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What is Customer Segmentation

What is Customer Segmentation and How Does It Benefit Distributors?

When answering the question, what is customer segmentation, consider your own experiences with family, friends, coworkers, and strangers. Chances are you have entirely different ways of communicating with each of these groups. How you approach greeting, asking questions, or confronting them is different. More, you probably have different expectations of interacting with each of these groups too.

Well, the same should apply to your customers in business. The concept is often mentioned but frequently overlooked as a tool for growing profits. With ease, you or someone on your team can mentally sort some of your key customers based on unique pain points, needs, or behaviors. You can probably think of at least one customer that consistently creates headaches for your business.

Whatever the case may be, the best way to create and maintain strong relationships (and, in turn, profit) is to recognize the differing needs of your customers. Then, understand how they prefer to address those needs. Do this right, and you’ll see continued revenue growth.

What is Customer Segmentation?

At its core, customer segmentation is simply a strategy wherein you divide your customer base into smaller groups that share similar characteristics. These characteristics can range from demographics to purchase history to any other traits relevant to your business.

From there, you can target those customers more effectively. As previously mentioned, changing and adapting your communication and marketing allows you greater control over every customer interaction. That means, potentially, more partnerships, more deals, and more revenue.

Your Segments Are Your Strategy

However, customer segmentation is more than just nominal grouping and categorization. If you approach your segmentation correctly—with real, profit-driving behavioral data—it becomes a blueprint for driving success throughout your organization.

Most distributors start their segmentation with basic filters like industry, region, or customer size. While it’s a quick and easy-to-understand way of organizing your customers, this type of stratification lacks a call to action for changing customer-purchasing behavior toward higher profit potential.

For example, imagine you group one of your customers into the “small” or “tiny” business size. Your protocol may call for assigning them the highest product price. Then, you are absolutely ensuring that they will always be small to you while they may be significant to your key competitors.

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Why Distributors Should Care

The number one reason distributors need to tighten up their approach to segmentation is profit. Many distributors are leaving money on the table because they are ignoring segmentation. When your segmentation and pricing strategy are aligned, large profit gains are the rule, not the exception.

At this point, you may be thinking that you’ve tried segmentation. Although, it probably hasn’t been at the forefront of your strategy. And, if it was, you may have only divided your customers by geography, demographics, or product preferences.

Segmentation is More Than Geography, Demographics, and Product Preferences

Segmentation in Distribution

Segmentation in distribution is also not about demographics. Many marketing employees are necessarily focused on demographics, meaning how your customers break down into small, medium, large, industry segments, and more. Demographics are the broad statistical breakdowns of your customer locations. This is helpful at a high level. Unfortunately, demographics cannot take you very far in your segmentation and pricing strategies. Just like with geography, you can have two medium-sized home builders who have totally different purchasing behaviors. One pays more but wants custom service. The other is just shopping jobs to the lowest bidder. They should be treated differently, or you will lose one of them and perhaps lose money on the other anyway.

Distributors don’t benefit from segmentation based on product preferences or attitudinal segments as retailers might. Attitudinal segmentation is essential when you are a retailer, and you want to understand what kinds of emotions you need to evoke when selling jeans to single millennials in Boston. But your customers don’t necessarily use the product they buy from you. Instead, they might install those products for their own customers. So, their preferences are a step removed from your customer. Your customer does have preferences, but they have to do with the experience they have with your company – are you priced right, are you consistent, are you convenient, do you make them more successful. In other words, maybe the customer’s customer has a product preference. Still, your customer is more interested in the factors that lead them to buy from you instead of another distributor.

Customer Segmentations That Drives Profit for Distributors

If geography, demographics, and product preferences don’t work for distributors, what kinds of segmentation work?

Customers exhibit three key profit-driving behaviors that influence their profits. The three most important behaviors that affect your profitability, and thus the behaviors that you need to focus on in your segments are:

  1. Buying power
  2. Profitability
  3. Cost to serve

Buying Power

Buying power can be defined as a combination of data such as sales revenue, unique items, and special orders. The more of those behaviors they exhibit, the higher their buying power. In general, customers with higher buying power are good customers but can also demand a tighter margin. It’s about their sales revenue, unique items, and unique orders. That’s the power they have on your business. And it is a critical component of your segmentation strategy.

Profitability

Another, somewhat evident behavioral influence a customer has on your business is their profitability. How profitable is this customer? The higher, the better. What drives profit? Margin dollars, gross profit percentage, and average order size. Defining and analyzing what a profitable customer is in your business is about having intelligent discussions and decisions about customers’ behaviors that matter most to your business.

Cost to Serve

The third key customer behavior you want to factor into your segmentation is, cost to serve. Your customer’s present cost to serve factors such as lines per order, average line dollars, returns percentages, and DSO.

You might think that buying power and profitability are all that matter. A big customer, placing large orders, driving purchasing efficiency, and doing so at profitable pricing is certainly a great customer. But you also must figure out what the impact on your entire business of that customer is a way to handle that is, cost to serve. Sure, that customer is placing large and profitable orders, but maybe they never pay their bills, or they place small, single-line orders that drive your profits down in other ways.

Fortunately, White Cup Pricing powered by epaCUBE has created an easy-to-use solution to create data-driven segments that matter to your business and drive better pricing and higher profits.

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