Identifying key segments

Identifying key segments reveals which combinations of offering and customer group generate the sales, profit and future potential that matter most. It is the first discipline in knowing where the business truly competes.

When to use it

• Use segmentation whenever strategy is being developed or refreshed. Without it, market research, competitor analysis and capability investment may be aimed at an economically marginal part of the business.

Origins

Businesses have always distinguished among types of buyers, but Wendell R. Smith gave market segmentation a central place in modern marketing theory in the mid-nineteen-fifties. He argued that heterogeneous demand could be divided into meaningful groups and served with more precise offers. Later practice expanded the idea from demographic groupings to needs, behaviour, profitability and value.

What it is

A business segment is a specific product or service sold to a specific customer group. The central questions are simple: which segments do we serve, which create profit today and which could create it in the future?

Sales alone can mislead. One segment may be large but costly to acquire, serve or retain; another may be smaller but produce stronger margins. Strategy should concentrate leadership attention on the segments that contribute—or could credibly contribute—the majority of business value. Spending disproportionate effort on a segment responsible for only 1 per cent of operating profit is difficult to justify unless its future potential or strategic role is material. In many businesses, a small set of segments contributes 80 per cent or more of the result.

How to use it

Start with the business mix. List distinct offerings on one axis and distinct customer groups on the other. Treat an offering as distinct when its customer value, economics or competitors differ. Define customer groups using differences that change how the organisation reaches or serves them: needs, behaviour, sector, location, channel or another decision-relevant characteristic.

Each intersection is a product/market segment. If the business has 3 offerings and 3 customer groups across 2 countries, it operates in 18 possible segments. Do not assume every theoretical intersection is meaningful; combine cells where economics and strategic choices are genuinely alike.

For each active segment, assemble current and historical sales, gross profit and operating-profit contribution. When operating-profit data are unavailable, create documented estimates for marketing, service, travel, returns, working capital and other costs that differ by segment. Reasoned estimates are better than treating all segments as equally profitable, but test sensitivity to uncertain allocations.

A worked example makes the distinction clear. Suppose small, medium and large widgets are sold to manufacturing, engineering and construction customers in the UK and France. Large widgets for UK engineering contribute 40 per cent of sales; medium widgets for UK engineering contribute 25 per cent; and large widgets for French manufacturing contribute 15 per cent. Together, those segments produce 80 per cent. The other 15 segments produce the remaining 20 per cent.

A chart by product size or country alone would hide this concentration. The relevant strategic arena is not “large widgets” or “the UK” in general, but the exact intersection of offering, customer and geography. Demand drivers, economic cycles, competitor sets and production requirements may differ sharply at that level.

Add a forward view. If an extra-large widget for UK aerospace could contribute 20 per cent of sales in three years, show that expected segment beside the current portfolio and record the assumptions behind it. Use scenarios rather than false precision where demand is uncertain. The chart repeats the 40 and 25 per cent concentrations visually.

Then compare sales with profit. If large widgets for UK engineering generate 40 per cent of sales but only 30 per cent of operating profit, while medium widgets for the same market generate 25 per cent of both, investigate why. Structural competition may constrain the first segment, or a remediable capability gap may be suppressing its margin. Both the size of the segment and the cause of its economics affect the strategic choice.

For a start-up, segmentation is prospective rather than historical. Define the target customer, the problem or unmet need and the benefit promised. Test whether different customer groups value the offer for different reasons or require different routes to market. A single offering for a single coherent group needs no artificial subdivision; a niche discovered through needs-based research may, however, become the core proposition.

Finish with a concise portfolio showing the segments that make or could make the business, their economics, expected direction and confidence level. Keep the model usable: segmentation should improve decisions, not produce a taxonomy nobody can manage.

Top practical tip

Focus executive discussion on the two, three or four segments that contribute most to sales, profit or credible future value, and make the assumptions behind that ranking visible.

Top pitfall

Avoid paralysis through analysis. Dozens of weakly differentiated segments create data work without improving strategic choices.

Further reading

• Smith, W.R. (nineteen fifty-six). “Product Differentiation and Market Segmentation as Alternative Marketing Strategies.” Journal of Marketing.
• Wedel, M. and Kamakura, W.A. (two thousand). Market Segmentation: Conceptual and Methodological Foundations. Kluwer Academic Publishers.