Customer segmentation and value proposition design

Excellent products or services are a basic prerequisite for sustained business success. On their own, they are no longer enough for future competition.

For many years, the declared aim of strategy development was to achieve a sustained competitive advantage over the competition in the respective industry. The focus of strategic thinking was thus on one's own industry and its competitors. In many cases this led to competitors being copied and the customer simply being lost from sight.

As a result, exactly the opposite of what was intended occurred: little differentiation from the competition and therefore greater competitive intensity. The strong product orientation of many companies has further aggravated this development and pushed the commoditisation of markets further.

More recent strategy concepts put the customer at the centre. Customers have very different needs and therefore also different expected benefits, behaviours and bottlenecks. It would be a big mistake to commoditise them. Following Arnoldo C. Hax, one can say: products can be a commodity, a business never is.

Attention should therefore be on recognising and characterising customers and their needs, segmenting customers and understanding the differences between the segments precisely. Only in this way can highly attractive offerings (value propositions) be made to the target customer segments that go beyond mere “product thinking” and stand out from the competition.

This requires a change of perspective. Instead of assessing and steering the company's development from the point of view of its own products, an “outside-in” perspective from the customer's point of view takes over.

The point is to understand what really matters to individual customers and to turn this knowledge into attractive, customer-specific value propositions. The core question is: how can customers be retained through an attractive and individual offering, and how can competitors' access to these customers be made more difficult?

Consequently, different customer needs require different strategies to serve them successfully. From transformis' practical experience and with the help of various strategy models, five basic strategies have emerged as a suitable frame of reference. They draw on work by Kaplan/Norton, Hax and Treacy/Wiersema.

Each of the five basic strategies is oriented towards characteristic profiles of expected benefits of customers or customer groups. They offer differing degrees of customer retention potential.

Cost leadership aims to be the cheapest supplier on the market in an undifferentiated product category, that is, for mass goods or commodities. It offers the lowest potential for customer retention because price is the only differentiating criterion. As soon as a competitor offers these customers a lower price, the customer switches.

Product leadership relies on developing products that push beyond existing performance limits and justify a premium price.

The price-value strategy, also called operational excellence, offers an attractive mix of services based on internal standardisation. On the customer side, it leads to the best total cost over the entire period of use or life cycle.

Customer intimacy, understood as a complete customer solution, offers individual customers the best individually tailored overall solution.

System lock-in is based on high costs of switching systems for end customers. It comes in three forms. With a proprietary standard, there is a comprehensive network of complementors whose products and services have been developed specifically for use together with one's own product. With a dominant marketplace, an interface between buyers and sellers emerges that is very hard to displace once it has reached critical mass. With an exclusive distribution channel, considerable barriers make it difficult for competitors to reach the customer.

Customer intimacy and system lock-in allow the highest customer retention potential. System lock-in, however, can only be achieved under special conditions.

The route to an attractive value proposition runs through three steps that can be shown as a map of customer segmentation: the observation grid, the customer segmentation and the specific value propositions. It starts with the change of perspective from inside-out to outside-in. Distinguishing criteria such as size, turnover, profit or region are replaced by customers' needs, behaviours, bottlenecks, expectations and characteristics.

In the first step, the question to answer is which behaviour- and needs-oriented criteria from the customer's point of view are used to characterise and then segment customer groups. In other words, the observation grid for the segmentation process must be defined. This decision has a decisive influence on which customers or customer groups are later bundled into a customer segment.

If the traditional inside-out observation grids prevail at this point, focusing on one's own product structures and product assignments or on delimiting market segments, the innovative character of this form of segmentation cannot unfold. One remains stuck in existing patterns, and what is new remains closed off. Critical reflection on the assessment criteria is therefore the essential step towards new perspectives, assessments, insights and possibilities.

It is particularly important to distinguish market segmentation from customer segmentation. A frequently observed mistake is to use market segmentation criteria such as regions, products, company size, industry or age for customer segmentation. However, mid-sized companies are not all the same, any more than all companies in a region or all end consumers aged 20 to 30.

Put simply, the result of this form of segmentation is not “large” and “small” customers. Instead, “innovative”, “price-sensitive”, “time-critical”, “conservative” or “security-oriented” customers emerge, regardless of size or region.

In the second step, the following questions are answered clearly: who are our customers? What different needs, behaviours and expected benefits do they have? Which characteristic customer clusters can be formed on the basis of the defined needs- and behaviour-oriented criteria, that is, the observation grid?

It is particularly important not to define the term customer too narrowly and to include the insights from analysing the industry value chain. Often one's own business is influenced by groups with whom there is no direct business relationship at all. The map of customer segmentation therefore looks at customers along the stages of value creation.

The result of this step is different customer segments that can be clearly distinguished from one another in terms of expected benefits and characteristics but are largely homogeneous internally. The core expected benefits are described for each segment. This forms the basis for developing different, precisely fitting and attractive offerings.

The third step is first about deciding on the future target customer segments. Guidance comes from the segments' profiles of expected benefits, the associated customer retention potential and the company's identified core competencies.

This means consciously deciding for, and therefore also against, serving individual customer segments, or arriving at a clear prioritisation from which clear “rules of precedence” follow in day-to-day business. What matters is that the company chooses its customers and is not chosen by them. Otherwise it gives up control.

