Segmentation and Targeting

Basics
Market Definition
Segmentation Research and Methods
Behavior-Based Segmentation

Market Segmentation
Market segmentation is the
subdividing of a market into distinct
subsets of customers.
Segments
Members are different between
segments but similar within.

Segmentation Marketing
Definition
Differentiating your product and
marketing efforts to meet the needs
of different segments, that is,
applying the marketing concept to
market segmentation.

Primary Characteristics
of Segments
Basescharacteristics that tell us why segments
differ (e.g. needs, preferences, decision
processes).
Descriptorscharacteristics that help us find and
reach segments.

(Business markets)
Industry
Size Education
Location
Organizational
structure

(Consumer markets)
Age/Income
Profession
Life styles
Media habits

A Two-Stage Approach
in Business Markets
Macro-Segments:
First stage/rough cut
Industry/application
Firm size

Micro-Segments:
Second-stage/fine cut
Different customer needs, wants, values within macro-segment

Relevant Segmentation
Descriptor
Variable A: Climatic Region
1.
2.
3.

Snow Belt
Moderate Belt
Sun Belt

Fraction of
Customers

Segment 1

Segment 2

Segment 3

100%

Likelihood of Purchasing Solar Water Heater

(a)

Irrelevant Segmentation
Descriptor
Variable B: Education
1. Low Education
2. Moderate
Education
3. High Education

Fraction of
Customers

Segment 1

Segment 2

Segment 3

100%

Likelihood of Purchasing Solar Water Heater

(b)

Variables to Segment
and Describe Markets
Consumer

Industrial

Segmentation
Bases

Needs, wants benefits,

solutions to problems,
usage situation, usage rate.

Needs, wants benefits, solutions to

problems, usage situation, usage rate,
size*, industrial*.

Descriptors
Demographics

Age, income, marital status,

family type & size,
gender, social class, etc.
Lifestyle, values, &
personality characteristics.
Use occasions, usage level,
complementary &
substitute products used,
brand loyalty, etc.
Individual or group
(family) choice, low or high
involvement purchase,
attitudes and knowledge
about product class, price
sensitivity, etc.
Level of use, types of
media used, times of use,
etc.

Industry, size, location, current

supplier(s), technology utilization,
etc.
Personality characteristics of
decision makers.
Use occasions, usage level,
complementary & substitute
products used, brand loyalty, order
size, applications, etc.
Formalization of purchasing
procedures, size & characteristics
of decision making group, use of
outside consultants, purchasing
criteria, (de) centralizing buying,
price sensitivity, switching costs, etc.
Level of use, types of media used,
time of use, patronage at trade shows,
receptivity of sales people, etc.

Psychographics
Behavior

Decision Making

Media Patterns

Segmentation in Action
We segment our customers by letter volume, by postage
volume, by the type of equipment they use. Then we
segment on whether they buy or lease equipment.
Based on this knowledge, we target our marketing
messages, fine tune our sales tactics, learn which benefits
appeal to which customers and zero in on key decision
makers at a company.
Kathleen Synnot, VP, Worldwide Marketing
Mailing Systems Division, Pitney Bowes, Inc.
[quoted in Marketing Masters (Walden and Lawler)]

Segmentation
If youre not thinking segments, youre not
thinking. To think segments means you have
to think about what drives customers,
customer groups, and the choices that are or
might be available to them.
Levitt, Marketing Imagination

STP as Business Strategy

Segmentation
Identify segmentation bases and segment the market.
Develop profiles of resulting segments.

Targeting
Evaluate attractiveness of each segment.
Select target segments.

Positioning
Identify possible positioning concepts for each target segment.
Select, develop, and communicate the chosen concept.

to create and claim value

Overview of Methods for STP

Clustering and discriminant
analysis
Choice-based segmentation

Perceptual mapping
- later

Segmentation (for Carpet Fibers)

Strength
(Importance)
A,B,C,D:
Location of
segment centers.
Typical members:
A: schools
B: light commercial
C: indoor/outdoor
carpeting
D: health clubs

.
.

.. . .
.A. .. ..
.
B. .
.. .. . .
.. . .

