Market Segmentation Best Practices: Tips for Accurate Audience Identification

What Is Market Segmentation? 

Market segmentation is the strategic practice of dividing a large, diverse (heterogeneous) group into smaller, more similar (homogeneous) sections based on specific shared observable characteristics such as age, income, behavior or geographical location and/or unobservable characteristics such as attitudes and feature preferences. The ultimate goal is to tailor marketing efforts, product offerings and services to these specific groups in a way that maximizes relevance and appeal, optimizing return on investment (ROI). 

You may think that market segmentation is a technique only large corporations can afford to invest in, but that couldn't be further from the truth. In fact, 81% of business executives say market segmentation increases profits. Businesses of all sizes, from new startups to long-standing enterprises, can benefit substantially from market segmentation. Here’s why: 

• Focused marketing: With limited resources, it's essential for small to medium-sized businesses to concentrate their marketing efforts where they will have the maximum impact. Market segmentation allows these businesses to focus on specific consumer needs and fine-tune their messaging accordingly. 
• Resource allocation: For large corporations with diverse product lines and expansive markets, segmentation aids in judiciously allocating resources. By identifying high-performing segments, businesses can prioritize these areas and allocate funds, staff and other resources more effectively. 
• Customer retention: Knowing your customer segments inside and out enables you to cater to their specific needs, increasing customer satisfaction and loyalty. Pleased customers are more likely to become repeat customers and even advocates for your brand. 
• Innovation and product development: Understanding various segments' unique preferences and pain points can guide product development and innovation. This ensures that new or modified offerings will have a ready and receptive market, minimizing the risk of product failure. 
• Competitive advantage: In crowded marketplaces, differentiation is vital. Effective market segmentation allows you to pinpoint unique selling propositions (USPs) for each segment, setting you apart from competitors and enhancing your market position. 

Market segmentation is not just a strategy but a necessity for businesses seeking to survive and thrive in today's dynamic and competitive environment. By identifying and understanding your key market segments, you lay the foundation for targeted marketing strategies, more effective resource allocation and a more successful and sustainable business. 

Types of Market Segmentation 

Market segmentation is not a monolithic concept; there are several ways to segment a market, each with its own set of variables and insights. Understanding these differences is crucial for selecting the most effective segmentation strategy for your business. Here are the five primary types of market segmentation: 

Demographic Segmentation 

Arguably the most common form of segmentation, demographic segmentation categorizes the market based on demographic variables such as age, gender, income, education level and marital status. Businesses often use this type because the data is relatively easy to obtain, and the insights are straightforward to apply. For example, a cosmetic brand might target a specific age group with anti-aging products, while a luxury car manufacturer might focus on high-income segments. 

Geographic Segmentation 

As the name suggests, geographic segmentation involves dividing your market based on geographical boundaries. This could range from countries and regions down to specific cities or neighborhoods. Geographic segmentation benefits businesses whose products or services are influenced by location-specific factors like climate, culture or regulations. For instance, a clothing brand might offer heavier coats and jackets in colder regions while focusing on swimwear in coastal areas. 

Psychographic/Attitudinal Segmentation 

This type goes beyond basic demographics to explore the psychological attributes of customers, such as their values, lifestyles, attitudes and interests. Psychographic segmentation can be highly insightful but is also more complex to execute, and methods such as pairing attitudinal statements with clustering algorithms such as CCEA can do much better than other approaches. A fitness brand might use psychographic segmentation to target individuals who value a healthy lifestyle and are committed to regular exercise. 

Behavioral Segmentation 

Behavioral segmentation focuses on the actions or behaviors exhibited by customers, such as their buying habits, brand loyalty and product usage rate. This form of segmentation can be particularly effective for tailoring marketing strategies like customer retention programs or loyalty rewards. For example, a streaming service might offer special promotions to frequent viewers or binge-watchers to increase their engagement and reduce churn. 

Needs-Based Segmentation 

Needs-based segmentation focuses on consumers’ preferences for product/service features as well as their price sensitivity.  MaxDiff (best-worst scaling) and conjoint analysis (CBC) are excellent tools for assessing such needs.  Latent Class MNL is a widely used approach that Sawtooth Software specializes in that simultaneously estimates respondent preferences from choice data and assigns respondents into groups that are maximally different (with respect to product feature preferences and price sensitivity) between groups while being maximally similar within groups. 

Just as important is matching the statistical segmentation method used to create segments to the type of segmentation and the study objectives.  Read more about this more technical topic here:  Four Common types of Segmentation

Each of these types of market segmentation brings its own advantages and challenges. Your choice will depend on an array of factors, including the nature of your product, your business objectives and the resources available for market research. Often, businesses find the most success when combining multiple segmentation types to create a comprehensive and nuanced understanding of their target market. 

