Part 3: Target Segments
Capsule: Set your customer targets by determing the profitability of each customer and assigning each to a category based on the objectives you have for the customer: Stay In, Increase Use, Get In or Opportunistic. Then compare your projected results to your goals.
- Video #68: Overview of Segments Part 3: What to Do
- Video #54: Cost Reduction By Winners vs. Losers in Hostility
You should classify each current and prospective customer by its importance to you. This assignment tells you how much of the market you can serve profitably. It warns you of major changes you may need to make in what you offer customers and in how you incur costs. (See Symptom: “Competition is Beginning to Focus Resources on Market Segments as Market Growth Slows.”)
Non-Core Customer: A Non-core customer would contribute cash on every sale the Company makes to the customer but would not yield a positive return on capital through the business cycle.
Non-Core Customer Examples »
You should conduct this core, near-core and non-core assignment for each Very Large and Large current and prospective customer. If you do not serve many of those customers your assignment should cover the customer sizes making up the top 80% of your Company’s sales volume. You base your assignments of current customers on your present knowledge of them. The core, near-core and non-core assignments of prospective customers are based on your Size/Role segment analyses, adjusted for any customer-specific variances from the assumptions you used to analyze the segment.
This assignment of every customer into a profitability classification may warn you of impending problems. This economic analysis reflects the implicit value you offer customers and the efficacy of your cost structure compared to those of the other competitors in the market. (See Perspective: “Building on Customer Volatility.”) If you cannot assign the majority of industry sales volume to the core classification, you face a significant strategic question: Why? If you are a small company in the industry, you should plan a strategy to avoid the larger competitors if they might use price against you. (See Perspective: “Rare Mettle: Gold and Silver Strategies to Succeed in Hostile Markets.”) If you are a larger company, check the ratio of your market share to the core volume. The higher this index, the more challenge you face in growing profitably. You have highly penetrated your Core market. If your market share is not very high then your Core customer volume in the market is low. A high index would argue for you to examine your value ropositions for customers and your cost position compared to competition very carefully. Something may be seriously amiss. (See Perspective: “Staying Alive in a Hostile Marketplace.”)
What type of customer (i.e., Core, Near-core or Non-core) is each current and prospective Very Large and Large customer? In answering this question, you may find that the largest customers in the industry in Hostile times appear unprofitable. Be careful of this conclusion. It may be that these largest customers carry with them the industry leader effect. If you are able to serve these customers well, your reputation with the more profitable Medium and Small customers may be such that you Get-In the relationships or increase the sales volume you have with them because of your ability to serve these well known largest customers. This industry leader effect will often create a Core customer out of the these apparently low profitability largest customers.
What rules would the Company use to assign Medium and Small customers to types? Usually there are too many Medium and Small customers to consider each individually in your assignment of profitability categories and objectives. Instead, you may find it practical to use average prices, average costs to serve and average volumes for the assignment of unknown Medium and Small customers into profitability categories. In other words, you use the average profitability of a Size/Role segment to determine the Core, Near-core or Non-core category of an unknown customer in the Size/Role segment. Then you would assign minimum levels of pricing and sales volumes, along with maximum levels of cost to serve, in order to set final rules for service to any potential Medium and Small customer.
What percentage of the industry’s total sales volume falls in each type? Ideally, the company would like to have 100% of its sales devoted to Core customers. This may be the case in some Developing, Stable, and Reprieve industries, but is rarely the case in Deteriorating and Hostile markets. In any market, the company should have the vast majority of its sales in Core customer relationships. Total sales below 67% in Core customer relationships probably indicates a significant problem, either with the company’s value proposition or its cost structure.
What is the ratio of the Company’s sales volume to the total industry’s core-customer volume? If the company has a high ratio of its sales volume to the industry’s total Core customer volume, the company is likely to have difficulty growing profitably in the future. This situation arises when the company has very high market share, so that its growth potential is limited by the difficulty of penetrating further customer relationships when it already has the vast majority of them. However, this condition also arises when the company simply can not serve profitably a high percentage of sales volume in the marketplace. This inability to serve a high proportion of customers as Core customers in the market suggest first that the company’s cost structure is likely to be out of line and, second, that its value proposition may fall well short of its peer competitor’s offerings.
Do these percentages of industry volume by the type suggest the need for the Company to make any major changes in its value proposition or cost structure?
Every customer in the market place falls into one of three groups:
You use the profitability classifications of each customer into core, near-core and non-core status to develop objectives for the marketing and sales calling programs you develop. These programs classify each current and prospective customer into “objectives” classifications defined by what you want to accomplish with the customer. The process sets a specific goal for the sales the Company expects from each of its current or prospective Very Large and Large customer relationships in the future.
