Industrial market segmentation is a scheme for categorizing industrial and business customers to guide strategic and tactical decision-making, especially in sales and marketing. While government agencies and industry associations use standardized segmentation schemes for statistical surveys, most businesses create their own segmentation scheme to meet their particular needs.
While similar to consumer market segmentation, segmenting industrial markets is different and more challenging because of greater complexity in buying processes, buying criteria, and the complexity of industrial products and services themselves. Further complications include role of financing, contracting, and complementary products/services.
The goal for every industrial market segmentation scheme is to identify the most significant differences among current and potential customers that will influence their purchase decisions or buying behavior, while keeping the scheme as simple as possible (Occam's Razor). This will allow the industrial marketer to differentiate their prices, programs, or solutions for maximum competitive advantage.
Webster describes segmentation variables as "customer characteristics that relate to some important difference in customer response to marketing effort". (Webster, 2003) He recommends the following three criteria:
Nevertheless, academics as well as practitioners use various segmentation principles and models in their attempt to bring some sort of structure. Here, we discuss a few of the most common approaches:
One of the recommended approaches in segmentation is for a company to decide whether it wants to have a limited number of products offered to many segments or many products offered to a limited number of segments. Some people recommend against businesses offering many product lines to many segments, as this can sometimes soften their focus and stretch their resources too thinly. See figure 1.
The advantage in attempting the above approach is that although it may not work at all times, it is a force for as much focus as practicable. The one-to-many model ensures - in theory - that a business keeps its focus sharp and makes use of economies of scale at the supply end of the chain. It "kills many birds with one stone".
Examples are Coca Cola and some of the General Electric businesses. The drawback is that the business would risk losing business as soon as a weakness in its supply chain or in its marketing forces it to withdraw from the market. Coca Cola's attempt to sell its Dasani bottled water in the UK turned out to be a flop mainly because it tries to position this "purified tap water" alongside mineral water of other brands. The trigger was a contamination scandal reported in the media.
The many-to-one model also has its benefits and drawbacks. The problem is that a business would stretch its resources too thinly in order to serve just one or a few markets. It can be fatal if the company's image is ruined in its chosen segment. However, there are many companies that have dedicated themselves to only one market segment, e.g. Flowserve is a US-based supplier of many different types of pumps, valves, seals and other components - all dedicated to fluid motion and control.
Among the above models, the most popular is the many-to-many version. As companies constantly try to balance their risk in different technologies and markets, they are left with no choice but to enter into new markets with existing products or introduce new products into existing markets or even develop new products and launch them into new markets (see figure 2).
The problem with the many-to-many model is that it can stretch a company's resources too thinly and soften its focus. One reason for the current financial problems of the world's largest car maker, General Motors, is that it has tried to be everything to everybody, launching model after model with no clear segmenting, targeting or branding strategy.
Yoram Wind and Richard Cardozo (1974) suggested industrial market segmentation based on broad two-step classifications of macro-segmentation and micro-segmentation. This model is one of the most common methods applied in industrial markets today. It is sometimes extended into more complex models to include multi-step and three- and four-dimensional models.
Macro-segmentation centres on the characteristics of the buying organisation [as whole companies or institutions], thus dividing the market by:
However, type of buying institution and the decision-making stage can only work on paper. As institutional buyers cut procurement costs, they are forced to reduce the number of suppliers, with whom they develop long-term relationships. This makes the buying institution already a highly experienced one and the suppliers are normally involved at the beginning of the decision-making process. This eliminates the need to apply these two items as segmentation criteria.
Micro-segmentation on the other hand requires a higher degree of knowledge. While macro-segmentation put the business into broad categories, helping a general product strategy, micro-segmentation is essential for the implementation of the concept. "Micro-segments are homogenous groups of buyers within the macro-segments" (Webster, 2003). Macro-segmentation without micro-segmentation cannot provide the expected benefits to the organisation. Micro-segmentation focuses on factors that matter in the daily business; this is where "the rubber hits the road". The most common criteria include the characteristics of the decision-making units within each macro-segment, (Hutt & Speh, 2001) e.g.:
The above criteria can be highly beneficial depending on the type of business. However, they may be feasible to measure only in high-capital, high-expense businesses such as corporate banking or aircraft business due to high cost associated with compiling the desired data. "There are serious concerns in practice regarding the cost and difficulty of collecting measurements of these micro-segmentation characteristics and using them". (Sudharshan, 1998)
The prerequisite to implementing a full-scale macro- and micro-segmentation concept is the company's size and the organisational set-up. A company needs to have beyond the certain number of customers for a segmentation model to work. Smaller companies would not need a formal segmentation model as they know their customers in person, so they can apply Hunter's n=1 model.