Perceptions/Ratings for one respondent:

Customer Values

.
.

.
D. . .
... ....
.
C. .
.. . .. .
.. . .

Water Resistance
(Importance)

Distance between
segments C and D

Targeting
Segment(s) to serve

Strength
(Importance)

.. .
. . ....
.
.
.
.. ... .
.. . .

.
.
.. ... .
.. . .
.
.
.. ... .
.. . .

Water Resistance
(Importance)

Positioning
Product Positioning

.. .
Comp 1

Comp 2

Strength
(Importance)

.
.
.. ... .
.. . .

Us

.
.
.. ... .
.. . .
.
.
.. ... .
.. . .

Water Resistance
(Importance)

A Note on Positioning
Positioning involves designing an offering so that the
target segment members perceive it in a distinct and
valued way relative to competitors.
Three ways to position an offering:
1. Unique
(Only product/service with XXX)
2. Difference (More than twice the [feature] vs.
[competitor])
3. Similarities (Same functionality as [competitor];
lower price)

What are you telling your targeted segments?

Behavior-Based Segmentation
Traditional segmentation
(eg, demographic,
psychographic)
Needs-based segmentation
Behavior-based segmentation
(choice models)

Steps in a Segmentation Study

Articulate a strategic rationale for segmentation (ie, why are we
segmenting this market?).
Select a set of needs-based segmentation variables most useful for
achieving the strategic goals.
Select a cluster analysis procedure for aggregating (or
disaggregating customers) into segments.
Group customers into a defined number of different segments.
Choose the segments that will best serve the firms strategy, given
its capabilities and the likely reactions of competitors.

Segmentation: Methods
Overview
Factor analysis (to reduce data before
cluster analysis).
Cluster analysis to form segments.
Discriminant analysis to describe
segments.

Cluster Analysis for

Segmenting Markets
Define a measure to assess the similarity of customers on the
basis of their needs.
Group customers with similar needs. Recommend: the Wards
minimum variance criterion and, as an option, the K-Means
algorithm for doing this.
Select the number of segments using numeric and strategic
criteria, and your judgment.
Profile the needs of the selected segments (e.g., using cluster
means).

Cluster Analysis Issues

Defining a measure of similarity (or distance) between segments.
Identifying outliers.
Selecting a clustering procedure
Hierarchical clustering (e.g., Single linkage, average linkage, and minimum
variance methods)
Partitioning methods (e.g., K-Means)

Cluster profiling
Univariate analysis
Multiple discriminant analysis

Doing Cluster Analysis

Dimension 2

=
distance from
member to cluster
center

=
distance from I
to III

Perceptions or ratings data

from one respondent

III

Dimension 1

II

Wards Minimum Variance

Agglomerative Clustering
Procedure
First Stage:
Second Stage:

Third Stage:

A =2B =

5C =

9D =

AB =

4.5BD =

12.5

AC =

24.5BE =

50.0

AD =

32.0 CD =

0.5

AE =

84.5CE =

18.0

BC =

8.0DE =

12.5

CDA =38.0

CDB =14.0

AE =85.0

BE =50.5

Fourth Stage:

ABCD = 41.0ABE=

Fifth Stage:

ABCDE = 98.8

CDE =20.66

93.17CDE =

10E =

AB =5.0

25.18

15

Wards Minimum Variance

Agglomerative Clustering
Procedure
98.80
25.18

5.00
0.50
A

Discriminant Analysis for

Describing Market Segments
Identify a set of observable variables
that helps you to understand how to reach
and serve the needs of selected clusters.
Use discriminant analysis to identify
underlying dimensions (axes) that
maximally differentiate between the
selected clusters.

Two-Group Discriminant
Analysis
Price
Sensitivity

X-segment

x = high propensity to buy

o = low propensity to buy

XXOXOOO
XXXOXXOOOO
XXXXOOOXOOO
XXOXXOXOOOO
XXOXOOOOOOO

Need for Data Storage

O-segment

Interpreting Discriminant
Analysis Results
What proportion of the total variance in the descriptor data
is explained by the statistically significant discriminant
axes?
Does the model have good predictability (hit rate) in each
cluster?
Can you identify good descriptors to find differences
between clusters? (Examine correlations between
discriminant axes and each descriptor variable).

