Customer segmentation is the cornerstone of your product strategy
If you don’t know who you are building for and what they value what is guiding you?
Section 1
What is customer segmentation?
Customer segmentation (verb)
For product strategy, prioritization, and decision-making purposes, customer segmentation is grouping individuals who make problem-driven or need-specific purchases based on the same set of values.
Uh what?
Unless you are an experienced product person or builder that sentence probably sounds at best confusing at worst like a foreign language - one that you may not speak.
The purpose of this article is to explain in plain terms what customer segmentation is, why it matters for your product strategy and your business, and how to do it to create a baseline for decision-making rooted in validated customer value.
Customer segment (noun)
Let’s try with another, even simpler, definition to ground our thinking.
A customer segment is a group of people who all value the same things in a solution.
Now let’s dissect this statement to make it operationally relevant.
Value (verb)
A customer segment is a group of people who all value the same things in a solution.
Value in this sentence means purchase based on. The most basic and most important application of the word value in a product context is what a user will pay for with their money, time, or attention.
Solution (noun)
A customer segment is a group of people who all value the same things in a solution.
Solution in this sentence means a complete product offering including features, quality, accessibility, and price. Solution to the customer quite simply means the (best) resolution to their problem or need.
It is important to remember that this resolution is not just the technology behind a product but also includes how the user encounters or finds the product, their experience accessing and using the product, and their ability to effectively and easily resolve the problem or need that prompted them to look for a solution in the first place.
Pricing is part of the complete product offering but is managed and set in parallel to the features, quality, and access components of the solution. This is because pricing is relative and must reflect the relevance of the product’s value proposition in relation to other factors that change over time such as alternative solutions or new technologies or norms that impact the initial problem or need.
Things in a solution (noun)
A customer segment is a group of people who all value the same things in a solution.
Things in a solution in this sentence means the same specific features and/or level of quality including ease of use and/or accessibility that this specific group of people purchase the product based on.
The product term for things in a solution is value drivers. Value drivers are the generally 4-8 features, quality elements, ease of use aspects, or accessibility factors of your product that make it the best solution for your core customer segment.
Value drivers are the absolute most critical element to isolate when undertaking customer segmentation. Once you have effectively identified value drivers you know exactly why a specific customer segment (user) purchases your product (solution).
Customer segment V2 (noun)
A customer segment is a group of people who all purchase a product based on the same specific features, level of quality, ease of use, and/or accessibility.
Section 2:
What is NOT customer segmentation?
It is possible to do something also called “customer segmentation” for other purposes, such as broad reach or branding awareness marketing campaigns. I want to reiterate that for product strategy, prioritization, and decision-making purposes customer segmentation must focus on uncovering groups of people who all purchase a solution based on the same features, level of quality, ease of use, and/or accessibility.
Therefore we do not consider segmenting or dividing a market any other way to be a relevant stand-alone methodology including many of the more popular and well known approaches. Each of these are complements to value-centric customer segmentation, which isolates value drivers/purchasing drivers, not surrogates for value-centric customer segmentation.
Demographics alone
Age, gender, race, ethnicity, geo, and socio-economics are all nice to haves and often inform customer engagement and isolating value drivers. Demographics are also useful for creating personas which inform design.
Demographics without value drivers are not useful for defining customer segmentation that definitively drives product strategy because they do not uncover the why of the customer purchase.
Preferences not directly tied to purchasing behavior
Feedback via surveys, interviews, and concept testing are all amazing inputs to isolating value drivers. For these inputs to truly deliver insight they must be directly tied to a customer making a purchase.
It must be absolutely clear that a user purchased or will purchase this solution for an exact combination of features, level of quality, ease of use, and accessibility for the feedback to be relevant to customer segmentation. If that direct correlation cannot be made then these customer preferences are ancillary or secondary to the value proposition that drives product strategy. They inform but don’t direct.
As a note, it is generally difficult to obtain absolute clarity linking an exact combination of features, level of quality, ease of use, and accessibility via surveys, interviews, and concept testing.
Rather surveys, interviews, and concept testing are best utilized early in the value-centric customer segmentation process to create and visualize value hypotheses. Value hypotheses can then be iteratively tested as tied to purchasing behavior via these mechanisms and likely graduating into focused prototype testing and eventually value-based selling (more later).
User feedback/experience not directly tied to purchasing behavior
Feedback via user testing that does not explicitly include “check out” or “credit card input” type functionality is again useful to inform the context around a user’s preferences or behavior but is in and of itself not a primary driver of product strategy.
User feedback and experience testing, including through clickable prototypes can be employed in the later stage value-centric customer segmentation process. Again, value hypotheses must be iteratively tested as tied to purchasing behavior and ideally through value-based selling. Making a sale based on a clear and well defined value hypothesis is the absolute best way to validate that you understand the customer and why they are purchasing your product.
Product strategy is primarily informed and driven by value drivers that can be directly linked to customer purchasing decisions.
Section 3:
Why does customer segmentation matter?
Value proposition
Customer segmentation clarifies and fortifies a clear product value proposition. One you know who your user is and what they value enough to take out their wallet and make a purchase, you know what your value proposition is for this specific customer type.
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Here demographics, user preferences, and user feedback/experience are super valuable information for contextualizing and creating a rich user personas for the customer segment but remember that they cannot in and of themselves reveal the value proposition.
Market opportunity
Customer segmentation defines your true market opportunity for a specific solution/product offering. Once you know who your user is based on value drivers you can size roughly how many of those people exist within your current serviceable market. Notice that I said serviceable and not obtainable market.
Knowing your core customer segment enables you to expand your market size from what is obtainable to what is serviceable based on your own operational readiness or investment.
