Customer Segmentation: A Step by Step Guide for Growth

In this section of our Funding Series, we will show you how to use customer segmentation to improve customer service, customer experience, customer relationships, customer retention, and customer feedback.

August 11th, 2022   |    By: The Startups Team

Continuing in Phase Three of a four-part Funding Series:

Phase One - Structuring a Fundraise

Phase Two - Investor Selection

Phase Three - The Pitch

Phase Four - Investor Outreach

Let’s dive in!

A company in the early growth stages should concentrate its efforts on a particular segment of customers whose needs most closely match that of their best current customers and not a broad universe of prospects for expansion.

Customer segmentation works for companies that started yesterday, and mature companies as well. In the modern digital marketing landscape, it's not optional for success in most marketing channels.

What is customer segmentation?

The term consumer segmentation or market segmentation means segmentation of the consumers into subgroups. This allows you to tailor your message to your clients' needs. Several kinds of statistics inform customer segmentation.

The idea behind dividing a business by customer types is an effective method. Using this knowledge will help you understand how to influence people's customer journey and ultimately purchase decisions.

The best way to communicate with clients is to resonate with them. The best way to resonate with our customer base is to segment customers based on customer data and deliver a customer journey that increases purchase likelihood, improves customer experience, increases customer loyalty, and grows customer lifetime value.

Customer segmentation isn't just about new customers, it's about using our segments to turn new customers into valuable customers and valuable customers into our most valuable customers.

We can use customer segmentation to improve customer service, to improve customer experience, to improve customer relationships, customer retention, and customer feedback.

Many view customer segmentation as a "digital marketing" thing — but nothing could be further from the truth.

Start by defining who are and who aren't your customer segments.

Defining your customer helps everyone understand who your audience really is — and who it's not. The better you define your customer and tie that to the Problem you solve, the better everyone will understand your plan, from Customer Acquisition to your Revenue Model.

The problem most Startups run into is either being way too broad “Our audience is anyone with ears!” or way too narrow “Our audience is anyone who likes Alt Goth Punk Metal Classical Music from Saskatchewan!”

When developing your Customer Definition you’re trying to articulate a solid understanding of who is most likely to use and buy your product. It should start fairly broad and then refine down to more specific segments.

Customer Segments

Not every customer is your core customer. Think of it like your favorite musical artist.  You have people that are die-hard groupies. That's your absolute core audience.  

Then you have people who really enjoy the music and probably attend a concert when the band is in town. Those are fans. And then you have people who don't change the station when their song comes on, but probably don't own a full album. Those are listeners.

Segmenting your customer into specific audiences helps you provide a lot more clarity to Investors as to who you care about — and why.  

Imagine we were building a business plan for our new Indie band, “Rage Against Mozart” - a defining pioneer of the Rage Metal Classical genre. Perhaps the only one.  But whatever.

We could begin to split our customers (the people who listen to our music) into three basic tiers — Groupies, Fans, and Listeners.

Example

Groupies - Roughly 20% of our audience but they buy absolutely everything we produce, from bonus tracks to merchandise. Very high lifetime value and great opportunity to convert others.

Fans - Roughly 30% of our audience. They are likely to attend a concert, buy some merchandise and purchase our next album. Reasonable purchase behavior but have a fairly finite cutoff point where they will no longer spend. 

Listeners - Roughly 50% of our audience. They will likely listen to our music but will only do so as part of a larger listening behavior (radio, Spotify, Pandora) versus seeking us out directly. Not likely to attend conferences or buy merchandise, representing a low to no yield. 

Each of those represents a level of customer, and with that, a particular buying behavior. You don't want to lump everyone together, because this makes targeting really hard. It'll also make it easier for you to explain how each group will likely react differently to your product and perhaps how some may represent a larger percentage of your revenue than others.

Startup Founders rarely do this very well. Usually, because it’s not obvious why it matters so much. If you don’t break out your customers into segments or tiers, your investors may get the impression that you only have one audience and that audience may sound too broad or too narrow.  

You want to create more clarity so that you can view the opportunity in multiple lenses, providing a better sense for how real it is.

Demographics vs Personas 

Typically when people think about demographics they immediately jump into Age, Location & Household Income, or some of the tried and true basics.  

