group.

Segmenting customers in a market is very much like picking your friends as a child. You cannot serve all customers. Some might not welcome your products and services because they deem you unfit to supply them. Others might abuse your interest in them by asking you to do things that cause you more costs than you’ll recover in revenue. You need to find those customers that really fit you in order to prosper in your market place. Of course, if there are not enough of the customers with whom you fit to support a successful business, you will have to alter some of your capabilities.

When you segment customers in a market place, you identify customer groups with a common set of needs. You expect that, if you were to meet those needs, you would employ a predictable set of costs to serve those customers. You find these segments either to increase revenues or to decrease costs. You increase revenues by selling more to some customer segments because you better meet their needs. Alternatively, you can raise prices to high cost-to-serve segments in order to make up for their higher costs. You decrease costs by reducing benefits for some segments that put no value on those benefits. You also reduce costs by eliminating customers whose costs are greater than their revenues.

The diagnosis of segments in the market focuses on the profitability of the customer relationship that you may gain, or protect if you already have it. The profitability of the relationship depends on several obvious, and a few not-so-obvious, factors. The obvious factors include the size of the customer and your share of his purchases. Less obvious factors include how volatile customers are, the reasons for their volatility and whether your competition is strong or weak. These factors combine to isolate target segments that you should be able to pursue profitably. Once you have identified your target segments, you can develop something new for them by examining their needs in more detail. Approaches to developing new products are on the Improve/Segments section of the web site.

The diagnosis of the customer segments in the market involves three parts.

Part 1: Value of a Customer Relationship. This part shows you how to segment and then estimate the value of a relationship with any prospective customer. Much of this analysis revolves around the questions of size and profitability of the customer relationship.

Part 2: Sources of New Market Share. Next, you will analyze the volatility in the market and seek its causes. The answers to these questions help you determine whether to compete defensively or offensively.

Part 3: Target Segments. In the final section, you will determine the customer segments you should pursue in the future based on the conclusions of Parts 1 and 2 and on an analysis of your Company’s performance in the market.

Before embarking on Parts 1 through 3, you should complete the following preliminary analyses to define clearly your business and its customers, competitors and products. These preliminary steps may seem unnecessary. But customers and competitors change as your business evolves. These two analyses will help you comprehensively and objectively describe your business and its customers.

Preliminary Analysis #1: This first preliminary analysis, Analysis 1, describes how to divide products into businesses. It develops a clear definition of the market. Your Company’s market is a business defined by a distinct set of products, customers and competitors. The key to defining a market is describing both the customers and competitors for each of the products your Company offers. As either the customer types or competitors change, it is likely that the business changes as well. This first preliminary analysis, Analysis 1, describes how to divide products into businesses.

In order to determine whether you have defined your business tightly enough, you should consider the following questions:

  • First, do all the products in the business use the same kinds of assets and infrastructure?
  • Second, do all the competitors in the industry (that is, the competitor itself, or the subsidiary or division of the competitor) in the business sell the majority of their products in the business?
  • Finally, do the various customer types use the products in similar applications?

If you can not comfortably place your product as a Standard Leader, Performance Leader or a Price Leader in your market, you may not have defined the business tightly enough. On the other hand, you might be creating an entirely new business if you have created a Next Leader product.

Business Definition Example:

In 1992, ConAgra targeted the health-conscious with new products. It succeeded by placing Healthy Choice in a separate category from its other brands, Banquet and Armour.
This is new business for ConAgra. It entered competition with health-oriented competitors such as Weight Watchers. The consumers purchasing Healthy Choice were also different from those who purchased Banquet and Armour.

More Business Definition Examples >>

Preliminary Analysis #2: The second preliminary analysis helps you gather and organize information about customers in each business. This information includes data on customer sizes and buying patterns, on the volatility of market share and on competition. Analysis 2 outlines these data needs. This data is the source of answers to the diagnostic questions to follow. Analysis 66 provides you with a quick and low cost approach to gather this information.

Basic Strategy Guide Users Return To: Step 1

Summary PointsNext: Part 1: Value of Customer Relationship