Each of the Company’s current customers falls into one of three “objective” categories:
The Stay In and Increase Use customers are profitable Core customers for the Company. They deserve long-term investment. The Company’s objective with a Stay In customer is to maintain the Company’s current proportion of the customer’s total purchases. (See Symptom: “Customers are Making Significant Changes in Their Supplier Arrangements.”) The Company adopts this approach to these customers because it believes there is little prospect that the Company can increase its volume with that customer. Because the customer is profitable, however, you do not want to lose any part of the customer relationship to another competitor.
Current customers who are Increase Use candidates offer the Company the potential to increase the proportion of their purchases with the Company. You have two objectives with these customers. First, to avoid any negative volatility with them and, second, to increase volume with them through positive volatility.
The company may wish to set priorities for its marketing and sales programs devoted toward Core customers. Here the results from Analysis 25: The Expected Gain Index prove very helpful. The company is far more likely to gain share from weak competition than it is from strong competition. This is particularly true in industries where failure dominates volatility. In setting its priorities for marketing and sales efforts, the customers most likely to produce additional volume for the company are those served by weak competitors.
Customers who are not current customers, but who are attractive potential customers, are Get In customers. Often the Company knows much less about a Get In customer than it knows about current customers. The Company’s objective with these customers is to enter the relationship. The Company’s earlier analyses of the profitability of Size/Role segments lead it to assign Get In customers as potential core customer targets due to their Size/Role position on the matrix and the expected profitability the customer offers. This expected profitability, in turn, is the result either of assumptions of averages for the Company’s current customers in the segment or of a specific evaluation done by the marketing and sales organizations of the Company. The analyses the Company does on sales volume averages for the Size/Role segments enable it to project the volume it should receive from selling to the group of these Get In customer relationships.
The Opportunistic customer is a customer the company serves only when trying to use excess capacity. Such a customer would offer the company positive cash flow on sales but little or no return on invested capital through the business cycle. Opportunistic customers would be Near-core and Non-core customers the company would choose to serve at its convenience. The Company serves near-core customers in the hope of converting them to core customers within some reasonable period of time. The company may also serve near-core customers with the intention of gradually withdrawing sales to them, as the company needs more capacity to support the growth of its core customers. You would choose to serve Non-core customers in periods when the Company has excess capacity. Over time, the Company would prefer to substitute core customer sales for any of the opportunistic customer volume.
The company should use averages with Get-In customers very carefully. The price that a customer actually pays may vary quite distinctly from the average of the Size/Role segment. This is particularly true in Hostile marketplaces where the range of prices paid within a customer size may be greater than the average difference across all size categories. As you establish rules linking minimum price, maximum cost-to-serve and minimum volumes to serve a customer in any Size/Role segment.
In addition, the company should be leery of joining a customer relationship because of low price. A lower than average price in a customer relationship is often an indication that the customer is not now a Core customer. It may be that the low price has a limited life and the customer will quickly convert into Core status with time. However, many price-based relationships are Tertiary role relationships that carry with them little prospect of movement into more strategic Primary and Secondary roles in the relationship.
Opportunistic customers are able to take advantage of the marketplace as long as the leaders in the industry have excess capacity. Eventually, the leaders no longer have excess capacity and then the formerly Opportunistic customers become Get-Out customers, where the company plans to withdraw from the customer relationships. The company can not afford to provide capacity for Near and Non-core customers at the expense of Core customers, nor would the company plan to build capacity for these Near and Non-core customers. These customers simply can not pay for this capacity. Instead, the company would gradually withdraw its capacity devoted to Non-core customers until there were no longer any Non-core customers in its customer portfolio. Next it would draw down the capacity used for the Near-core customers until there was no longer any Near-core customer volume in its customer portfolio. Before the company reaches the point where it has no Near-core customer volume left in its portfolio, it is likely that the prices in the industry would already be high enough to have encouraged the profitable addition of capacity in the marketplace to serve the further growth of current and potential Core customers.
Final Targets Questions
- What is the “objectives” classification (i.e., Stay In, Increase Use, Get In, Opportunistic or Get Out) of each Very Large and Large customer (alternatively, the customers who could account for 80% of Company sales volume) in the market? (Analysis 31)
- Should any prospective or current customer change categories based on the Company’s specific evaluation of the customer, including the industry leader effect or below minimums on price or volume, or above maximum on cost-to-serve?
- How would the Company classify the segments on the Medium and Small customers in the market?
- How much volume does the Company project from each customer? (Analysis 31)
The final step in determining your customer targets is to compare your potential to your aspirations. You compare your likely sales volume growth to the sales and market share targets you have set for the Company. A shortfall in this comparison demands aggressive changes to your value proposition and cost structure.
- Will the target core customers provide the growth and market share increases the Company wants?
- If not, what must the Company change in order for more current and prospective customers to fall in the “core” category?
Once you have completed these analyses, you have done a thorough job of identifying the customer segments in the market that you are likely to serve well. Your next step would be to move to the Improve Segments section of the site. Here, you begin developing new segmentations of your target customers based on their needs as buyers and users of your products and services. If you prefer, you could also move to the Improve/Products and Services section to begin creating innovations for your target customers.