There's nothing wrong with that, and this data can provide some useful parameters that help shape the perception of your audience.

Yet what tends to be more impactful at this stage are Customer Personas. Personas help tell a story about what a person cares about, versus what their binary stats are.

Personas are incredibly helpful in communicating who your customer is because they humanize the person to your audience, allowing them to build a much more recognizable person that they can connect to.

Example

“The Demographic for Rage Against Mozart’s typical customer is males aged 15-25 who live in predominantly urban areas and have a median income of $35,000 per year.” 

All of that may be true — but it tells you very little. This could describe any of a billion products on the market today. It’s correct, it’s just not visceral.

Let’s view the same audience in a different light — as a persona.

Example

“A typical Persona for a Rage Against Mozart’s music is an angry teenager who is frustrated with society and has a pent up rage they need to express. Our lyrics reflect their frustration and our violin power chords provide a soundtrack to their rage.”

Technically both of those descriptions are true. But the latter provides a real narrative that the audience can connect with.  

If you’re doing a great job developing a persona your audience will be able to start visualizing that person, those behaviors and why that persona matches your product very well.

Customer Motivations

If you can paint an elegant picture of what your customer looks like, you can then take it a step further by exposing their motivations.  

Customer Motivations are the different problems and scenarios that your audience is faced with when they look at your product. They include emotions and thought processes that lead to the search.

Ideally you would have touched on some of this in your Problem Statement at the beginning of your pitch, but this is a great place to start digging into a handful of real-world scenarios that an investor can see in their mind's eye.

Example

“Ricky was a young boy, he had a heart of stone. Lived 9 to 5 and worked his fingers to the bone. Just barely got out of school, he came from the edge of town. Fought like a switchblade so no one could take him down.”

OK we’re just messing with you. That’s the opening lyric to Skid Row’s 1989 hit “18 and Life”.  But it’s actually not bad as a customer persona, so let’s stick with “Ricky” and see how he relates to Rage Against Mozart.

Example (for real)

“Ricky is a 15-year-old high school sophomore. He only has a few friends and gets picked on at school for being “different.” His parents are going through a painful divorce and his home life is a mess.  

Every day he becomes more disenchanted with the way society works and his place inside of it. He’s looking for a voice to reflect his own disharmony and provide a companion to his angst.”

Ah, that gives me some more color. I can picture “Ricky” because either I was him, I knew a version of him, or maybe he was a character in an after-school TV special I watched. No matter what the connection, I can start to connect with his motivations because I understand his world.

You don’t have to create a Steven King character backstory, but at least try to develop some scenarios that people can understand. Don’t just explain the frustration, provide some story around how that frustration manifested itself.  Problems start with root causes.  

The backstory builds up to the problem here. You knew Ricky was going through some tough times personally, so the manifestation of his problem (anger, frustration) becomes pretty obvious. That’s called motivation, and when it’s well articulated, it can tell an incredibly powerful story about your idea or product.

Good Ol’ Demographics

Don’t think we’ve forgotten about the old tried and true demographic data. Personas and motivations provide a nice introduction to your Customer Definition, but before you can move to the next step (Market Size), you need to determine what critical parameters delimit your audience.

Demographics tend to be most useful when trying to determine the size of your audience or where to find them. You will certainly make good use of Demographic Profiles in your Customer Acquisition section as it relates to targeting your marketing efforts.

Start with your Top 3

You can go super overboard with citing every demographic possible. You don’t lose points for being thorough, but for the sake of presentation, try to put more emphasis on your “Top 3 Most Defining Characteristics.”

In most cases, this helps you determine how “findable” your audience will be with your marketing efforts. Your needs may vary, but for most startups, you can work backward from where you might find your customers.

Example

The Top 3 Critical Demographic Indicators for Rage Against Mozart’s audience:

Age: 15-24 - Our listening audience tends to be very young as our lyrics and music cover themes most associated with youthful angst.

Music Taste: Metal, Punk - Although our music is composed mostly from symphonic instruments, the cadence of our music and the influences skew heavily toward fans of Metal and Punk genres.

Habitat: Social Networks - The frustrations and musical expression are most commonly shared among like-minded fans on popular social networks that center around music.

