What is market segmentation?

Why is market segmentation important?

Market segmentation results in more effective and efficient marketing, advertising and sales. Rather than targeting a broad audience with generic messaging and offers, market segmentation enables brands to provide offers specifically tailored to each segment's needs.

Consider an advertising campaign organized around a particular market segment. By selecting relevant criteria that's targeted toward that segment, a brand can more effectively reach users who fit that segment.

Implementing a marketing segmentation process can result in a campaign that's both effective and efficient: Audience segmenting and customized messaging drive higher success rates, while advertising dollars are spent to reach only the defined audience. The same non-segmented campaign would suffer from lower response rates, with a portion of the advertising budget wasted on the wrong audience.

Types of market segmentation

There are five primary types of market segmentation, which include the following:

1. Geographic

Geographic segmentation works by grouping potential customers by the areas in which they live or reside. Example geographic market segments include the following:

• North America.
• Europe, Middle East, Africa.
• Midwest United States.
• Northeast United States.
• New York, New Jersey and Connecticut.
• Northern California and Southern California.
• Cuyahoga County, Ohio.

For geographic market segments, a brand might choose to offer products and services tailored to the following:

• Local or regional preferences, such as seasonal offerings like beach and ski season.
• Regional tastes like barbecue in the Southern or Midwestern U.S.
• Local laws and regulations.

Geographic segmentation is relatively simple to manage, assuming the brand has the location and address information of potential customers.

2. Demographic

Demographic segmentation works by grouping potential customers by their individual attributes, such as age, ethnicity, education, job title, industry, marital status and income. A brand might define a demographic market segment based on a single attribute or a combination of several. Examples of demographic market segments include the following:

• Single men.
• Married couples with two or more children.
• Women with an annual income above $65,000.
• Women with a master's degree or related graduate degree.
• Men with senior-level job titles in the automobile industry.

Demographic segmentation is relatively simple to manage, assuming the brand has the necessary demographic information of potential customers.

3. Behavioral

Behavioral segmentation works by grouping potential customers based on observed actions or behaviors. Actions can include past purchases, lifestyle choices, travel destinations and daily routines. Behavioral data can be observed or queried via online interactions, such as social media posts, forum posts and published reviews.

Examples of behavioral market segments include the following:

• People who purchased a new home in the past 12 months.
• People who take more than 10 flights per year.
• People who drive their kids to sports practices multiple times per week.
• People who had more than $1,000 in online purchases in the past year.

Behavioral segmentation is more complex to manage because it requires brands to have access to behavioral data. It also requires the necessary tools to manage that data and create market segments based on it.

4. Psychographic

Psychographic segmentation works by grouping potential customers based on their beliefs, values, lifestyles, opinions and interests. Brands use surveys, interviews and focus groups to determine psychographic attributes of potential customers.

Examples of psychographic market segments include the following:

• People interested in healthy eating and physical fitness.
• People who voted for a particular candidate for office.
• People who practice a particular religion.
• People who believe sustainability is important.

Psychographic segmentation is more complex to manage because it requires that brands acquire the necessary psychographic data from potential customers. In addition, tools are needed to manage that data and create market segments based on it.

5. Firmographic

Firmographic segmentation works by grouping potential business customers based on characteristics of the companies they represent. It's similar to demographic segmentation but focuses on organizations instead and is often used in business-to-business marketing.

Examples of firmographic segments include the following:

• Company industry, such as technology, healthcare or finance.
• Company size, such as small, medium or large businesses.
• Company revenue.
• Company location.

Firmographic segmentation enables brands to tailor their marketing strategies to specific types of businesses. This segmentation type can be more complex, though, as it requires access to a company's relevant data.

How to combine market segmentations

Brands can combine two or more of the four outlined market segmentations. Generational marketing is one example of these combined market segmentations. Brands that target the millennial generation use the following two segments:

• Demographic: people born between 1981 and 1996.
• Psychographic: people with a shared set of expectations about the workplace, political views or aspirations.

Although a person born between 1981 and 1996 is defined as a millennial, brands might refine their segment by combining age with psychographic attributes. After all, 100% of millennials don't share the same views or values. The right segment might be people in the millennial age range who share a common set of psychographic attributes.

Characteristics of market segmentation

For market segmentation to be used effectively, it must have the following characteristics:

• Viable. The people in a brand's market segment must be able to purchase the product or service. For example, if a business sells homeowner's insurance at high premiums, and its behavioral market segment is "people who purchased a new home in the past 12 months," homeowners in low-income communities might not be able to afford the offered policies. To make the segment more viable, the business could combine the behavioral market segment with demographics, selecting residents of communities with median family incomes above a certain amount.
• Quantifiable. A brand can measure the amount of revenue generated by the market segment. Without being able to quantify the success of selling into a market segment, it's hard to make decisions about future investments in that segment.
• Accessible. A brand can reach members of the market segment in adequate quantities. For example, the brand won't be able to reach its segment with digital marketing if its target customers live in communities without internet access or mobile data coverage.
• Measurable. A brand can accurately measure the size, characteristics and potential revenue of different segments. This helps ensure that marketing resources are effectively allocated and that the brand can effectively track performance over time.
• Relevant. A market segment should be related to the brand's products or services. This helps ensure that the target segment aligns with a brand's offering.

