The Power of Segmentation

The Power of Segmentation

When asked to name the most powerful tool or business process available to the executive, I will always answer without hesitation: “segmentation.” In fact, I would go as far as saying that segmentation is the foundation of most good marketing and operational decision making.

What? You mean I would pass up such luminary management tools as spreadsheets, social media, advertising (again, please tell me which ½ of my advertising expenditure is wasted?) and cost accounting (for those in manufacturing, that is) for the simple parsing of customers, markets or assets into logical affinity groups? In short, yes!

So why is segmentation such a powerful tool?

  • It allows an executive or a company to decide what is strategically important about individual customers or assets—size, profitability, potential….;
  • It allows groups of specific strategic importance to be removed from the “average”(the dreaded average) for critical examination or analysis; and
  • It stops management from treating broader-group averages as important strategic information—which is seldom the case. For example, say your average active customer may annually buy $2,400 from you, is profitable and receives 1.4 live sales calls each year from the field sales force each year. Is that information helpful? Unlikely.

What do we mean by segmentation and how does it work? Let me provide a few examples (and how to’s) to help answer that question.

  1. “Our sales representatives have 220 accounts, on average”. But more importantly, what do you want your sales representatives to do to increase individual customer sales and guard share of market with their assigned accounts? To answer that question the first task at hand is to segment all your customers into categories based upon such measures as revenue size or other strategic factors. For example, perhaps all your top 100 customers (in descending revenue order) generate 50% of annual company revenue. These can be considered strategic accounts (the “A” customers)—and treated to high sales-force attention. High sales-force attention may mean that a sales representative will call at least monthly (and in person) on these key and high-potential accounts. Using similar rules and methods, sales force time and energy can also be applied to other groups in the customer base—say the B, C & D accounts. Hence, there will be different sales-calling rules for each customer segment. In this real example, simple segmentation helps the company focus the attention of its sales force on the “right” accounts with real opportunities, and also helps them determine if enough sales resource exists to meet all known customer needs.
  2. “It is an “A” account so we must give them what they want.” But, how much is too much? A photo-finishing and supply client once asked us to segment their account base into strategic groups reflecting current and historical sales volume. When completed, we found that very few top accounts were clearly the most important players when only considering historical revenue. As I recall, the top 20 customers (of 500) accounted for more than 50% of company annual volume.

    But, this same company also was experiencing a stubborn problem with profitability. It seemed the top 20 were slightly less profitable (before overhead was applied) than other accounts, on average, but that difference did not seem to explain the company’s lack of profitability.

    As a further step in our segmentation analysis, we suggested that an activity-based-cost analysis be done on the top 100 company accounts. In such an analysis cost items generally considered overhead (e.g.: free pick up or delivery charges—and there was plenty of that, or the cost of the sales force) are traced to and applied to each account that required services or sales-staff support. When we applied delivery, pick-up and other servicing costs directly to the company’s top 100 customers we were shocked to find that 19 of the top 20 revenue accounts were big money losers. Clients always want to know where they make or lose money—well we just found out!

    In this second real example, simple segmentation (with a little fancy cost accounting thrown in) helped this company raise its prices for top-tier accounts and begin to better manage (and charge for) out-of-pocket delivery and pick-up services and support cost as a whole. But more importantly, they developed a whole new appreciation (and love) for those slightly smaller and less demanding—yet profitable—customers.

  3. “We cannot seem to assemble and ship customer orders on schedule because of a lack of assembly parts.” Demand was soaring and so were customer backorders. This was a hot topic for the VP of Sales & Marketing in the weekly President’s staff meeting, but the newly-minted (and unmanned) Director of Materials could not see how this could be happening. His 1950’s legacy inventory-performance reports dutifully supplied by the MIS department showed inventory balances for the 80 top highest-usage parts or assemblies (the “A” items as reported as a single group) as having two-week’s supply of inventory, and lots of shop orders were issued for more to be made. Hmmmmm……., it seemed it was time to dig deeper.

    As a next step, these same 80 top parts were segmented into 3 groups based upon descending usage & cost. The real top group was comprised of 12 parts that accounted for over 30% of product material value added. Of these 12 parts, all 12 were out of stock and their expedited replenishment was taking up a disproportionate amount of company machines & resources (i.e.: clogging the shop)—are you familiar with the concept of “order sizing” and “machine-center capacity?” No more analysis was required.

    In this final example, management thought that they were looking at the right universe of parts to make manufacturing and scheduling decisions, but were not even close. When the inventory was segmented and analyzed more deeply and the true drivers of trouble were identified, appropriate actions could be taken to get back on schedule. In the end, on-time delivery was returned to customer requirements while both inventory and manufacturing variance were drastically reduced—resulting in increased profit. The daily status of those 12 parts was never far from the desk of the Materials Director in the coming months and years.

We have tried to show in these three examples, methodologies and techniques effectively used or seen in the past. Perhaps you have used one or two yourself.

If you like or are intrigued by what you have seen but are unsure how market or asset segmentation might help your company, ask yourself the following three questions—

  • Do you know on which accounts you want your sales force to spend 80% of their time each year?
  • Is it clear where you are really making or losing money (on a customer-by-customer basis), and why?
  • What few elemental manufacturing parts, assemblies, or activities are getting in the way of company success or profits, and why?

If you do not have good answers to the above, we suggest that getting these answers should be a priority this year. I would be mighty surprised if segmentation is not part of finding answers and solutions.

And if a member of your staff or a colleague uses the term “on average” to describe an important metric or issue in the future, stop the meeting and tell them to dig deeper.

Wilkening & Company has assisted clients with the segmentation of customers, products, assets or processes and the formulation of indicated solutions during the past 25 years. Do you have a problem or profit impediment where you think this might apply? Call us at (847) 823-5090, or write at bob@wilkeningco.com.

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