Notice what’s missing here - Income, Gender, Education, etc. — the staples of most demographic charts gracing the conference rooms of would-be investors.  

This isn’t to say those can’t be accounted for — it’s to say they should be presented in order of what’s most salient to finding your audience.  

Similar to how you presented personas, it helps to present the most defining demographics that allow an investor to say “Oh, yeah, I can see how you would be able to find people like that!” 

Market Size

Once you have a good handle on your Customer Definition the obvious question becomes - how many are there? You'll touch on this in summary with your Market Size information so consider this to be the more detailed view of that. 

Sizing an audience isn't easy, particularly for products entering new markets without a lot of data. Investors rarely expect you to be dead on with your numbers, they are looking for a fairly good argument for why the audience isn't too niche if they are involved.  

Market Size Matters

Whether you’re pitching for millions of dollars to venture capitalists or plundering your own savings to fund your startup, your Market Size really does matter. It just matters for slightly different reasons depending on who cares about it.

Market Size Indicates Opportunity Size

If investors are looking at your deal, they will use the potential Market Size to determine how big this company can get. More specifically, they will be looking to see if there is a fairly low ceiling that would prevent the business from growing any further.  

A small market size is always a huge red flag for a potential investment because it limits how big a company can be, which limits its potential value — something investors don’t love.

This isn't just for investors

Even if you're not interested in the needs of investors, it still helps to have a sense of the size of your audience so you can get a sense of how big the business can become and where some of your Customer Acquisition efforts may tap out if the audience is small (like a local business).

Find a Base of Reality

It’s difficult to size a market, however, you do want to be able to find at least one source that can help substantiate your market size claims.  

Try to leverage existing data

You may not have access to official industry-sourced information about your market (like a market report from a major consulting firm that covers your industry) but you may be able to find other market size indicators based on who else plays in your space.

In the case of our new favorite band, we may find that there are telling numbers about our genre versus others when we dig into the popular music service Spotify.

Example

"The top 10 largest Rock/Metal artists on Spotify have an average of 7 million people following that artist.  We consider that to be an average of how big a top act can get on Spotify alone. The second 100 artists in that category average 250,000 followers. We consider that to be difficult to achieve, but not impossible if people love our music. Over 25,000 artists appear to have an average of 50,000 followers and have achieved some level of commercial success, so we believe if we attract a market of 50,000 followers or more we can build from there." 

This example shows real numbers that correlate to known success in the Rock/Metal music genre, however, you'd still want to dig into how successful those artists are in each tier.

What's important with this example is that you've provided real numbers that show both the size and goals that you'd need to achieve to get market traction.

Make sure you can defend it! 

Remember, in this case, you want a defensible number that you can explain your position (how you got there) versus an absolute number that's unquestionable (which likely doesn't exist).

Size by Segments (Again)

At the beginning of this long diatribe about Customer Definition, we talked about Customer Segments or the different “tiers” of customers. In this case, it helps to talk about how each of the potential size of each of these segments.

Show how it grows.

The reason you really want to create customer segments from small to large is to show how your core audience can grow into a much larger audience. Most products start by attracting a small, loyal core audience and then grow into a larger audience over time. Facebook started by connecting co-eds on Harvard’s campus before connecting a billion humans. We all have to start somewhere.

Customer segmentation helps paint a picture

There’s no absolute rule here, but if you were to at least present a Primary and Secondary segment it may help show where you see your core audience trailing off and where your larger audience starts to grow. Think of it like a local coffee shop.  Your primary audience is within 3 blocks of you. Your secondary audience is anyone in your town.  

Customer segmentation is Customer Acquisition Gold

The other benefit of having segments is that it can help you focus your Customer Acquisition efforts on your initial audience and therefore use the smaller initial market as a better use for capital and testing critical assumptions.

What are the benefits of customer segmentation?

When you begin implementing a marketing plan you are essentially hitting a 1-inch target that's 100 feet away blindfolded and without knowing which direction you're facing. The chances to hit the target are mostly based on luck.

Data analysis over luck

We can reduce this reliance on luck by performing customer segmentation. If you already have customers, look at current customers and determine if the factors that make them similar or dissimilar. Is there a difference between your profitable customers and those that are the bane of your customer service team?

