Twenty percent of customers make eighty percent of sales, Vilfredo Pareto (1911)*

The popular “20/80” metaphor of the Pareto principle reflects its simplicity and broad applicability. This is one of the most used and most cited principles in economy. Anyone who ever tried to trade on an open market can recognise this pattern.

Segmentation is a wide marketing topic, which, among other, helps understanding the value of each customer to your organization, and vice versa – it creates insight to what are the aspects of your products and services that your customers value the most. Such awareness enables adapting of business strategies to different homogeneous market  groups that we call segments. Differentiating customers with regards to the value that they ‘deliver’ to the organization became particularly important in recent decades with highly saturated markets and consumers that show great immunity to the large amounts of marketing information they have been exposed to. The marketing response to such market conditions is basically answering the question: “how to keep the most profitable customers in the most efficient and cost-effective way?”. Driven by the above mentioned transformation in market environments and by changes in technological capabilities of modern information and communication systems, the evolution of marketing has yielded some new and innovative concepts. Among those, the services marketing represents a fundamental change in the traditional market approach, followed by important concepts such as niche marketing, relationship marketing and the customer relationship management (CRM).The latter two concepts are mutually overlapping and complementing each other. Boundary between them is a wide “zone” of common postulates and shared principles. In this ‘zone’, the understanding of the value that customers ‘deliver’ to the organization, take a very prominent place. A number of segmentation tools and techniques exist that are used to support strategies aimed to identifying and retaining the most profitable groups of customers (customer segments).

The value exchange as foundation of business

The purpose of markets as well as the foundations of the marketing concept lies in exchange of value. How much are you aware of the value provided to your organization by each of clients you serve? It’s a good question indeed, because the value is not allocated only within the tangible parameters, such as actual sales figures. It is the difference between costs and revenues, but much more than that. Doing business with certain clients for your organization can be matter of image, reference, or some other “intangible” benefits. Some clients, even if they do not contribute significant revenue to your business, can be your good messengers to a wide number of potential customers. On the other side, some others will take a significant place in your business books and stand up with figures, but a deeper analysis will discover that they are actually “value destroyers”. There are different ways in which your customers can destroy value. Those can be reflected in requests for (unreasonable) product customizations or frequent urgent deliveries. Other aspects of destroying value could be wide exploiting of customer service rights, taking advantage of long delays in payment and by generating similar expenses or other extraordinary pressures to your organization’s resources. We often justify such actions by customer’s revenue figures. However, we should ask ourselves: is it the volume of transactions on our bank account the purpose of our business? Or is it perhaps the amount that remains after the transactions are completed, through a longer period of time?

Value based segmentation

There are different methods of recognizing the value of customers for the purpose of grouping them into segments. These methods range from the most primitive measurement of sales figures to complex models that include the allocation of the current and future value creation such as potential referrals or future use of other products in your portfolio. In practice, the value of a client is measured by different surrogate measures. Some well known segmentation methods are RFM (Recency, Frequency, Monetary value), usage analysis and Customer Lifetime Value.

Within Customer Relationship Management strategy, the most suitable segmentation is the one based on the so-called Customer Lifetime Value. It is used to define the general approach to the customer set. The Customer Lifetime Value is a complex, synthetic value gained by allocation models that take into account both present and future value exchange factors. To simplify identification of present and future “value creators” marketers seek to identify visible client attributes that indicate his or her tendency toward specific behaviors that affect value creation. For example, within a costly customer lifetime value segmentation project, conducted by one of America’s leading insurers, among other findings, they understood that the size of individual’s US credit score represent a very strong “value creation” predictor.

ABC method – earn the status

Director of Customer Service department of one of Croatian telecom operators, when arguing the substantial investment in segmentation and distinctiveness of customer service levels, said: “We started the investment when we realized that we couldn’t afford any more the highest service levels to all of our customers.” What the telecom operator actually did in that occasion was to use the ABC method to diversify approach to their customers based on their value creation. The best customers were entitled to the so-called premium service. When deciding about the granted quality of service, the CRM system was able to distinguish not only those which created value, but those who were destroying it as well. The investment in a customer’s service level was reciprocal to his or her contribution to the profitability as the operator’s measure of sustainable success.

For a better segment “visualization”, the value levels within the ABC method are often marked by descriptive terms such as “bronze”, “silver” and “gold”.

In the late nineties, the former Swiss monopoly telecommunications operator Swisscom, started a loyalty program to protect its market position during the market liberalization process*. The objectives of the program were focused on keeping the leader position, retaining the most profitable customers, while trying to avoid price wars with the newly introduced competitors. The loyalty program was delivering certain benefits to its members. Based on the data collected through the program, Swisscom was able to analyze more than 20 target groups. Four segments were chosen based on the analysis. Using the ABC analysis method, different approaches were deployed towards each of the four segments:

– Premium customers: keep them loyal at all costs

– Profitable customers: keep them loyal and intensify cross selling

– Customers with medium consumption: offer packaged services, cross sell

– Unprofitable customers: there are no benefits without increasing consumption

The ABC method can easily be recognized by clients in the banking industry. The personal banker (or clerk) service is meant to be a lever of investing in “value creators.” The remaining clients are left with the option of waiting in queues within the branches, the ATMs or other self-service systems. For the “worst ones”, which can be described as “the value destroyers”, the preferred channel of business is – the one with the competition.

Customer segmentation based on benefits

The above described segmentation will differentiate customers according to their contribution and their potential profitability. It is obvious that it puts the needs of sales organizations in the focus (which client is better for ME).On the other side, it is good to know what customers find most valuable in our offer or our general approach. We’d like to know that in particular, for those that we value the most.

Contemporary markets are often perceived as collections of different business models (within the organizational buyer) and lifestyles (in case of consumer markets). Such determinants of our clients define the reasons why they would accept our value proposal. Benefit segmentation is a mirror in which we try to figure out how our customers segment their “suppliers market” based on their perception of value. In contrast to value based segmentation, the segmentation based on benefits puts the needs of customers in the center of the segmentation effort.

A business organization, whose business model is based on low costs or minimal inventory, will value your ability of flexible, frequent and timely delivery options. Two persons that purchase the same vehicle will base their decisions on completely different reasons. While one will value a prestigious brand and design, the second will be making the purchase based on safety features and high quality service network. This understanding of value that the customer perceives within our proposal can have a powerful impact on adapting the product / service, the marketing approach, as well as the pricing strategy.

Segmentation based on value will give us the answer to the question about who are the customers that are worth our best effort, while the segmentation based on benefits will help us to understand what this effort should look like. Modern marketing segmentation concepts keep confirming – Vilfredo Pareto was right.

*The idea use of Vilfredo Pareto’s principle in this article was  inspired by Art Weinstein’s “Hanbook of Market Segmentation – Strategic Targeting for Business and Technology Firms”, The Harworth Press, 2004

The original of this article has been published in MarketingUP, 05/2007  magazine. The article and the above English translation are copyright of Alen Gojceta.

The Swisscom business case is described in: Brown, Stanley A.; Customer Relationship Management – a strategic imperative in the world of e-business; John Wiley & Sons Canada Ltd; Toronto, 2000.

If you decide to use this article or its parts for academic or professional work, do not forget to cite the author and the source.

© 2011 Alen Gojceta