Examples of Market Segmentation 

Sometimes, the best way to understand the power of market segmentation is to see it in action. We'll look at a few examples of market segmentation that demonstrate how it can propel businesses to new heights across diverse industries. 

Coca-Cola 

Coca-Cola is a textbook example of demographic and geographic segmentation. Recognizing that consumer preferences for beverages can vary widely based on age and location, the brand has diversified its product line to appeal to different demographics. Their standard Coke appeals to a broad audience, while Diet Coke is often marketed to an older demographic concerned with sugar intake. Additionally, flavors like "Georgia Peach" target specific geographic locations where those flavors are popular. 

Netflix 

Netflix employs behavioral and psychographic segmentation to an extraordinary degree. Utilizing complex algorithms to analyze viewing behavior, Netflix not only suggests content that keeps users engaged but also uses this data to inform its original programming. The result is a product offering that resonates strongly with various psychographic segments, from rom-com lovers to documentary aficionados, reducing churn and increasing customer lifetime value. 

Tesla 

Tesla's market segmentation strategy is a compelling example of income and psychographic segmentation. Targeting a high-income bracket that is also environmentally conscious, Tesla positioned its electric cars as a luxury yet sustainable alternative to traditional gas-guzzling vehicles. This focus allowed the company to create a unique brand identity and corner a previously untapped market segment.  

The takeaway is that market segmentation isn't confined to any specific industry or type of business. Whether you're a multinational corporation, a local startup or a specialized service provider, a well-executed market segmentation strategy can offer unparalleled insights into your customer base. These insights empower you to develop targeted products, fine-tune your marketing strategy and build stronger, more enduring customer relationships. 

Turn to Sawtooth Software for Market Research Solutions 

Sawtooth Software is a leading provider of innovative market research solutions for needs-based segmentation, like MaxDiff and Conjoint Analysis, including choice-based conjoint studies. You can rely on our extensive experience and expert knowledge to help you generate results that will make a difference in your business. Contact us today to learn more. 

The Market Segmentation Process

Understanding the types and examples of market segmentation is essential, but knowing how to effectively execute a market segmentation strategy is where the real work — and reward — comes in. Here is a step-by-step guide to the market segmentation process: 

1. Segmentation Strategy and Data Collection 

The first step in any market segmentation strategy is gathering the requisite data. The type of data you collect will depend on the kind of segmentation you're aiming for and the business problem to be solved. Demographic information might be the easiest to acquire, often already existing on your company database. But, demographic information may not necessarily be useful for the business problem at hand.  If you're leaning towards psychographic, needs-based, or behavioral segmentation, your research may involve techniques like preliminary focus groups, followed by in-depth interviews,  and finally quantitative surveys. 

2. Target Audience Identification 

Once the data is collected and analyzed, the next step is identifying your target audiences or customer segments. These are the groups of people who share common characteristics and are most likely to be interested in your product or service. Consider creating customer personas with specific demographics, psychographics, product feature preferences/needs, price sensitivity, and behavioral traits to guide your marketing efforts. 

3. Segment Profiling 

Now that you've identified your target segments, delve deeper to profile each group comprehensively. What are their pain points? What are their preferences? What is their price sensitivity and/or budget constraints? What media channels do they use most often? The more detailed the profile, the better tailored your marketing strategies can be. 

4. Strategy Implementation 

With your segments identified and profiled, you can implement your tailored marketing strategies. This could involve personalized email marketing campaigns, exclusive promotions for specific segments or even developing new products tailored to meet a segment's needs. The key is to ensure that each strategy is aligned with the characteristics and preferences of its corresponding segment. 

5. Evaluation and Iteration 

The final and often overlooked step is evaluating the effectiveness of your segmentation strategy. This means not only looking at key performance indicators (KPIs) like sales and customer engagement but also assessing whether your segments remain valid. Market conditions, customer preferences and even global events can change the landscape, necessitating tweaks or overhauls to your segmentation strategy.  

The market segmentation process is not a one-time endeavor but an ongoing cycle. By continuously collecting data, identifying and profiling segments, implementing targeted strategies and evaluating their effectiveness, you can adapt to market changes and ensure your marketing efforts are as impactful as possible. 

Common Market Segmentation Mistakes

Market segmentation is a potent tool, but like any tool, its effectiveness depends on how well it's used. Here are some common mistakes that businesses often make during the segmentation process and how you can steer clear of them: 

Over-Segmentation or Under-Segmentation 

Striking the right balance in segmentation is crucial. Over-segmentation might result in segments that are too narrow, making your marketing efforts inefficient and potentially costly. On the other hand, under-segmentation may yield segments that are too broad, making it challenging to address the specific needs or preferences of your audience. The key is to find a sweet spot where the segments are large enough to be worthwhile but specific enough to enable targeted marketing strategies. 