Then, for each chosen target customer segment, the appropriate basic strategy can be selected on the basis of its specific characteristics. Guided by it, the appropriate value proposition is made concrete.

The value proposition is the unique combination of benefit criteria from the customer's point of view. Its description draws on the work of Kaplan/Norton. According to this, an offering consists of product and service attributes, the customer relationship and the image. In transformis' view, the seven benefit criteria derived from this comprehensively cover all aspects of a value contribution relevant to the customer.

The product and service portfolio describes the breadth and depth of the portfolio and the specific attributes and features of the products or services.

The criterion of time covers all time spans that play a role when the services are used. Examples are the time until a price is quoted, the time until a quotation is prepared, delivery times, response times to enquiries, emergencies or complaints, and times for maintenance.

Quality answers the question of how far a company keeps the promise of performance it has made without impairment, for example in relation to the available product and service portfolio, the assured time spans, prices and aspects of the relationship. It must be clarified which impairments are definitely ruled out and which impairments, or what degree of impairment, the customer tolerates. Examples are restrictions in the availability of products and services, downtimes, poor accessibility, missed deadlines or unfriendliness.

Price covers the prices of the products and services and the associated terms.

Service refers to clearly identifiable services provided as an add-on without being explicitly or separately invoiced to the customer. This applies before, during and after the service is used.

Relationship means the intensity and variety of the relationship between company and customers. Examples are contact options, contact persons, availability, duration and frequency of contact, the degree of familiarity and the integration of the company into the customer's organisation.

Brand means the brand name of the product, the service or the company itself. It is about what the customer associates with this brand and how far this influences their choice of supplier or product.

Attractive value propositions must offer a certain threshold benefit in all benefit criteria, which results from the minimum requirements of the respective customer segment. Beyond that, a company can differentiate itself through certain benefit criteria and so shape a value proposition individually.

Defining the threshold benefits is an extremely demanding process. If a threshold benefit is not reached, the customer becomes dissatisfied with the offering or stops using it.

If, on the other hand, a threshold benefit is set too high because of misjudgements and a lack of customer knowledge, this jeopardises the clear strategic focus and differentiation in these customer segments. Resources are also wasted, because from the customer's point of view the service components provided add no value.

A value proposition is therefore made up of benefit criteria for which the threshold benefit is offered and of differentiation criteria for which an individual form becomes possible. The threshold benefit can be more or less pronounced, depending on the minimum requirements customary in the industry. The precisely fitting uniqueness of a value proposition thus arises from the combination of benefit criteria.

This can be shown as a profile: for each of the seven benefit criteria, the degree of differentiation is plotted, each with the threshold benefit, the current situation and the target situation.

The individual value propositions for different target customer segments, which may be based on different basic strategies, often result in different and sometimes contradictory requirements for internal structures and processes. A company should nevertheless be able to offer equally competitive solutions for different and contradictory customer needs.

To master this challenge, a company must consciously take its own core competencies into account when deciding for or against customer segments and when designing individual offerings. It is also crucial to identify the functions, people and processes relevant to serving customers and customer segments in a differentiated way and to align them with the emerging requirements or develop them accordingly.

Work on customer segmentation and value proposition is divided into four modules: kick-off, customer segmentation, customer survey with strategic positioning, and strategy map.

The first module consists of a kick-off workshop. At its end there are five to ten behaviour- and needs-oriented distinguishing criteria as the basis for the customer segmentation. In addition, there is a catalogue of company-specific expectation and performance parameters used to determine the expected benefits and develop the value propositions. The relevant market segments and their assessment criteria are also clearly defined, and there are jointly held trend assumptions on influencing factors critical to success.

The second module is devoted to customer segmentation. First, templates and a tailored online platform are prepared, whose question and answer structures serve to determine minimum expectations and differentiation potential for each customer segment and to assess the market. This is followed by the behaviour- and needs-oriented characterisation of all customers included and the assessment of the defined market segments.

On this basis, the behaviour- and needs-oriented customer segmentation is produced, with a characterisation of the segments and an evaluated market assessment. A customer segmentation workshop concludes the module. Its result is an approved customer segmentation with segment characterisation and a finalised market assessment.

The third module combines the customer survey and strategic positioning. An online platform is set up to determine the threshold benefits and potential of the customer segments. It is used for a self-assessment and a customer survey, for which a high response rate is sought.

The evaluation shows minimum expectations and differentiation potential for each customer segment at the level of the expectation and performance parameters, as well as discrepancies between the external and internal view. In the strategic positioning workshop, the target markets are clearly defined. For each customer segment identified, a precisely fitting and attractive value proposition is created, based on valid customer feedback on minimum expectations and differentiation potential.

The fourth module is a strategy map workshop. It leads to a clear and coherent implementation plan for achieving the goals.

Innovative customer segmentation offers a new view of customers, competitors and one's own strategic positioning. Engaging intensively with the specific needs of customers and potential customers, and the subsequent characterisation and segmentation, enable a company to develop unique value propositions that give it unique selling points. Important participants in the value chain can be systematically assessed and the differences worked out in order to arrive at one's own unique strategic positioning.

This concept reveals possibilities that traditional models and concepts do not even touch on. In addition, the awareness of key players can be broadened so that something new emerges in the discussion and a foresighted process of self-renewal becomes possible. The result is a unique offering with sustained competitive advantages.