PDA Example

PDA Segmentation
Performs Wards method - Code:
proc cluster data=hold.pda method=wards standard
outtree=treedat pseudo;
var Innovator
Use_Message Use_Cell Use_PIM
Inf_Passive Inf_Active
Remote_Acc Share_Inf Monitor
Email Web M_Media Ergonomic Monthly Price;
run;
proc tree data=treedat;
run;

PDA Segmentation (alternative)

Performs K-means method - Code:
proc fastclus data=hold.pda maxc=4 maxiter=10 random=41 maxiter=50 out=clus;
var Innovator Use_Message Use_Cell Use_PIM Inf_Passive
Inf_ActiveRemote_Acc Share_Inf Monitor Email Web M_Media Ergonomic ;
run;

proc means data =clus;

var Innovator
Use_Message
Inf_Active
Remote_Acc
M_Media
Ergonomic Monthly
Price;
by cluster;
run;

Use_Cell Use_PIM Inf_Passive

Share_Inf Monitor Email Web

Output

The following clusters are quite close

together and can be combined with a
small loss in consumer
grouping information:
i) clusters 7 and 5 at 0.27,
ii) clusters 1 and 6 at 0.28, ii)
fused cluster 7-5 and cluster 2 (0.34).
However, when going from a four-cluster
solution to a three-cluster solution, the
distance to be bridged is much larger
(1.11);
thus, the four-cluster solution is indicated
by the ESS.
In addition, four seems a reasonable
number of segments to handle based on
managerial judgment.

Distance
(not to scale)

3.13

1.45

1.11

0.34

0.28

0.27

3 Cluster

Four Cluster Solution profile code;

proc tree data = treedata nclusters=4 out=outclus no print;
run;
** create new data set;
data temp;
merge hold.pda outclus;
run;
** profile these segments;
proc means data =temp;
var Innovator Use_Message Use_Cell Use_PIM Inf_Passive Inf_Active
Remote_Acc Share_Inf Monitor Email Web M_MedErgonomic Monthly
by cluster;
run;

Price;

PDA profiles

PDA Visual profile

PDA Visual profile

PRICE

INNOVATOR
2.5

USE_MESSAGE

2
MONTHLY

USE_CELL
1.5
1

ERGONOMIC

USE_PIM

0.5
0
M_MEDIA

INF_PASSIVE

WEB

INF_ACTIVE

EMAIL

REMOTE_ACC
MONITOR

SHARE_INF

Series1
Series2
Series3
Series4

PDA profiles
Cluster 1. Phone users who use Personal
Information Management software, to whom
Email and Web access, as well as Multimedia
capabilities are important.
Cluster 2. People who use messaging services and
cell phones, need remote access to information,
appreciate better monitors, but not for multi-media
usage.

PDA profiles..
Cluster 3. Pager users who have a high need for fast
information sharing (receiving as well as sending)
and also remote access. They use neither email
extensively, nor the Web, nor Multi-media, but do
require a handy, non-bulky device.
Cluster 4. Innovators who use cell phones a lot, have
a high need for Email, Web, and Multi-media use.
They also require a sleek device.

Profile based on Demos/behaviour

Name the segments

Cluster 1 - Sales Pros:
Cluster 1 consists mainly of sales professionals: 54% of the cluster members
indicated Sales as their occupation. They use the cell phone heavily, and many
(45%) own a PDA already; practically all have access to a PC. Their work often
takes them away from the office. They mostly read two of the selected
magazines: 30% read BW. From the needs data, we see that they are quite price
sensitive.

Cluster 2 Service Pros:

Cluster 2 is made up primarily of service personnel (39%) and secondarily of
sales personnel (23%). They use cell phones heavily, but only about one fifth
currently use a PDA. They spend much time on the road and in remote locations.
They read PC Magazine, 29%. From the needs data, we see that they are quite
price sensitive.