Copy the wins!

Obviously, we'd rather target potential customers who look more like our most profitable customers than new customers who'll simply be a customer satisfaction nightmare. These similarities and dissimilarities in customer data are what allow you to form your customer segments.

Marketing campaigns that hit home.

Once you segment customers, luck becomes less of a factor than researching a particular segment to understand the specific customer journey and create marketing campaigns to build this ideal customer base.

Sources of Segmentation Data

Your Customer Relationship Management (CRM) platform should be a rich source for data analysis and the creation of customer segmentation models — and certainly, there are referenceable data for things like demographic segmentation — but how else can we generate data for conducting customer segmentation?

1 - Conduct Surveys of your Customer Base

Surveys are a great way to gather data about your various target customers. Start be being clear on what your goals are with the survey — otherwise, you'll end up asking the wrong questions and getting data, but not data that's useful for the various types of customer segmentation. Once you are clear on the goal of the survey, and what customer segmentation analysis you want to perform based on it — knowing which questions to ask becomes far easier.

2 - Signup Forms / Downloads / Lead Magnets

When you offer premium content to your users you can ask for some basic data in return. Getting name, email address, and phone number may not seem like much — but if you use marketing automation tools to enrich this data (with their LinkedIn profile information for example) combined with what you can infer based on what they downloaded in the first place, we've got some interesting customer segmentation insights!

3 - Customer Interviews

While this can be used for initial customer segmentation — it is more often used to add detail or confirm or deny your assumptions about a particular customer persona. Interviewing 5-10 people from each customer segment is a great way to enrich your understanding of that segment's customer journey. So while it may not be as useful for initial segmentation it is wonderfully supplemental to the customer segmentation process.

4 - Audience Insights from Facebook

If you've got the Facebook Pixel installed on your site — you can create custom audiences based on website traffic. Once you have these custom audiences you can access audience insights — and see things like demographic data, interests, location, affinities, and more. This is an easy way to perform the customer segmentation process for things like behavioral customer segmentation.

5 - Tests and Quizzes

Ever taken something like the "which dinosaur would you have been in the Jurassic Period?" (hint, if it comes back Coelophysis — you're dealing with amateurs... Coelophysis was totally a Triassic period 'saur — but I digress). Well, this might come as a surprise to you - but the host of that quiz isn't just trying to enlighten people about an impossible scenario...what they are really after is customer segmentation data — and you can use this technique to your advantage as well. It works particularly well for gathering basic info as well as psychographic segmentation analysis. For a customer segmentation project focused on customer behavior, quizzes can give you a wealth of data. Quizzes are most often used for behavioral and psychographic data — but can be adapted to gather other types of customer segmentation data with a little creativity!

There are dozens if not hundreds of other ways to collect data or to find and make use of existing data for customer segmentation — but that's a full article in it's own right.

Types of customer segmentation

Different customer segmentation strategies have their advantages and disadvantages which need to be taken into account. At the highest level customers are segmented according to a two-part structure:

Segmenting customers based on what they do

You can segment customers according to observable behaviors. These might be macro-level behaviors like "owns a car" or highly specific behaviors like "they downloaded our ebook on aftermarket exhaust extension installation." Ideally, we're able to segment customers based on

Segmenting customers based on who they are

The process for determining customers is often based on demographics. This includes things like age, gender, education level, income, or geographic segmentation.

Going deeper with customer segmentation

4 common types of customer segmentation

A good customer segmentation strategy takes into account what information will be most useful in locating, communicating with, and ultimately converting members of the target audience into customers.

Behavioral segmentation

Behavior segmentation involves separating consumers according to one or more observable characteristics. Behavioral segmentation in the digital age often involves behavioral analytics technologies to analyze consumer behavior with the target market to develop customer segmentation.

For example, every time someone watches or rates a film or song, it gives the streaming services information about their behavior that can be used for customer segmentation, and to deliver relevant recommendations based on the preferences of other users in the same target audience/customer segment driving a better customer experience and increasing customer loyalty.

