Market Segmentation: Definition, Example, Types, Benefits

What Is Market Segmentation?

Market segmentation is a way of aggregating prospective buyers into groups or segments, based on demographics, geography, behavior, or psychographic factors, in order to better understand and market to them.

Understanding Market Segmentation

Companies can generally use three criteria to identify different market segments:

1. Homogeneity, or common needs within a segment
2. Distinction, or being unique from other groups
3. Reaction, or a similar response to the market

An athletic footwear company, for example, might have market segments for basketball players and long-distance runners. As distinct groups, basketball players and long-distance runners respond to very different advertisements. Understanding these different market segments enables the athletic footwear company to market its branding appropriately.

Market segmentation is an extension of market research that seeks to identify targeted groups of consumers to tailor products and branding in a way that is attractive to the group. The objective of market segmentation is to minimize risk by determining which products have the best chances of gaining a share of a target market and determining the best way to deliver the products to the market. This allows the company to increase its overall efficiency by focusing limited resources on efforts that produce the best return on investment (ROI).

Types of Market Segmentation

There are four primary types of market segmentation. However, one type can usually be split into an individual segment and an organization segment.

Demographic Segmentation

Demographic segmentation is one of the simple, common methods of market segmentation. It involves breaking the market into customer demographics such as age, income, gender, race, education, or occupation. This market segmentation strategy assumes that individuals with similar demographics will have similar needs.

Example: The market segmentation strategy for a new video game console may reveal that most users are young males with disposable income.

Firmographic Segmentation

Firmographic segmentation is the same concept as demographic segmentation. However, instead of analyzing individuals, this strategy focuses on organizations and looks at a company's number of employees, number of customers, number of offices, or annual revenue.

Example: A corporate software provider may approach a multinational firm with a more diverse, customizable suite while approaching smaller companies with a fixed-fee, more simple product.

Geographic Segmentation

Geographic segmentation is technically a subset of demographic segmentation. This approach groups customers by physical location, assuming that people within a given geographical area may have similar needs. This strategy is more useful for larger companies seeking to expand into different branches, offices, or locations.

Example: A clothing retailer may display more raingear in their Pacific Northwest locations compared to their Southwest locations.

Behavioral Segmentation

Behavioral segmentation relies heavily on market data, consumer actions, and the decision-making patterns of customers. This approach groups consumers based on how they have previously interacted with markets and products. It assumes that consumers' prior spending habits are an indicator of what they may buy in the future.

Example: Millennial consumers traditionally buy more craft beer, while older generations are traditionally more likely to buy national brands.

Psychographic Segmentation

Often the most difficult market segmentation approach, psychographic segmentation strives to classify consumers based on their lifestyle, personality, opinions, and interests. This approach may yield the strongest market segment results as it groups individuals based on intrinsic motivators as opposed to external data points. However, it's also difficult to achieve, primarily because the traits it focuses on can change easily and there may be a lack of readily available objective data.

Example: A fitness apparel company may target individuals based on their interest in playing or watching a variety of sports.

How to Determine Your Market Segment

There's no single universally accepted way to perform market segmentation. To determine market segments, it's common for companies to ask themselves the following questions along their market segmentation journey.

Phase I: Setting Expectations/Objectives

• What is the purpose or goal of performing market segmentation?
• What does the company hope to find out by performing marketing segmentation?
• Does the company have any expectations on what market segments may exist?

Phase 2: Identify Customer Segments

• What segments are the company's competitors selling to?
• What publicly available information (i.e. U.S. Census Bureau data) is relevant and available to our market?
• What data do we want to collect, and how can we collect it?
• How should we segment customers?

Phase 3: Evaluate Potential Segments

• What risks are there that our data is not representative of the true market segments?
• Why should we choose to cater to one type of customer over another?
• What is the long-term repercussion of choosing one market segment over another?
• What is the company's ideal customer profile, and which segments best overlap with this "perfect customer"?

Phase 4: Develop Segment Strategy

• How can the company test its assumptions on a sample test market?
• What defines a successful marketing segment strategy?
• How can the company measure whether the strategy is working?