This is the opposite of hand-waving because the expansion and capture of your market opportunity is based on deeply understanding your value proposition as relative to your customer base.
Competitors who matter
Customer segmentation defines your competitive set for a specific solution/product offering. Once you know who your user is and what they value, you know exactly which competitors offer this same value proposition.
Competitors who offer a somewhat similar or adjacent value proposition but vary in terms of the specific features, level of quality, ease of use or accessibility that matter for your specific customer segment are not competitors who matter for an initial product offering and go-to-market.
Unless these competitors are developing a product that directly competes with your target customer segment on the exact same value proposition/drivers you can come back to them once you’ve launched and found product/market fit with this offering.
Keeping an eye on the market and competition is always good. Getting distracted by what other companies are building, if it is outside of your current market opportunity, can be deadly to your business because your time, energy, money, and resources are limited.
Current state of product
Customer segmentation enables you to clearly and factually define where your product stands in relationship to competitors who matter (those who challenge your specific solution/product offering on the same value proposition within the market).
By defining the value drivers and competitors who matter you are able to do a direct comparison between how your solution stacks up against each value driver versus your competitors who are offering the same value proposition to the same customer base.
Development and go-to-market priorities
Customer segmentation gives you verifiable insight into your product and go-to-market priorities based on how you stack up against the competitors who matter. You do this by weighting the value drivers as important to the customer segment and scoring yourself and your competitors against each driver.
You are able to clearly identify where you are ahead of delivering on your value proposition and where you lag behind your competitors. This clarity is contextualized by how much a customer values each aspect of the solution when making a purchase.
A price/value map is a tool that enables you to plot your overall standing of value proposition to price against your competitors to see where you stand in the market.
The outputs of a price/value map exercise are:
- Very clear options for how to invest in development across a defined set of value drivers which informs product strategy and a product roadmap
- Very clear options for how to refine, revise, or entirely pivot your sales/marketing strategy including your website, customer acquisition channels, and even your brand as a whole
To solidify product strategy and sales/marketing strategy you want to also conduct a market sizing exercise. That is outside of the scope of this article but will be covered in future content.
Value-based pricing
Customer segmentation creates a baseline for value-based pricing through the same price/value map tool.
Using the price/value map you can also decide to invest in pricing changes to either undercut your competition or develop alternative product lines that charge a higher price for providing more value or a lower price for less value.
Before you dive into pricing as a lever for your business you want to make sure you validate your hypotheses i.e. that this or another customer segment is willing to pay the increased price for more value or vice versa that this or another customer segment is looking for a cheaper alternative product.
Pricing, especially value-based pricing, is a complex subject but is not a black box and doesn’t involve magic to get it right.
We will cover value based pricing in detail in subsequent content.
Section 4:
How do I do customer segmentation?
The most important thing to know about doing customer segmentation is that it’s highly iterative and aligns with continuous customer discovery. Below is a process that is applicable to both first time customer segmentation and on-going refinement of segmentation as well as continuous customer discovery.
The recommended process is to start with a survey or broad reach approach that enables you to define, validate, or invalidate a user problem or need across a broad set of users and/or prospects. This may be a one-time exercise but more than likely will require multiple iterations to get crisp on one or more user problem(s) or need(s) that your solution is envisioned or will be designed to solve.
Once you have a clear understanding of one or more viable problem or need area(s) you are able to create value hypotheses and aligned concepts. Concepts are low-fidelity designs, renderings, or even verbal/hand drawn applications of a value hypothesis.
The purpose of a concept is to get a user or prospect to react to a value hypothesis without overly thinking about or analyzing it. Concepts can be tested in a variety of ways. Surveys and interviews are the most common approaches. The purpose of concept testing is to validate or invalidate value hypotheses for solving or meeting a problem or need via a specific concept.
It is common to test multiple problem or need areas via multiple value hypotheses and concepts at this stage. Each problem or need area can have one or more value hypotheses aligned to it. Each value hypothesis can have one or more concepts aligned to it.
When testing, the first step is to make sure you have clarity of purpose and are organized so that you know what you’re testing for each problem → value hypothesis → concept grouping. Then you need to make sure that you’re capturing feedback in a consistently structured way to feed analysis.
Finally you should feel confident going into testing that you know what any potential set of results will tell you regardless of what they end up being - i.e. there should be no ambiguity in the implication and what you learn if all your hypotheses are validated vs. invalidated vs. anything in between.
Once you have narrowed to the problem or need area you want to focus on solving, you are ready to build and test your value hypotheses in a deeper way. This deeper way is usually via prototypes of your solution which are rendered at a much higher fidelity to create the experience of a product (often clickable and even coded).
The ultimate expression of value hypothesis testing is value selling. To reiterate an earlier point, making a sale based on a clear and well defined value hypothesis is the absolute best way to validate that you understand the customer and why they are purchasing your product. User engagement is a type of validation because users are effectively paying with their time and attention to use your product, however, the ultimate signal of value alignment is a signed and paid contract.
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Regardless if you employ the exact tools in the exact phases suggested above the most important points are:
- Be prepared to iterate, learn, and adjust your customer segmentation and implications to your product/GTM strategy as you go over both short (days/weeks) and long (quarter/years) time periods. This is not a one shot exercise.
- Clearly and consistently capture and document all feedback so it’s relevant for analysis both initially and over time.
- Always have clear, well-defined value hypotheses that you are actively testing and ensure your approach gives you clear signals validating or invalidating these hypotheses.
- Make sure you get to value-selling i.e. actually selling your product to paying customers predicated on clear, well-defined value hypotheses.