Segmentation is really useful for rationalizing your service and product portfolio, so you can further improve your EBIT and working capital. It’s also a convenient method to implement the strategy of your choice. But how should you tackle a segmentation exercise? The 6-step approach outlined below makes segmentation processes easier to manage.
You typically start by brainstorming possible segmentation criteria, which often generates a broad variety of segmentation parameters. However, it’s crucial to limit the parameters included in the segmentation model to preferably just 2 and a maximum of 6 parameters. In most cases, the basic segmentation happens on volume and margin, but it’s certainly possible to also include qualitative parameters, such as the willingness of the customer to innovate or co-create.
Once the parameters are in place, you can grade your customers in terms of ‘High-Medium-Low’ in order to define the A, B and C customers. Typically, you work towards a calculation model that assigns 90% of the customers correctly with around 20% of the parameters.
In this phase, it is crucial to get buy-in from Sales; if those colleagues do not back the exercise, it will never work. Therefore, it is essential to involve them from the start and give them the chance to upgrade or downgrade customers. Besides that, Product Management, Marketing, Supply Chain and Finance should also be at the table.
When segmenting your products you generally shouldn’t use volume and margin as parameters, because they increase the risk of a forced, high correlation. Therefore, we usually recommend that you take a more qualitative approach to segmenting your products, based on two dimensions: the ‘strategic fit’ and the ‘operational fit’. The first dimension requires input from Marketing, whereas the second requires input from Production and Supply Chain. A product will have a strategic fit if it is aligned with where the company wants to be in 3 to 5 years’ time. To define the operational fit, you should take account of aspects such as the ease to produce, the changeover time and amount of off-grade products.
Not all customers are equal and nor are all products, so in the next step you start differentiating service based on your customer-product segmentation. Therefore, you have to define the types of services within your company and your service parameters. Hence, another brainstorming session is needed to clarify how your organization differentiates in service.
When classifying the parameters the Kano model can be useful; this is an insightful way of understanding and categorizing customer requirements. The model assumes a distinction between qualifier, performance and excitement parameters. Only the performance parameters affect your business in two ways: if you perform worse than the competition it will negatively affect your profit and, conversely, outperforming the competition will de facto positively impact your profit. This is really the key to steering your business in the market and making the distinction between A-level and C-level customers. Aim to dominate for the A-A combination and be more opportunistic for the C-C combination.
When you start differentiating it creates a lot of uncertainty within your company. It can even be a little daunting, because you need to be prepared to lose some C-level customers. Simulating scenarios can support you in this process. We typically run a pessimistic and an optimistic scenario. Pessimistic could be loss of 50% of the C business with limited gains in the A and B segments. Optimistic could be loss of 5% of the C business with significant gains in the A and B segments. You should run as many scenarios as necessary until you understand the potential leverage and the potential risks. Although C customers and products may be less strategic and less profitable, they may still be important because of their volume and hence their contribution to covering the fixed costs. This uncertainty should be addressed in the simulation.
When is the segmentation process finished? We advise you to reiterate until you feel that it’s right and that the segmentation really reflects your business. Note that you may need a separate segmentation exercise for different business units.
One challenge of segmentation is getting Sales on board. It’s important to show Sales colleagues what’s in it for them; ultimately, a good segmentation process can be an instrument for developing customers. It makes it easier for Sales to counter questions about price discounts when they can link price to a certain service level. For example, if your customers ask for price X, you can offer them that price based on you providing service X but no longer service Y or Z. It becomes a structured way to set boundaries with customers. Gaining buy-in from Sales will eventually drive revenue growth.
Furthermore, make sure that you implement your model at each step of the Sales and Operations Planning (S&OP) process. Concerning the demand review, for example, once you know your A-level customers it’s clear you have to try to set up collaborative planning with them.
It is an ongoing process, not a project. You need to recalculate at least once a year, e.g. linked to the budgeting process. You should also define a procedure for new customers. Besides that, allow Sales to upgrade and downgrade but include a quarterly result check.
Finally, because segmentation is a process that needs to be re-done regularly, it’s advisable to invest in good tooling to support that process. We notice that many companies run internal exercises using Excel, but an Excel sheet is not suited to the complexity of segmentation. Given the amount of data that needs to be processed, Excel files tend to become slow. Instead, when initiating a segmentation process, consider using a proper tool and ask for external advice to support the change within your organization.