Demographic segmentation

Using demographic segmentation is a very common segmentation strategy. It uses a combination of demographic factors like age, gender, education, income, race, and religion and compares them to existing customers' data. By doing so, patterns in who is (and who isn't) part of the customer base emerge, and a customer segment is born.

Psychographic segmentation

Psychographic segmentation is a slightly less common approach because of the less objective nature of the underlying data. Psychographic segmentation studies are designed to divide the markets into factors like lifestyle, values, identity, beliefs, social status, and opinions. While harder to execute, the power of being able to more clearly reflect the image of your customer segment in your messaging, advertising, and product features...is immense.

Geographic segmentation

Geographic segmentation involves dividing your market by location - pretty straightforward. Sections might have an area as broad as a nation or a city, or could be narrowed to a single postal code. Patagonia definitely runs fewer ads for down-filled jackets in Phoenix than it does in Denver. With even basic analytics we can pretty easily sort out who is where — or when media buying (GoogleAds for example) we simply include the locations we know our customer segments occupy and exclude those we don't. Geographic customer segmentation can also be combined with other segmentation analyses for even better insights.

Combine different types of customer segmentation for a better customer segmentation strategy.

Combining different types of Customer segmentation into a single customer segmentation strategy can produce amazing results. If your marketing strategy involves using Facebook Ads to reach your target audience and you know they live mostly in the South Eastern United States, it's a start.

But, imagine combining geographic customer segmentation analysis with demographic customer segmentation — and now we know they live in the South East and are between the ages of 20-25, have a median income of $42,000, and at minimum a bachelor's degree. We can get FAR more targeted audience segmentation as well as far more targeted marketing messages.

Let's go a step further and throw in some psychographic customer segmentation into this mix — and now we know all of the above AND that they lack a strong National Identity, but strongly value family and community, and are primarily secular.

Now imagine how much more ability we have to deliver targeted marketing messages from our email marketing software to a really specific target market! We won't always have this level of data on our target customers, but whenever we do... we should use it in our marketing campaigns.

Customer segmentation vs market segmentation

Market segmentation is generally broader and focuses on a complete market segment. Whereas market segmentation applies to the whole market, customer segmentation applies to groups of customers within that market.

Think of the market segment as the bucket, and the customer segments as the various things that fill the bucket and compose our customer base.

An example of market segmentation and customer segmentation.

For instance, if we look at the automotive market as a whole, then we could perform market segmentation at the highest level between consumer vehicles and commercial vehicles. Within the market segment of commercial vehicles, you'll have more than one customer segment, like freight, or construction-related buyers.

You want to compare customers' individual needs within these customer segments so that you can more easily create a marketing strategy or sales channels that support them to our customer base.

Summary

Customer segmentation works for brand new and mature companies and it's not optional for success in most marketing channels. It can be used to improve customer service, customer experience, relationships, retention, and feedback.

Customer segmentation can be defined by grouping customers by demographics, personas, market size, motivations, etc. — it's important to know who is and who isn't part of our target customer so we have a solid understanding of who is most likely to use and buy our product. Customer segmentation should be started broadly and narrowed down as we refine our findings.

Value-based segmentation is when your hard work pays off. There are many benefits of customer segmentation — knowing the data so you can duplicate it over and over again to reach more ideal customers is top of the list.

Ways to define your customer segmentation strategy:

1 - Conducting Surveys

Start by being clear on what your goals are with the survey — otherwise, you'll end up asking the wrong questions.

2 - Signup Forms/Downloads/Lead Magnets

Offer premium content to your users in exchange for useful data such as: names, email addresses, and phone numbers.

3 - Interviews

Interviewing 5-10 people from each customer segment is a great way to enrich your understanding of that segment's customer journey — this is a great way to supplement the customer segmentation process.

4 - Audience Insights from Facebook

With the Facebook Pixel tool — create custom audiences based on website traffic to see things like demographic data, interests, location, affinities, and more.

After all that, the best customer segmentation strategies go deeper with the most useful information and this is done by:

  • Behavioral segmentation

  • Demographic segmentation

  • Psychographic segmentation

  • Geographic segmentation

Continue to Part 6 - Customer Acquisition 


About the Author

The Startups Team

Startups is the world's largest startup platform, helping over 1 million startup companies find customers, funding, mentors, and world-class education.

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