Friday, January 8, 2010

Who the hell should be my customer segment?? contd..

So, where were we the last time? I had to define no focus on "who can be satisfied through similar distribution channels" part of the definition. If you are just wondering what I am talking about, please read my previous post.

First of all, I hope you know what distribution channel means. Even if you don't, don't worry I 'm explaining that also. (I have lots of time:)) Distribution channel is the way the product reaches the customer. So, you can use an indirect distribution channel whee you supply your products to the distributors, who then supply the products to the retailers, who then in turn finally sell those products to the consumers. Or you can use a direct distribution channel in which you directly supply your products to the consumer. Example could be online retailing or mail orders.

Now, the reason of having this condition of satisfying through similar distribution channels can be illustrated through an example. Suppose there are two persons X and Y. In all other aspects, they are similar but X shops only through brick and mortar shops and Y only through online. Now, from company's perspective, they would different service levels, offer different margin levels and would require different ways to reach them. So, in this way they would be different.

So, I have completed the definition of a customer segment. Now, moving on to the question of choosing the customer segment for my products or services. One answer is to say that the segment which has the maximum profit potential should be my customer segment. Is this definition right? Partially is my answer.

I mean it is right but how is the profit potential defined. Suppose there are two segments X and Y. X has 1 lac customers who can spend 1 thousand each and Y has 10,000 customers who can spend only 100 each. So, does Y has more profit potential than X? Yes or No. My answer is I don't know. Suppose my product costs 50 only. This means each of X will buy 20 items and each of Y will buy two items. So, is I am the only one in the market, my revenue from X would be 100 times from X. But what about the profits? Would profits from X also be 100 times profits from Y? May be. May not be. It depends upon a number of factors. Some of the factors could be:

  • How much marketing effort do I require to sell my products to X compared to effort required to sell my product to Y? If X will not buy my products until I have Shahrukh in my ads or I sell the products only in the elitist malls, then it is very expensive to sell my products to X.
  • How much service is required by X compared to Y? If X is an idiot and keep calling my customer care to know about every small feature or benefit of the product or just for time pass, then it's expensive to serve X.
  • How loyal is X customers compared to Y? In case when I am the only supplier, the question may not apply?
There could be other factors which could affect the profitability of a segment. So, it would be naive to only look at the size of the segment. A comprehensive analysis is needed.

The problem becomes even more interesting when I have competitors also. Now, I have to ask one question. Why would anyone buy my product over my competitors product? If the answer is only price, then I'm in for a price competition. The only differentiator between me and my competitor is price. So, we'll both play on price and keep on reducing the price to match each other and try to undercut each other. The result would be we'll reach a point where our costs would be equal to our prices and we'll be making zero profits. The condition can worsen than this also like it happened in airline sector in 1990s.

But there can be other answers like quality or service or brand or distribution or something else. In that case, I and my competitor will be playing with different variable and we'll both possibly end up making profits. In this case, I have to ask myself which segment should I serve. The answer is that I should serve that segment in which I have a competitive advantage over my competitor. I mean if I am a small player and don't have big distribution and segment X is spread out and thus demands a good distribution, then I should possibly look towards segment Y because I don't have what it takes to satisfy X. I am small player and thus very nimble and can maintain a very good service level because my decision making is fast. Suppose Y want very high service levels. Then I can serve this customer segment better than my big competitor who may not be able to provide service level comparable with me.

A thought may come to your mind that if Y requires such high levels of service, won't that increase my costs and decrease my profits. The answer is possibly no. As you are the only one who can provide what Y requires, you can charge higher amount to Y for providing higher level of services and believe me, Y won't mind paying that. Just think do you mind paying more for a private hospital when you have a chance of going to a government one.

Hope you enjoyed reading.

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