Benefits of market segmentation

Market segmentation is helpful because it enables learning, decision-making and action to take place at the subgrouping level. Instead of spreading resource allocation across an entire market, an organization can test segments against each other based on hypotheses or prioritize some segments over others based on variables that are already understood.

Other benefits of market segmentation include the following:

• Services and messaging that's more in tune with customers. By definition, market segmentation creates smaller, more focused groups of potential customers. Instead of relying on generic and nonspecific messaging, brands can tailor their marketing to the unique needs of each market segment.
• Competitive differentiation. Brands can separate themselves from the competition by using market segmentation. A company that takes a one-size-fits-all approach to its marketing and sales will struggle to win against a brand that provides offerings that are tailor-made for particular customers.
• Higher response rates. Focused efforts in advertising to the right groups of people will increase the likelihood of prospective customers following through with a purchase or a response such as a website visit.
• Higher customer retention. By providing products and services tailored to specific market segments, a brand provides more value to customers. Satisfied customers, in turn, will become repeat customers and stay with a brand over the long term.
• Explore new market niches. As a brand finds success within particular market segments, it might discover new niches based on combinations or variations of existing segments. These market niches help brands uncover new and unmet customer needs in the market. By creating new customer segments, they can take advantage of these market niche opportunities to grow revenue.
• Messages that stay on target. With set primary target segments, it's easier for an organization to stay consistent with its marketing strategies, as they lessen the chance of getting distracted by segments that are less likely to respond accordingly.
• Increased return on investment (ROI). Through testing and measuring responses from different segments, organizations can find the market segments that provide the most opportunities for a positive ROI.
• AI. Some market segmentation tools use AI features, which make the process more precise. For example, an AI tool can analyze large amounts of data to identify customer patterns, preferences and trends.

Challenges of market segmentation

Despites its benefits, market segmentation also has some negative effects, including the following:

• Increased cost. Segmenting target audiences increases marketing costs. For example, it costs more to do segmented market research and to create targeted marketing campaigns.
• Overlooking potential customers. Only focusing on customer segments that provide the most ROI can also lead to ignoring potential customers who don't fit into those segments.
• Complexity. Market segmenting requires detailed research, which might overcomplicate customer needs.
• Stereotyping. There are also ethical concerns regarding stereotyping groups depending on their designated segments.
• Changing markets. Market conditions can shift over time, which can affect and change consumer behaviors. This might impact a segment's behavior.
• Tracking challenges. It can be challenging to measure the effectiveness of different segmented strategies to determine ROI.

Examples of market segmentation

Mercedes-Benz used market segmentation to reach a new demographic: younger drivers. The company traditionally catered to an older, wealthier demographic. Its customers liked driving the luxury sedans for which Mercedes-Benz became known. In 2012, the company introduced a new A-Class hatchback. The new model was designed with a modern, sporty look, moving away from the boxy, minivan-like designs of previous models.

According to representatives of Mercedes-Benz, the company targeted buyers in their late 30s and early 40s for the new model. They projected that over half of the customers for the new model would be new to the brand. Both the product design and the marketing strategy Mercedes-Benz used were highly tailored to this younger demographic.

Another example of market segmentation comes from CVS Pharmacy, a subsidiary of CVS Health. CVS used a demographic-based market segmentation strategy to tailor the mix of in-store product offerings based on urban vs. suburban locales.

In urban stores, customers shop like they're in a general store, so CVS made it easy to find and select grocery items, snack foods and household items, such as toilet paper and batteries.

Suburban stores were located near general-purpose stores, such as Walmart, so shoppers weren't there to buy general household items. CVS designed the suburban stores to conveniently place health and beauty products close to the pharmacy, where customers went to pick up their prescriptions. CVS tailored the shopping experience based on these two distinct demographic segments.

Market segmentation vs. customer segmentation

While customer segmentation uses similar criteria to create subgroupings, it's different from market segmentation. Customer segmentation focuses on existing customers, while market segmentation focuses on target markets, including prospective customers.

Typically, market segmentation divides an entire market, including both unpreferred and preferred targets, to highlight the preferred business areas. Customer segmentation usually includes only customers -- not prospects -- and seeks to create useful categories within the group of people or companies who have historically already purchased from the seller company.

Take the example of Mercedes-Benz. Its customers were middle-aged -- or older -- and wealthy. Younger drivers weren't a part of their customer base. However, seeking to attract younger customers, the company created a market segment of drivers in their late 30s and early 40s, then delivered products and messaging to reach that segment.

Market segmentation can be equivalent to customer segmentation when a brand's target market matches an existing customer segment. However, as with the Mercedes-Benz example, market segmentation is different when targeting new customer segments.

AI is being implemented in different areas to automate time-consuming customer segmentation tasks. Learn how customer segmentation analytics is changing with the advent of AI and other technologies.