Who the customer is: segments by need and by value
Split customers by why they buy and by what they are worth, with a worked example where the biggest group earns the least.
Key takeaways
- A segment is a group of customers who want the same thing and are worth about the same to you.
- Common mistakes: Segmenting by what is easy to measure (age, gender, city) instead of by need.
- By need: why do they buy, and what would make them switch? Commuters want speed.
- By value: how many are there, how often do they buy, how much do they spend each time, and what margin do you keep?
Key idea
A segment is a group of customers who want the same thing and are worth about the same to you. Split customers by need (why they buy) and by value (how much profit they bring). The largest group by headcount is often not the one that earns the profit.
"The customer" is almost never one person. A coffee chain serves office workers grabbing a drink on the way to work, students who sit for three hours with one cup, teams holding meetings, and families out at the weekend. They come for different reasons, spend different amounts and cost different amounts to serve. Segmentation means splitting customers into groups like these so you can decide whom to serve, what to offer each group and where to spend money.
Two ways to split, and you need both
- By need: why do they buy, and what would make them switch? Commuters want speed. Students want a cheap seat and good wifi. Needs tell you what to offer and how to win the group.
- By value: how many are there, how often do they buy, how much do they spend each time, and what margin do you keep? Value tells you which groups are worth winning and keeping.
- A useful segment passes four tests: its members want something different from other groups, it is big enough to matter, you can reach it (through a channel, a place or a message), and you would treat it differently.
"Women aged 25 to 34" is a description, not a segment, unless those women want something different from everyone else. Start with the need or the occasion (on the way to work, a weekend treat, a team meeting), then check whether age, income or place helps you find those people.
| Segment (need) | Customers (thousands) | Visits per customer per year | Spend per visit (INR) | Contribution margin (percent) |
|---|---|---|---|---|
| Commuters (speed on the way to work) | 200 | 100 | 180 | 40 |
| Students (a cheap place to sit and study) | 400 | 30 | 120 | 25 |
| Office teams (somewhere to meet) | 50 | 40 | 600 | 45 |
| Weekend families (a treat) | 150 | 12 | 500 | 35 |
So-what
Students are half of all customers, but they visit less, spend less and get the most discounts. Work out the profit of each segment before deciding whom to chase.
Worked case
Which segment earns the profit?
The prompt
Using the table above, the fictional coffee chain wants to know which customer segment to build its next year around. Work out the revenue and contribution of each segment, in INR crore (1 crore is 10 million), and the contribution per customer.
The structure
- Segment contribution = customers x visits x spend per visit x contribution margin
- Revenue by segment
- Contribution by segment
- Key: Contribution per customer
Working it through
1. Commuter revenue
200,000 customers, 100 visits each, INR 180 a visit, divided by 10 million to get crore.
Commuter revenue (INR crore):200,000 × 100 × 180 ÷ 10,000,000 = 3602. Commuter contribution
40 percent of revenue.
Commuter contribution (INR crore):360 × 0.4 = 1443. Student revenue
400,000 customers, 30 visits, INR 120 a visit.
Student revenue (INR crore):400,000 × 30 × 120 ÷ 10,000,000 = 1444. Student contribution
25 percent of revenue, lower because of student discounts and long stays.
Student contribution (INR crore):144 × 0.25 = 365. Office team contribution
50,000 customers, 40 visits, INR 600 a visit, at 45 percent.
Office team contribution (INR crore):50,000 × 40 × 600 ÷ 10,000,000 × 0.45 = 546. Family contribution
150,000 customers, 12 visits, INR 500 a visit, at 35 percent.
Family contribution (INR crore):150,000 × 12 × 500 ÷ 10,000,000 × 0.35 = 31.57. Total contribution
Add the four segments.
Total contribution (INR crore):144 + 36 + 54 + 31.5 = 2668. Commuter share of contribution
Commuters are a quarter of customers. What share of contribution do they bring?
Commuter share of contribution (percent):144 ÷ 265.5 × 100 = 54.249. Contribution per commuter
INR 144 crore over 200,000 commuters.
Contribution per commuter (INR):144 × 10,000,000 ÷ 200,000 = 7,20010. Contribution per student
INR 36 crore over 400,000 students.
Contribution per student (INR):36 × 10,000,000 ÷ 400,000 = 900
The recommendation
The chain should build next year around commuters, and protect office teams, because commuters are a quarter of customers but bring about 54 percent of contribution, INR 144 crore of INR 265.5 crore. First, a commuter is worth about INR 7,200 a year against INR 900 for a student, eight times as much. Second, office teams are worth the most per head, about INR 10,800, though the group is small. The risk is that students fill seats that commuters and teams would use at peak times, so serving them costs more than the margin shows. As a next step, check sales by hour and by store to see whether students crowd out higher value visits.
A gym chain in Riyadh has 8,000 members. 2,000 are "serious lifters" who each bring SAR 3,000 of contribution a year; the other 6,000 bring SAR 500 each. What share of total contribution comes from the serious lifters, in percent?
Segmenting by what is easy to measure (age, gender, city) instead of by need. Ranking segments by size or revenue instead of contribution. Forgetting the cost to serve: a customer who needs a sales visit or free delivery can earn less than one who spends less. Making so many segments that none is big enough to act on.
Which split is most useful for a coffee chain deciding what to offer?
Segment A has twice as many customers as segment B. What do you need before saying A is more valuable?
Sources for this lesson (1)
- Recognized public explanations of case-interview concepts and terms
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