The challenging present economic climate makes it hard to pinpoint opportunities for revenue and margin expansion. Some businesses may be witnessing a drop in volumes and intense margin stress.
In response, you might attempt to sustain volume by reducing prices and expenses rather than focusing on price optimization. However, this undermines your business's long-term profitability and sustainability. While lowering prices may attract more customers in the short term, it often leads to a downward spiral where profit margins shrink. This erodes your company's ability to invest in innovation, quality improvement, and customer experience enhancements.
Additionally, competing solely on price can commoditize your product or service. This makes it difficult to differentiate from competitors and reduces brand value.
This article provides a practical method for determining customer groups based on comparable purchasing behaviors, which supports efficient price differentiation. By applying this method correctly, you can increase your profit margins by two to three percentage points.
What is customer segmentation?
Customer segmentation is a strategy that divides customers into groups based on similar characteristics or behaviors. By categorizing customers into segments, companies can better understand their needs, preferences, and buying patterns. This allows companies to tailor their marketing strategies, products, and pricing to meet the requirements of each customer segment. Ultimately, customer segmentation helps companies improve customer satisfaction, increase sales, and enhance overall profitability.
Every transaction at the right price
Many businesses employ a standard product price list along with a discount matrix to vary net prices among customers. Ideally, since each customer has a distinct willingness to pay, they should each receive a unique product discount. However, determining the maximum willingness to pay from a large client base can be complicated. As a result, businesses often establish net prices based on a blend of instinct, cost-plus pricing, and competitive pricing, supplemented with numerous additional manual discounts.
This haphazard approach to pricing, coupled with multiple additional manual discounts, has two primary drawbacks:
Margin leakage
Margin leakage happens when the price customers pay is lower than their perceived value of the products. To improve margins, you must capture the customers’ willingness to pay effectively.
Specifically, you should implement price variation based on segmentation standards that mirror a customer's value to the business. These segmentation standards should not be excessively complicated to ensure they are manageable.
Price variation involves providing different net price points to various customers to align with their varying willingness to pay. However, businesses often formulate deals and construct discount matrices without a thorough understanding of the differences in perceived value among customers.
Comprehending these perceived differences is crucial to determining willingness to pay. Depending on the segment, customers can have entirely different views of a product's value.
Alignment risks among customers
The absence of a structured price variation strategy results in less than optimal profits. Moreover, alignment risks among customers escalate during mergers and acquisitions.
There's a significant chance that customers may learn about the varying prices paid by others for the same products and services. If there's a lack of a justified price differentiation, customers may question your credibility, leading to demands for price reductions.
To prevent such scenarios, it's crucial to take a proactive approach by establishing a well-structured price differentiation strategy, thereby minimizing risk.
How to segment your customer base
Pricing hugely influences profitability. Despite the significant benefits, numerous businesses fail to exploit the enhancement opportunities inherent in pricing.
Companies can leverage pricing to tap into the customer's willingness to pay, thereby boosting their profitability. A practical approach to achieve this is to use data to segment customers according to their purchasing habits.
Typically, businesses categorize customers into similar groups based on elements such as revenue contribution, wallet share, and potential. However, it can sometimes be more effective to segment customers bottom up. For example, based on their similar buying patterns/purchase history.
The benefit is that it establishes a compelling value proposition for the customer, as segmentation is based on real customer behavior. This type of customer segmentation is often referred to as behavioral segmentation.
This enables the establishment and upkeep of equitable and efficient price variations among different customer groups. In turn, this leads to improved extraction of willingness to pay. Moreover, it is a much better option than just depending on the presumptions of your in-house sales team.
The method employed for customer segmentation largely hinges on the magnitude of the customer pool. Companies can segment small customer bases manually. Nonetheless, as the customer base expands, different approaches must be contemplated. If your company has several thousands of customers, we recommend statistical methods when considering the bottom-up segmentation approach.
The bottom-up strategy involves examining consumer purchasing habits to discern their purchasing trends. These buying patterns are useful for grouping comparable customers into segments.
Customer segmentation analysis often involves using data analytics techniques, such as clustering algorithms, to identify patterns and similarities among customers. This allows you to group customers who exhibit similar characteristics or behaviors together, enabling more personalized and relevant interactions.
Identifying segments should be based on their unique factors. Correct segmentation is vital for success and should be carried out by or with the help of professionals with robust market understanding.
Effective price differentiation by segment
Once you've identified customer segments, you can determine the importance and value of different products and services to each segment. This data can be utilized to classify products and services into groups like primary assortment and secondary assortment.
Primary products and services are those that are bought regularly and hence, are highly noticeable on the customer's price radar. The prices of these products and services ought to be competitive. They will typically realize lower margins than the same products that customers consider add-ons in other segments.
Supplementary products are those customers rarely buy and perceive as an addition to the set of core products they buy frequently. Customers tend to overlook the prices of the add-on products they purchase.
Implementing a well-organized and efficient price differentiation among customer groups, which aligns with their purchasing habits, can help tap into the customers' readiness to pay.
Example of customer segmentation
- An international imaging company was facing challenges due to growing customer expectations for effective digital solutions. This led to disparate commercial approaches across markets.
- To address this, our consulting team conducted a comprehensive analysis of customer data and developed a clear customer segmentation model.
- Collaborating closely with our client, we designed an integrated commercial strategy, prioritizing segments and establishing guiding principles for marketing and sales.
- The new strategy was successfully rolled out across markets through process and system changes, resulting in an estimated increase of over 100 base points per annum in EBIT. Read the full case study.
How Simon-Kucher can help
At Simon-Kucher, we empower companies to maximize their revenue potential by aligning pricing strategies with the needs and behaviors of distinct customer segments. Leveraging our expertise in market segmentation and pricing, we help businesses in developing robust customer segmentation models tailored to their specific industry and objectives.
By analyzing segment data and identifying common characteristics among customers, we unearth valuable insights into customer behavior and preferences. This refined understanding enables our clients to map out the customer journey comprehensively, optimizing the customer experience at every touchpoint.
Through a meticulous customer segmentation process, we help businesses pinpoint target markets with precision, allowing for more effective marketing campaigns and tailored product offerings.
Looking to enhance your customer segmentation strategies? Reach out to Simon-Kucher today!
