Market segmentation is a form of action usually underpinned by market research that divides broad markets into smaller subsets based on some common element like features or needs. The purpose of market segmentation is to be able to maximise revenues more efficiently by differentiating between groups of consumers with common characteristics that can be fragmented. Through the process of market segmentation, we can help clients to create and implement a focused marketing strategy that divides a market into sub-segments and extracts the maximum producer surplus from each of the identified sub-segments.
The process is highly dependent on the specific market being addressed and the strength of the firm to divide the market into segments, since different approaches need to be taken with markets exhibiting different characteristics, like competition, closeness of substitutes, replicability, customer segments and value in use of each one of the segments. Markets can thus be segmented based on several variables. Some of the broad features along which market segmentation can occur include: geographic, demographic, usage, psychographic/lifestyle, and organisational dimensions.
Geographic segmentation is one of the most popular forms of market segmentation. Markets can be divided by geographic area such as by continent, region, nation, or neighbourhood. Through geographical segmentation, markets can be subdivided by regional culture, climate, accessibility, urban-rural typology, elevation, and geopolitical situation. Through geographic segmentation, a firm might be able to determine where to focus its product or service marketing based on its competitor’s market positioning and market share in the area(s) that the firm would like to enter or consolidate. Where a firm considering market segmentation has significant market power, it might also need to consider the regulatory environment in which it operates as it may become liable to competition policy regulation.
Another traditional method of segmenting a market is through demographic features. These include, inter alia, gender, age, religion, race, and educational level. These segmentation criteria are widely used due to their high correlation with other variables that are important for marketing such as the needs of consumers. Although demographic segmentation has been used in market research for decades, on occasions it can have its limitations in predicting consumer behaviour. For this reason, psychographic/lifestyle segmentation is coming to the fore as a supplementary form of market segmentation characteristic.
Historically, segmenting markets by social factors such as income and occupation was common and demographic segmentation has stood the test. This form of market segmentation, however, has its limitations in that categorisation by social class is not always an accurate method of grouping similar individuals due to variations that may exist in their behaviour and preference. Having a higher income, for instance, does not invariably translate into a higher expenditure on a particular product or service. To make up for this limitation, demographic market segmentation can be fine-tuned through observed information on lifestyle choices. These include consumption attitudes, behaviours, values, perceptions, beliefs, and interests. The capturing of such data is becoming easier and more pervasive as traditionally physical activities continue acquiring novel cybernetic forms.
Lifestyle measurement is based on the Activities, Interests and Opinions (AIO) of consumers. AIO combine internal and external characteristics to map the lifestyle of a consumer. Activities and interests determine how individuals spend their time and money while opinions are based on attitudes and preferences. One way lifestyle segmentation can be achieved is by segmenting consumers by either declared social media interests or by surfing habits. In most cases, adding this information to marketing clusters can significantly ameliorate targeting effectiveness.
While similar to consumer market segmentation, organisational segmentation presents a bigger challenge due to the additional complexities involved when dealing with commercial or public entities. Organisational markets can be segmented using several factors that can be classified into macro segmentation and micro segmentation. Under macro segmentation, business markets can be grouped based on organisational size and type of industry. The demand and budget for a product by larger businesses will be different than the demand and budget for the same product by smaller businesses. On the other hand, micro segmentation allows clients to categorise different companies within an industry based on variables such as their internal decision-making units and their choice criteria.
Other potential market segments include: customer loyalty, customer capabilities, user status of customers, usage rate, buyer readiness, and the purchasing criteria of customers. Having said that, in order to have effective segmentation, it is important to ensure that segments are sustainable enough to warrant separate marketing campaigns or prices. Additionally, information about the different segments should be measurable. This implies that the information about the size, composition, and purchasing power of each segment can be collected and utilised to facilitate the client’s decision-making process.
From an industrial perspective, market segmentation is widely used by commercial and public entities to carry out various degrees of price discrimination.
First degree price discrimination occurs when a company sets different prices for different customers and/or different prices for different units of a good or service.
Second degree price discrimination arises when different prices are charged for different quantities of a product or service, such as bulk discounts.
Third-degree price discrimination, or group pricing, occurs when different separable market segments are charged different prices in order to increase total producer and consumer surplus. The textbook example of third-degree price discrimination, which is arguably the easiest price discrimination policy to implement, occurs when a price discount is given to students or the elderly. Another form of group pricing occurs when discounted prices are allowed for first time consumers. A firm will charge different prices to consumers who are usually segmented on the basis of their demand elasticity and their price sensitivity. Group pricing is commonly used by sectors like public transport when creating different pricing options for commuters and casual travellers and telecommunications when tariffing and creating service packages.
Price differentiation may increase both consumers’ and producers’ welfare since it allows firms to serve market segments which have differing willingness to pay levels. Uniform pricing in situations that are not perfectly competitive can result in a portion of the total market demand being unmet due to a lower demand elasticity by niche sub-markets. Price differentiation, for instance, occurs when different prices are charged for peak and off peak periods. This is commonly used by telecoms, electricity and gas supply firms, and airlines.
Producers’ pricing flexibility is generally limited by the competitive alternatives available. If a firm does not have any degree of market control, it would be difficult to charge different prices to different consumers or consumer groups as competitors will be able to undercut the higher price, defeating the market segmentation strategy. Equinox Advisory Ltd can assist firms in identifying the market environment in which they are operating for particular products, services or categories, classes or clusters thereof, (e.g. a perfectly competitive market, an imperfectly competitive market, an oligopolistic market, a monopolistic market, or a monopolistic competition market), and to advise on whether first-, second- or third- degree price discrimination could yield commercial benefits after weighing antitrust risks from a legal standpoint (for more information please see our competition law page). Equinox Advisory is also able to determine whether different groups of buyers exist and the extent of difference between each group’s elasticity of demand.
The team at Equinox Advisory can apply their combined data analysis and economics skills to serve your needs by:
- Identifying markets based on the client’s needs and product or service offering to pave the way for segmentation;
- Determining which factors and data inputs should feature in a client’s market segmentation decision;
- Determining whether segmentation is in a client’s best interests from an economics and a legal perspective
- If segmentation is in the client’s best interest, advising on how to optimise segmentation through different degrees of price differentiation;
- Identifying whether or not a company can legally perform group pricing, and whether or not this pricing mechanism will increase profitability (total producer surplus); and
- Assisting companies with segmenting a market and assigning profit maximising prices to each segment through the calculation of different segments’ willingness to pay and price elasticities of demand.