Ironically, Webster states that "the strategic implications of micro-segmentation lie primarily in promotional strategy. ..... Decisions influenced by micro-segments include selecting individuals for the sales call, design of sales presentations and selecting the advertising media" (Webster, 2003). However, promotion should not be seen in isolation, as it cannot facilitate log-lasting success, unless supported on all the relevant functions such as product, price and place. One only needs to consider that purchasing criteria (part of micro-segmentation) includes factors such as product quality, price and delivery, which are directly relevant to product, price and place.
Taking the Wind & Cardozo model, Bonoma & Shapiro extended this into a multi-step approach in 1984. As the application of all the criteria recommended by Wind and Cardozo and subsequent scholars who expanded upon their two-stage theory became increasingly difficult due to the complexity of modern businesses, Bonoma and Shapiro suggest that the same / similar criteria be applied in multi-process manner to allow flexibility to marketers in selecting or avoiding the criteria as suited to their businesses. "They proposed the use of the following five general segmentation criteria which they arranged in a nested hierarchy:
The idea was that the marketers would move from the outer nest toward the inner, using as many nests as necessary". (Kalafatis & Cheston, 1997). As a result, this model has become one of the most adapted in the market, rivalling the Wind & Cardozo model head-on. One of the problems with the nested approach "is that there is no clear-cut distinction between purchasing approaches, situational factors and demographics". Bonoma and Shapiro are aware of these overlaps and argue that the nested approach is intended to be used flexibly with a good deal of managerial judgment" (Webster, 2003).
Kotler suggests a "build-up" approach, where masses of customer data are studied and similarities searched to make up segments that have similar needs, i.e. "assessing the customer base quantitatively and grouping them - i.e. building up - the segments based on similarities in purchasing attitude" (Kotler, 2001).
When starting the segmentation process, instead of seeing customers as identical, the build-up approach begins by viewing customer as different and then proceed to identify possible similarities between them. "In a turbulence market (pretty much all markets today), using a build-up approach is more suitable than a breakdown approach" (Freytag & Clarke, 2001).
One of the most significant uses of industrial market segmentation schemes is to make targeting and product positioning decisions. Companies chose to target some segments and downplay or avoid other segments in order to maximize their competitive advantage and the likelihood of success.
"There is a critical difference in emphasis between target market and [target] audience. The term audience is probably most useful in marketing communication". (Croft, 1999) Target markets can include end user companies, procurement managers, company bosses, contracting companies and external sales agents. Audiences, however, can include individuals that have influence over purchasing decision, but may not necessarily buy a product themselves, e.g. design engineers, architects, project managers and operations managers, plus those in target markets.
Croft quotes Friestad, Write, Boush and Rose (1994) as stating that because the purpose of advertising is to persuade, consumers become sceptical of its methods and approaches [and indeed intentions]. However, while this may be entirely true in consumer marketing, the level of trust and reliance on marketing communication by industrial customers is fairly high due to the professional experience and knowledge of the industrial buyer. Some even appreciate advertising because it keeps them informed of the products and services available in the market.
In the area of marketing, industrial market segmentation usually refers to the demand side of the market, the goal being for companies to segment groups of potential customers with similar wants and demands that may respond to a particular marketing mix. When companies also work with potentially different suppliers, segmenting the supply side of the market can be very valuable as well. There are many supplier segmentation approaches in the literature: Parasuraman (1980), Kraljic (1983), Dyer et al. (1998), Olsen and Ellram (1997), Bensaou (1999), Kaufman et al. (2000), van Weele (2000), Hallikas et al. (2005), Rezaei and Ortt (2012).
Parasuraman (1980) proposed a stepwise procedure to implement this approach: Step 1: Identify the key features of customer segments Step 2: Identify the critical supplier characteristics Step 3: Select the relevant variables for supplier segmentation, and Step 4: Identify the supplier segments.
Kraljic (1983) considered two variables: profit impact and supply risk. The profit impact of a given supply item can be defined in terms of the volume purchased, the percentage of total purchase cost or the impact on product quality or business growth. Supply risk is assessed in terms of the availability and number of suppliers, competitive demand, make-or-buy opportunities, storage risks and substitution possibilities. Based on these two variables, materials or components can be divided into four supply categories: (1) non-critical items (supply risk: low; profit impact: low), (2) leverage items, (supply risk: low; profit impact: high), (3) bottleneck items (supply risk: high; profit impact: low), and (4) strategic items (supply risk: high; profit impact: high). Each category requires a specific supplier strategy.
To see the theoretical bases of, and to review, different supplier segmentation approaches see Day et al. (2010), and Rezaei and Ortt (2012).
Rezaei and Ortt (2012) considering two dimensions "supplier willingness" and "supplier capabilities" defined supplier segmentation as follows.
"Supplier segmentation is the identification of the capabilities and willingness of suppliers by a particular buyer in order for the buyer to engage in a strategic and effective partnership with the suppliers with regard to a set of evolving business functions and activities in the supply chain management".
Considering two levels low and high for the two dimensions, suppliers are segmented to four segments.