Name the segments

Cluster 3 Hard Hats:
Cluster 3 is made up predominantly of construction (31%) and emergency
(19%)
workers. They use cell phones, but usually do not own a PDA.
By the nature of their work, they have high information relay needs and
generally work in remote locations.
They exchange information with colleagues in the field (e.g. construction
workers on the site). Many read Field & Stream (31%) and also PC
Magazine. Note also from the needs data, that they are the least price
sensitive (willing to pay highest price plus monthly fee) and also have the
lowest income.
This apparent anomaly occurs because these folks are less likely to have to
pay for the device themselves, raising the question of whose preferences
their own or their employerswill drive the adoption decision

Name the segments

Cluster 4 Innovators:
Cluster 4 represents early adopters (see needs data),
predominantly professionals (lawyers, consultants,
etc.).
Every cluster member has access to a PC, 89
percent already own PDAs.
They read many magazines, especially BW 49%,
PCMag 32%. Most are highly paid and highly
educated.

Who to target
Discuss.

Interpreting Cluster Analysis

Results
Select the appropriate number of clusters:
Are the bases variables highly correlated? (Should we reduce the data through factor
analysis before clustering?)
Are the clusters separated well from each other?
Should we combine or separate the clusters?
Can you come up with descriptive names for each cluster (eg, professionals, technosavvy, etc.)?

Segment the market independently of your ability to reach the

segments (i.e., separately evaluate segmentation and discriminant
analysis results).

Discrimination based on
demographics/behaviour
proc discrim data=temp outstat=outdisc method=normal pool=yes list
crossvalidate;
class cluster; priors prop;
vars age education etc ;
run;

** all relevant vars. not used to create segment solutions;

Discrimination based on
demographics/behaviour
This allows us a way to
target and profile future
customers:

Discrimination based on
demographics/behaviour

Discrimination based on
demographics/behaviour
The first discriminant function above explains 51% the variation.
According to its coefficients, i.e., the four groups are particularly
different with respect to the amount away from the office.
In addition, the function shares high correlation with the level of
education, possession of a PDA, and income.
The second function explains 32% of the variance and primarily
distinguishes the occupation types construction/emergency from
sales/service, and the third function separates Sales and Service
types.

Visualising relationships

Correspondence Analysis
Provides a graphical summary of the interactions in a table
Also known as a perceptual map
But so are many other charts

Can be very useful

E.g. to provide overview of cluster results

However the correct interpretation is less than intuitive,

and this leads many researchers astray

Interpretation
Correspondence analysis plots should be interpreted by
looking at points relative to the origin
Points that are in similar directions are positively associated
Points that are on opposite sides of the origin are negatively
associated
Points that are far from the origin exhibit the strongest associations

Also the results reflect relative associations, not just which

rows are highest or lowest overall

Software for
Correspondence Analysis

Earlier chart was created using a specialised package called

BRANDMAP
Can also do correspondence analysis in most major statistical packages
For example, using PROC CORRESP in SAS:
*---Perform Simple Correspondence AnalysisExample 1 in SAS OnlineDoc;
proc corresp all data=Cars outc=Coor;
tables Marital, Origin;
run;
*---Plot the Simple Correspondence Analysis Results---;
%plotit(data=Coor, datatype=corresp)

Cars by Marital Status

Segmentations
Other details

Tandem Segmentation
One general method is to conduct a factor
analysis, followed by a cluster analysis
This approach has been criticised for losing
information and not yielding as much
discrimination as cluster analysis alone
However it can make it easier to design the
distance function, and to interpret the results

Tandem k-means Example

proc factor data=datafile n=6 rotate=varimax round reorder flag=.54 scree out=scores;
var reasons1-reasons15 usage1-usage10;
run;
proc fastclus data=scores maxc=4 seed=109162319 maxiter=50;
var factor1-factor6;
run;

Have used the default unweighted Euclidean distance

function, which is not sensible in every context
Also note that k-means results depend on the initial cluster
centroids (determined here by the seed)
Typically k-means is very prone to local maxima
Run at least 20 times to ensure reasonable maximum

Cluster Analysis Options

There are several choices of how to form clusters in
hierarchical cluster analysis

Single linkage
Average linkage
Density linkage
Wards method
Many others

Wards method (like k-means) tends to form equal sized,

roundish clusters
Average linkage generally forms roundish clusters with
equal variance
Density linkage can identify clusters of different shapes

