How Many Segments Should You Create?

Everyone who tries to create customer segments runs into the problem of numbers. By using recency, frequency, monetary (RFM) analysis, it is possible to come up with hundreds of different RFM cells. By using SIC codes, you can create hundreds of types of customers that you can market to. By using profitability, you can subdivide your customers into deciles, for example, from the most profitable to the least profitable. How many segments make up the right number?

To get the answer, you need to consider the imagination and creative genius available in your marketing organization. Every new marketing idea requires time and resources for its execution. Few organizations can develop and support as many as five or six simultaneous marketing efforts. Therefore, the sector marketing strategy must end up creating and marketing to just a few sectors.

Are Your Segments Viable?

OK. You have divided your customer base into five segments, and you have developed a marketing program for each of the five. Let’s say you divided your customers by level of total spending (rather than by age, income, product categories, etc.). Were your segments the most profitable that you could have devised? How can you know?

One good way to find out is to create a universal control promotion that you use with your segment control groups. This is a good promotion that has worked in the past and resulted in a lot of sales. It is used to test the marketing promotions designed for each segment. Table 8-2 shows a possible result of a mailing to your segments based on total spending.

Table 8-2 : Testing Segment Promotions

Customer segments	Number promoted	Sales rate	Lift	Lift in sales
Gold	100,000	8.10%	0.16%	160
Control	20,000	7.94%
Silver	100,000	6.60%	0.19%	190
Control	20,000	6.41%
Bronze	100,000	5.01%	0.41%	410
Control	20,000	4.60%
Lead	100,000	2.34%	–0.06%	(60)
Control	20,000	2.40%
Total	480,000			700

Here’s how we did the math for the lift in sales. We subtracted the sales rate for the control group from the sales rate from the test. In the Gold segment, for example, we subtracted 7.94 from 8.10 and got 0.16 percent. Then we multiplied that 0.16 percent by the number of people in the test segment—in this case 100,000—to get the lift in sales. What this tells us is that the creative material we used with the Gold people resulted in 160 more sales than we would have gotten if we had sent them the control package.

Unfortunately, this segmentation scheme is a self-fulfilling prophecy. The high spenders spent a lot. The low spenders spent a little. You knew that when you set up your segments. You could not think up enough creative things to say to the Gold customers, for example, to differentiate their behavior from that of the Gold customers who got the same message that was sent to everyone else. This is bad segmentation strategy.

Suppose we were to create our segments in a different way. We might do it by the age of the customer. We create special promotions for people in their teens, people in their twenties and thirties, people in their forties and fifties, and senior citizens. We want to see if we can design messages that reach these segments and do better at selling to them than a generic message. Table 8-3 shows a possible result.

Table 8-3 : Age Segment Promotion

	Number promoted	Sales rate	Lift in	Lift sales
Teens	115,000	9.50%	3.50%	4,025
Control	20,000	6.00%
20s and 30s	145,000	7.70%	1.90%	2,755
Control	20,000	5.80%
40s and 50s	75,000	5.00%	–0.70%	(525)
Control	20,000	5.70%
Seniors	65,000	4.00%	0.90%	585
Control	20,000	3.10%
Total	480,000			6,840

As you can see, we have the same number of people, but they are divided into age groups. The lift from our promotions is very much more pronounced. The teen message really scored well and produced a 4025-customer lift over the control groups. We can’t say the same for the work that our creative staff did for people in their forties and fifties. From this you can see that the way you create your segments often determines your results.

You should experiment with several segmentation schemes before you settle on the one that you will use for a long time.

Rules for Segment Marketing

Based on this discussion, how do you go about profitable segment marketing? There are several rules:

• Build a customer database with demographics and transaction history. Find a reliable way to get regular updates on transactions and responses.

• Come up with a profitable method for creating customer segments that you can market to.

• Select just a few segments and design a marketing program for each segment.

• Set up control groups that have exactly the same characteristics as the groups selected for marketing, but that do not get the promotional material. Measure the performance of the segment that received the promotion against that of the control group.

• In the marketing campaign for each segment, use the database to create personalized content: emails, direct-mail pieces, telephone calls, Web response pages, and so on. Monitor the response from each segment and each response method and record them in the database.

• Constantly test new methods of marketing to each segment, recording the results and increasing the resources devoted to those methods that work.