The “Curse of Dimensionality” 

Many researchers think that the more variables you use to segment your market, the better the segments may become.  It’s usually the opposite.  The more basis variables you use to develop your segmentation, the less differentiation will be seen in the segments.  This is usually counterproductive.  

It is better to plan ahead regarding what kind of segmentation will likely best answer the business problem and to be very selective regarding how many basis variables to use in developing your segments.  As a basic guideline, it’s better to have (say) 8-12 basis variables that are relatively uncorrelated and are predictive of the attitude or behavior that matters to the business problem than to have 50+ basis variables that involve a mixture of intercorrelated attributes and attributes that have no relation to the business problem at hand. 

Ideally all this planning works to identify a small, focused set of segmentation variables.  Often it does not, however, so for more on how to solve this problem analytically see our more technical white paper here: Garbage Can Cluster Analysis 

Ignoring Market Changes 

Market conditions are anything but static. Consumer preferences evolve, new competitors enter the field and external factors like economic fluctuations or global events can dramatically impact the market landscape. Ignoring these changes can render even the most meticulously crafted segmentation strategy obsolete. Continuous monitoring and adaptability are crucial for maintaining an effective market segmentation strategy. 

Inadequate Research or Data Collection 

The foundation of any segmentation strategy is the quality of the data you collect. Skimping on this crucial first step can result in inaccurate or overly broad segments, diminishing the effectiveness of your subsequent marketing strategies.  Remember, garbage in, garbage out; your segmentation is only as good as the data it's based on.  

As you might expect, some common statistical pitfalls can also derail a segmentation study.  For a description of these common obstacles and for how to set up a process that avoids them see: Segmentation: How to Do It Badly and Well

Avoiding these common pitfalls will set the stage for a robust and effective market segmentation strategy. With careful planning, constant monitoring and a commitment to quality data collection, you can maximize the benefits of market segmentation for your business. 

The Importance of Market Segmentation

While the concept of market segmentation is easy to grasp, its impact on various facets of a business is profound and multifaceted. Let's look more closely at its critical role in product development, marketing strategy and customer satisfaction and retention. 

Role in Product Development 

The saying "You can't be everything to everyone" holds especially true in product development. Trying to design a product that appeals to all is not only a challenging task but also an inefficient use of resources. Market segmentation lets you identify gaps in the market or unmet needs within specific segments.  

By homing in on these niches, you can develop products or services tailored to meet the unique needs of a targeted group, thus increasing the likelihood of product success. Furthermore, insights derived from segmentation research can inform feature prioritization and pricing strategies and guide future product iterations. 

Influence on Marketing Strategy 

A well-defined market segmentation strategy directly feeds into your overarching marketing plan. Once you've identified your key segments, you can tailor your marketing mix — the Four Ps (Product, Price, Place and Promotion) — specifically for these groups. For example, if one of your segments is particularly price-sensitive (which can be assessed quite well using conjoint analysis), offering discounts or value bundles could be a winning strategy. Alternatively, for a segment that values premium quality and is willing to pay for it, an "exclusivity" marketing angle may be more effective. In essence, segmentation enables you to customize marketing campaigns in a manner that resonates most powerfully with different audience subsets, maximizing engagement and ROI. 

Impacts on Customer Satisfaction and Retention 

Generic mass-marketing strategies risk alienating potential customers who feel their specific needs are not being addressed. Market segmentation, on the other hand, allows for personalized customer interactions. Whether it's a customized email, a tailored product recommendation or targeted customer services, these personalized touches significantly enhance customer satisfaction. 

Customers who are happy will likely make repeat purchases and become brand ambassadors, recommending your product or service to their network. In the long run, high customer satisfaction driven by effective market segmentation can increase customer retention rates, which is often more cost-effective than acquiring new customers. 

Frequently Asked Questions About Market Segmentation 

Sawtooth Software understands your concerns about market segmentation and has the answers you're looking for. Read the following questions for additional details. 

What Are Five Types of Market Segmentation? 

The five primary market segmentation types are demographic, geographic, behavioral, psychographic/attitudinal as well as needs-based. 

What is One Example of Market Segmentation?  

One classic example of market segmentation is the approach taken by the automobile industry, where manufacturers offer different models of cars to appeal to various market segments. 

How Do You Identify a Market Segment? 

There are several key criteria for identifying a usable market segment: 

• The segment's primary needs must be similar (homogenous). 
• The segment members must share distinct characteristics.  
• The segment must be large enough/economically viable for targeting. 
• These segments must also empower you to reach your business objectives 

Trust Your Market Research Needs to Sawtooth Software 

With an industry-leading stable of market research solutions, including tools especially useful for market segmentation, Sawtooth Software is a partner you can depend on. Contact us now to discover everything we can do for you.