Phase 5: Launch and Monitor

• Who are the key stakeholders that can provide feedback after the market segmentation strategy has been unveiled?
• What barriers to execution exist, and how can they be overcome?
• How should the launch of the marketing campaign be communicated internally?

Benefits of Market Segmentation

Marketing segmentation takes effort and resources to implement. However, successful marketing segmentation campaigns can increase the long-term profitability and health of a company. Several benefits of market segmentation include:

• Increased resource efficiency: Marketing segmentation allows management to focus on certain demographics or customers. Instead of trying to promote products to the entire market, marketing segmentation allows a focused, precise approach that often costs less compared to a broad reach approach.
• Stronger brand image: Market segmentation forces management to consider how it wants to be perceived by a specific group of people. Once the market segment is identified, management must then consider what message to craft. Because this message is directed at a target audience, the company's branding and messaging are more likely to be very intentional. This may also have an indirect effect of causing better customer experiences with the company.
• Greater potential for brand loyalty: Marketing segmentation increases the opportunity for consumers to build long-term relationships with a company. More direct, personal marketing approaches may resonate with customers and foster a sense of inclusion, community, and a sense of belonging. In addition, market segmentation increases the probability that the company lands the right client, who fits its product line and demographic.
• Stronger market differentiation: Market segmentation gives companies the opportunity to pinpoint the exact message they want to convey to the market and competitors. This can also help create product differentiation by communicating specifically how a company is different from its competitors. Instead of a broad approach to marketing, management crafts a specific image that is more likely to be memorable and specific.
• Better targeted digital advertising: Marketing segmentation enables a company to perform better targeted advertising strategies. This includes marketing plans that direct effort toward specific ages, locations, or habits via social media.
  

Limitations of Market Segmentation

Market segmentation also comes with some potential downsides. Here are some disadvantages to consider when implementing market segmentation strategies.

• Higher upfront marketing expenses: Marketing segmentation has the long-term goal of being efficient. However, to capture this efficiency, companies must often spend resources upfront to gain the insight, data, and research into their customer base and the broad markets.
• Increased product line complexity: Marketing segmentation takes a large market and attempts to break it into more specific, manageable pieces. This has the downside risk of creating an overly complex, fractionalized product line that focuses too deeply on catering to specific market segments. Instead of a company having a cohesive product line, a company's marketing mix may become too confusing and inconsistently communicate its overall brand.
• Greater risk of misassumptions: Market segmentation is rooted in the assumption that similar demographics will share common needs. This may not always be the case. By grouping a population together with the belief that they share common traits, a company may risk misidentifying the needs, values, or motivations of individuals within a given population.
• Higher reliance on reliable data: Market segmentation is only as strong as the underlying data that support the claims that are made. This means being mindful of what sources are used to pull in data. This also means being conscious of changing trends and when market segments may have shifted from prior studies.

Examples of Market Segmentation

Market segmentation is evident in the products, marketing, and advertising that people use every day.

Auto manufacturers thrive on their ability to identify market segments correctly and create products and advertising campaigns that appeal to those segments. For example, different zip codes can have drastically different average incomes, which impacts car buying budgets, and terrain. People living in a big city tend to prefer smaller cars, while people living in the country may prioritize greater fuel efficiency and perhaps even off-road capabilities.

Cereal producers market actively to three or four market segments at a time, pushing traditional brands that appeal to older consumers and healthy brands to health-conscious consumers, while building brand loyalty among the youngest consumers by tying their products to, say, popular children's movie themes.

A sports shoe manufacturer might define several market segments that include elite athletes, frequent gym-goers, fashion-conscious people, and individuals who have health issues or who spend a lot of time on their feet. In all cases, the manufacturer's marketing intelligence about each segment enables it to develop and advertise products with a high appeal more efficiently than trying to appeal to the broader masses.

The Bottom Line

Market segmentation is a process companies use to break up their potential customers into different groups or segments. This allows a company to allocate the appropriate resources to each individual segment, resulting in more accurate targeting across a variety of marketing campaigns.