Many organizations are segmenting customers and products to improve EBIT and working capital or to implement their strategy more consistently. Although segmentation initially seems to be little more than a logical reflection on the customer and product portfolio, it is actually a lot more complex than that. When embarking on a segmentation exercise, keep in mind the following pitfalls:
Some organizations prefer to focus on just one of the two forms of segmentation, rather than combining them. But even if you have a top-class customer segmentation process, for example, it won’t help you draw up a good production schedule. Ultimately, scheduling production is about making products, not about scheduling customers. For example, a Belgian company that produces boards, decorative panels and finished products, conducted a customer segmentation exercise without paying attention to product segmentation. But when production capacity came under pressure, the company really missed also having product segmentation to support rational decision-making. How can you choose between making a commodity product or a high-quality product for an A-category customer? Which products should you prioritize? Without a product dimension in your segmentation less-strategic commodity products may cannibalize premium products, undermining the company strategy and infuriating the CEO.
It is not uncommon to find a lack of buy-in from sales colleagues, who have not been involved in the segmentation process and see it as a potential threat to part of their customer-product portfolio. If sales employees do not back the exercise, it will never work. Therefore, it is crucial to involve the sales team from the start, so they can gradually get used to the idea. After all, sales obtains information from customers first-hand and as such can make a valuable contribution to the segmentation exercise. Once convinced of the added value, sales managers can use the segmentation framework as a vehicle to support their customers growth. It’s easier to counter questions about price reduction when you link it to a certain service level. For example, if your customers ask for price X, you can offer them this price giving that you deliver service X and no longer service Y or Z. Gaining buy-in from sales will eventually drive revenue growth.
Segmentation is a strategic exercise. It requires significant involvement and active input from the CEO and the executive committee in order to clearly define the strategy. After all, segmenting customers and products is about defining which products and customers should be targeted for growth, and which should be treated more opportunistically. The sponsor in this case should be the CEO, because he is responsible for making the final strategic decisions. The supply chain manager or an external partner can never do this in his place. Furthermore, the CEO can benefit greatly from a strong product and customer segmentation as a way of ensuring the right trade-offs are made and the right focus is created.
Taking over an internal segmentation process at one of our customers in the oil refinery sector, we clearly saw the negative effect of having too many parameters. They defined six parameters which created a situation in which every customer was perceived as an ‘average’ customer. Having too many parameters destroys the differentiating power and makes that employees can’t explain why a certain customer actually ended up in level A, B or C. Our advice is to work with just two, maybe 3 or maximum 4 parameters. There has to be a very compelling reason to go from 2 to 3 or 4 parameters.
The two most common parameters are volume and margin, but always let the team come to its own conclusions. The road to defining the different axes on which to classify customers and products is one of the most important parts of any segmentation exercise thanks to the nature of the discussions leading up to a consensus. Going through the exercise of scoring some products or customers during the sessions will quickly show why less is more when it comes to classification parameters. Because how do you define the future volume? Should you take the forecast into account, or the expected budget or the potential growth instead? And which volume-related data is available and up to date for all your customers?
The initial list of criteria will be big, mostly because there will be some exceptions to any rule the team comes up with, but keep in mind that you should not be trying to cover all your customers or products in one go. Aim to create a model that will correctly classify 80% of the total population and have a review process in place to deal with the rest. Any change to the classification should be justified and there should be an ‘audit trail’ that allows anybody to quickly identify the reason for the change.
Customer and product segmentation is a process, not a project, which is why it is important to introduce a certain degree of structure right from the start. This is also beneficial because of complexity of the segmentation exercise. We notice that many companies run internal segmentation exercises using Excel, but an Excel sheet is not suited for the complexity of segmentation. In Excel you can’t track who made certain changes, for example, which means you risk working with different versions of the truth. When initiating a segmentation process, consider using a proper tool and ask for external advice to support the change within your organization. Segmentation is far more complex than many of us are ready to believe. It is about redefining the way you do business.
Curious to find out how segmentation fits into your S&OP process?