FASTCLUS

Density Linkage

Cluster Analysis Issues

Distance definition
Weighted Euclidean distance often works well, if weights are chosen
intelligently

Cluster shape
Shape of clusters found is determined by method, so choose method
appropriately

Hierarchical methods usually take more computation time than kmeans

However multiple runs are more important for k-means, since it can be
badly affected by local minima
Adjusting for response styles can also be worthwhile
Some people give more positive responses overall than others
Clusters may simply reflect these response styles unless this is adjusted
for, e.g. by standardising responses across attributes for each respondent

MVA - FASTCLUS
PROC FASTCLUS in SAS tries to minimise the root mean
square difference between the data points and their
corresponding cluster means
Iterates until convergence is reached on this criterion
However it often reaches a local minimum
Can be useful to run many times with different seeds and choose
the best set of clusters based on this RMS criterion

See http://en.wikipedia.org/wiki/K-means_clustering for

more k-means issues

Iteration History from FASTCLUS

Relative Change in Cluster Seeds
Iteration
Criterion
1
2
3
4
5

1
0.9645
1.0436
0.7366
0.6440
0.6343
0.5666
2
0.8596
0.3549
0.1727
0.1227
0.1246
0.0731
3
0.8499
0.2091
0.1047
0.1047
0.0656
0.0584
4
0.8454
0.1534
0.0701
0.0785
0.0276
0.0439
5
0.8430
0.1153
0.0640
0.0727
0.0331
0.0276
6
0.8414
0.0878
0.0613
0.0488
0.0253
0.0327
7
0.8402
0.0840
0.0547
0.0522
0.0249
0.0340
8
0.8392
0.0657
0.0396
0.0440
0.0188
0.0286
9
0.8386
0.0429
0.0267
0.0324
0.0149
0.0223
10
0.8383
0.0197
0.0139
0.0170
0.0119
0.0173
Convergence criterion is satisfied.
Criterion Based on Final Seeds = 0.83824

Results from Different Initial Seeds

19th run of 5 segments
Cluster Means
Cluster
FACTOR1
FACTOR2
FACTOR3
FACTOR4
FACTOR5
FACTOR6

1
-0.17151
0.86945
-0.06349
0.08168
0.14407
1.17640
2
-0.96441
-0.62497
-0.02967
0.67086
-0.44314
0.05906
3
-0.41435
0.09450
0.15077
-1.34799
-0.23659
-0.35995
4
0.39794
-0.00661
0.56672
0.37168
0.39152
-0.40369
5
0.90424
-0.28657
-1.21874
0.01393
-0.17278
-0.00972

20th run of 5 segments

Cluster Means
Cluster
FACTOR1
FACTOR2
FACTOR3
FACTOR4
FACTOR5
FACTOR6

1
0.08281
-0.76563
0.48252
-0.51242
-0.55281
0.64635
2
0.39409
0.00337
0.54491
0.38299
0.64039
-0.26904
3
-0.12413
0.30691
-0.36373
-0.85776
-0.31476
-0.94927
4
0.63249
0.42335
-1.27301
0.18563
0.15973
0.77637
5
-1.20912
0.21018
-0.07423
0.75704
-0.26377
0.13729

Howard-Harris Approach
Provides automatic approach to choosing seeds for kmeans clustering
Chooses initial seeds by fixed procedure
Takes variable with highest variance, splits the data at the mean,
and calculates centroids of the resulting two groups
Applies k-means with these centroids as initial seeds
This yields a 2 cluster solution
Choose the cluster with the higher within-cluster variance
Choose the variable with the highest variance within that cluster,
split the cluster as above, and repeat to give a 3 cluster solution
Repeat until have reached a set number of clusters

I believe this approach is used by the ESPRI software

package (after variables are standardised by their range)

Another Clustering Method

One alternative approach to identifying clusters is to fit a
finite mixture model
Assume the overall distribution is a mixture of several normal
distributions
Typically this model is fit using some variant of the EM algorithm
E.g. weka.clusterers.EM method in WEKA data mining package
See WEKA tutorial for an example using Fishers iris data

Advantages of this method include:

Probability model allows for statistical tests
Handles missing data within model fitting process
Can extend this approach to define clusters based on model
parameters, e.g. regression coefficients

Also known as latent class modeling

Segmentations via Choice Modelling

Choice Models
1. Observe choice:
(Buy/not buy =>
direct marketers
Brand bought packaged goods, ABB)

2. Capture related data:

demographics
attitudes/perceptions
market conditions (price, promotion, etc.)

