R E P R I N T

Segmentation and Strategy

Segmentation problems often go unrecognized.
Each of the managers quoted below focused on
something else as the critical factor.
In this business the key to success is the
broad product line. However, we are losing
business to small producers who are cherry
picking at key accounts.
We are the Cadillac of our industry and
recognized as the leader in quality. However,
our competitors seem to be growing more
rapidly than we are. Lately our profitability
has been declining.
We seem to do a lot better in some regions
than others. It's probably the result of differences in sales capability, although recently we
shifted some sales assignments and our performance didn't change much.
Segmentation is a critical aspect of corporate
strategy. It is essential in visualizing the competitive arena and analyzing the preferred strategic
emphasis. The goal is to find a way to convert differences from competitors into a cost differential
that can be maintained.
For commodity products the basic segment
boundary is the cost differential for serving different classes of customers. Cost differences between customers often can be easily determined
differences in logistics or packaging are obvious.
Other cost differences may be even more important but more difficult to measure. The cost of customization, the disadvantage of maintaining a
broad product line or the cost of technical service
are examples.
For differentiated products, the basis of segmentation is the combination of the features built into
the product and their cost/price ratio. For
example, Cadillacs, Torinos and Volkswagens are

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all very different in their price-feature relationships

and for that reason do not compete directly with
each other. The segmentation of markets for differentiated products rests on the relationship between the cost features to the producer and the
value of features to the customer.
In considering differentiation, it is important to
include all of the conditions of the transaction, as
well as the product itself. Service, reliability of vendor and delivery times are likely to be as important as inherent product characteristics. There are
often highly differentiated suppliers in markets for
commodity products.
A differentiated product remains a differentiated
product only until the emergence of the first follower. After that it begins to behave as a commodity.
Over time all products tend to become commodities. With the evolution of the market, pioneering companies face the choice of becoming limited volume, high priced, high cost speciality
producers or high volume, low cost producers of
standard products. There is no obvious answer to
which is best. The choice is dependent upon the
predilictions and financial resources of the individual company.
It is possible to serve both segments with great
benefits in lowering average cost. However, to do
this it must be possible to sell at different prices to
each segment. Cost to the customer must match
value in each segment. Different value requires
different prices to cover different costs.
Powerful competitive strategies often can be
constructed to force a competitor to choose one
segment or the other. The alternate, in the absence
of a price differential, is to sell below cost in one
segment and be non-competitive in the other
because a price must be charged based on average
cost.

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R E P R I N T

Segmentation and Strategy

Measuring profitability by customer group is
important. The inability to monitor profitability
by customer group is extremely hazardous since it
permits major changes in competitive position
within a given group of customers to go undetected. Averages hide more than they disclose.
The base for a strategy is identification of products and customer groups which will achieve and
sustain an economic advantage with respect to
competitors. This requires:
An assessment of the relationship between
cost and value to the customer by both product group and customer group.
An assessment of cost on a comparative basis
with selected competitors by product group
and customer group.
An assessment of the eventual effects on cost
and volume of changing the definition of the
segment and consequently its potential market size.

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Competitive segmentation is a competitor specific process. There is always a leading competitor

in any area. The classic segmentation forces that
specific competitor to choose between parts of the
segment. If he chooses either alternative, he must
abandon the rest or serve it at a loss. This choice
is virtually unavoidable where a common price
must be offered to customers who have quite different service or support costs. The same choice is
forced where small volume customers will pay
high margins for special features but high volume
customers will pay nothing extra for such characteristics.
The infinite variety of factor combinations
make segmentation an extremely difficult decision
process to optimize. This is also why the competitive strategy rewards are potentially so great.
Seymour Tilles
The Boston Consulting Group, Inc. 1974

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