What is Segmentation?

Segmentation is the process of partitioning markets into groups of customers and prospects with similar needs and/or characteristics who are likely to exhibit similar purchase behavior. Strategic segmentation is for planning business and marketing strategy. Tactical segmentation is when a marketing manager wishes to prioritize marketing activities across a fairly large customer base, targeting certain products, offers and creative to certain customers. A good segmentation strategy supports both strategic and tactical activity.
Literature suggests the following steps:
Criteria for Market Segmentation
There are a huge number of variables that could be used for market segmentation in theory. They comprise easy to determine demographic factors as well as variables on user behavior or customer preferences. In addition, there are differences between private customers and businesses. The following table shows the most important traditional variables for segmentation.
Five criteria for an effective segmentation:
1)    Measurable: It has to be possible to determine the values of the variables used for segmentation with justifiable efforts. This is important especially for demographic and geographic variables. For an organization with direct sales (without intermediaries), the own customer database could deliver valuable information on buying behavior (frequency, volume, product groups, mode of payment etc).
2)    Relevant: The size and profit potential of a market segment have to be large enough to economically justify separate marketing activities for this segment.
3)    Accessible: The segment has to be accessible and servable for the organization. That means, for instance, that there are target-group specific advertising media, as magazines or websites the target audience likes to use.
4)    Distinguishable: The market segments have to be that diverse that they show different reactions to different marketing mixes.
5)    Feasible: It has to be possible to approach each segment with a particular marketing program and to draw advantages from that.

Benefits of segmentation
•    Segmentation is the best way to make marketing relevant, better matching customer needs.
•    By segmenting markets the target consumer can be reached more often and at a lower cost.
•    By marketing products that appeal to different customer preferences a business can retain customers who might otherwise switch to competing products and brands.
•    Provides a framework for the company to make more money. It provides a lens through which marketing can be continuously improved in the future.
•    Manage different types of customers differently across the various customer touch points and through the customer lifecycle.
•    Allocate different resources and investment levels to segments and deliver superior value to distinct groups of customers.

 Segments need to be
•    Large enough to be economic
•    Have similar attributes
•    Reachable or targetable
•    Relevant to business needs
•    Actionable
Each part of a good segmentation solution will yield typically between four and nine segments. Too few segments tend to result in very general segments, and too many segments results in lots of small segments that may not be usable or meaningful. Segmentation development should be driven by economic incremental gain; for example, the benefit of new email segmentation must be more than the cost of any extra creative or analysis required.

The segmentation process
The process itself begins with narrowing the universe to be studied into a specific market now served by the company and obtaining basic information on competing products or services now on offer. Once this step has been completed, variables to be used are identified, reviewed, and tested. At the most basic level such variables, for example, might involve income and demographic characteristics of the consumers.
With these preparations completed, actual market research is organized to collect and to analyze data on the selected broad body of consumers. Analysis of the data will begin to cluster the consumers into distinct groupings based on the variables. Additional analysis, possibly involving more research, will next be conducted to develop detailed profiles of each segment already identified.
If the right variables were chosen at the outset and the market research was competently done, the resulting groupings will have characteristics distinct enough, and documented well enough, to permit the company to select one or more segments which will be easiest or more profitable to serve. The company's own strategy will play a role. Its aim, for example, may be use its capacity more fully and the company will therefore select a segment which will purchase the largest volume; alternative the company's aim may be low production levels with high profits, leading to a focus on another segment.
The last stage of the segmentation process will be the development of product and marketing plans based on the segment(s) most closely matching the company's "ideal" situation.
In general, customers are willing to pay a premium for a product that meets their needs more specifically than does a competing product. Thus marketers who successfully segment the overall market and adapt their products to the needs of one or more smaller segments stand to gain in terms of increased profit margins and reduced competitive pressures. Small businesses, in particular, may find market segmentation to be a key in enabling them to compete with larger firms.

Statistical Method
Cluster analysis: groups individuals or organizations together is such a way that the components in the clusters are more similar to one another than they are to the components of other clusters
- Hierarchical partitioning
- Nonhierarchical partitioning

Recency Frequency Monetary Modeling (RFM): RFM is an effective process for marketing to your loyal customers and uses purchase behavior by recency, frequency and monetary to determine what offers work for what type of customers. Generally, only small percentages of customers respond to typical offers. But with RFM, you can ensure you are targeting the right set of customers who are most likely to respond. RFM is a powerful segmentation method for predicting customer response and ensures improvement in response as well as profits. It is used primarily for targeted campaigning, customer acquisition, cross-sell, up-sell, retention, etc and is a guarantor of campaign effectiveness and optimization.