3. Link
1 to 2 via choice model model reveals
importance weights of characteristics

Choice Models vs Surveys

With standard survey methods . . .
preference/
importance
choice

weights perceptions

predict
observe/ask
observe/ask

But with choice models . . .

importance
choice

weights

observe
infer

perceptions

observe/ask

Behavior-Based Segmentation
Model
Stage 1: Screen products using key attributes to identify the consideration set
of suppliers for each type of customer.
Stage 2: Assume that customers (of each type) will choose suppliers to
maximize their utility via a random utility model.

Uij = Vij + ij
where:

ij

Uij
=
Utility that customer i has for supplier js product.
Vij
=
Deterministic component of utility that is a function of product and supplier
attributes.
=
An error term that reflects the non-deterministic component of utility.

Specification of the
Deterministic Component of
Utility
Vij = Wk bijk
k

where: i
=
an index to represent customers, j is an index to
represent suppliers, and k is an index to represent attributes.
bijk =
is perception of attribute k for supplier j.
wk
=
estimated coefficient to represent the impact of bijk
on the utility realized for attribute k of supplier j for customer i.

A Key Result from this Specification:

The Multinomial Logit (MNL) Model
If customers past choices are assumed to reflect the principle
of utility maximization and the error ( ij) has a specific form
called double exponential, then:
^

eVij
pij

k e

=
Vik

where:
p^ij

=probability that customer i chooses supplier j.

Vij
=estimated value of utility (ie, based on estimates of
bijk) obtained from maximum likelihood estimation.

Applying the MNL Model in

Segmentation Studies
Key idea: Segment on the
basis of probability of
choice
1. Loyal to us
2. Loyal to competitor
3. Switchables:
loseable/winnable
customers

Switchability Segmentation
Loyal to Us

Losable

Winnable
Customers

Loyal to
Competitor

(business to gain)

Current Product-Market by Switchability

Questions: Where should your marketing efforts be focused?

How can you segment the market this way?

Using Choice-Based Segmentation

for Database Marketing
A
B
C
D
Average
Customer
PurchasePurchase
Profitability
Customer
Probability
Volume Margin = A B C
130%
22%
310%
45%
560%
622%
711%
813%
91%
104%

$31.00
$143.00
$54.00
$88.00
$20.00
$60.00
$77.00
$39.00
$184.00
$72.00

0.70
0.60
0.67
0.62
0.58
0.47
0.38
0.66
0.56
0.65

$6.51
$1.72
$3.62
$2.73
$6.96
$6.20
$3.22
$3.35
$1.03
$1.87

Managerial Uses of
Segmentation Analysis
Select attractive segments for focused effort (Can use models
such as Analytic Hierarchy Process or GE Planning Matrix).
Develop a marketing plan (4Ps and positioning) to target
selected segments.
In consumer markets, we typically rely on advertising and channel members
to selectively reach targeted segments.
In business markets, we use sales force and direct marketing. You can use
the results from the discriminant analysis to assign new customers to one of
the segments.

Checklist for Segmentation

Studies
Is it values, needs, or choice-based? Whose values and needs?
Is it a projectable sample?
Is the study valid? (Does it use multiple methods and multiple measures)
Are the segments stable?
Does the study answer important marketing questions (product design,
positioning, channel selection, sales force strategy, sales forecasting)
Are segmentation results linked to databases?
Is this a one-time study or is it a part of a long-term program?

Concluding Remarks
In summary,
Use needs variables to segment markets.
Select segments taking into account both the attractiveness of segments
and the strengths of the firm.
Use descriptor variables to develop a marketing plan to reach and serve
chosen segments.
Develop mechanisms to implement the segmentation strategy on a routine
basis (one way to do this is through information technology).