The content of this article is provided for informational purposes only. You should always obtain independent business, tax, financial, and legal advice before making any business decision.
September 9, 2024
September 9, 2024
5 mins read
Given the abundance of choice offered to modern consumers, blanket marketing campaigns don't cut it anymore. In fact, experts predict that the global revenue from customer experience personalization and optimization software will exceed 9.5 billion U.S. dollars by 2024.1
Enter customer segmentation. By categorizing your target audience into groups based on common characteristics like demographics, interests, and behaviors, you can tailor your marketing efforts to resonate better.
The result? There could be better communication, stronger customer relationships, and an increased return on investment (ROI) on your marketing campaigns.
In this guide, we’ll explore best practices for customer segmentation and provide actionable tips to help you get started.
Customer segmentation is the practice of dividing a company's target audience into groups with similar characteristics to improve customer engagement.
Think of it like organizing a messy closet. Instead of a jumble of clothes, you sort everything into categories: shirts, pants, dresses, etc. This makes it much easier to find what you need. Similarly, customer segmentation – a cornerstone of customer analytics and behavior – helps you "find" the right customers for specific marketing efforts.
The goal of segmentation isn't just about labeling groups. It's about understanding your audience on a deeper level. This allows you to:
While both customer segmentation and market segmentation involve organizing shoppers into smaller segments, they play unique roles in your marketing arsenal.
Customer segmentation spotlights your existing customer base, aiming to understand the different types of customers you already have. This approach is best for businesses with established customer bases who want to deepen relationships and tailor their offerings. For example, a clothing retailer might segment its customers into budget-conscious shoppers, fashionistas, and those who prioritize comfort.
Market segmentation, on the other hand, focuses on the broader potential market. The goal is to use market analysis to identify distinct groups and, subsequently, expand your reach – whether it’s by entering new markets, exploring new product lines, or identifying other untapped opportunities.
Understanding your customers is not a one-size-fits-all affair – there are several customer segmentation types to consider when approaching this challenge, including:
Here’s what makes each one unique.
Demographic segmentation involves organizing your target audience based on demographic factors like age, gender, income, and education level.
One of the biggest benefits of demographic segmentation is how it provides the foundation for developing targeted marketing strategies. For example, a cosmetics company may target ads specifically for women aged 18-35.
Because demographic data is relatively inexpensive and simple to gather, businesses can use it to easily predict consumer behavior and allocate marketing resources more efficiently, potentially resulting in increased engagement and conversion rates.
However, given its simplicity, solely focusing on demographic segmentation can lead to over-generalizations and missed opportunities. Whenever possible, try to pair it with other segmentation models.
The geographic segmentation model separates customers based on physical locations such as country, state, or neighborhood, allowing businesses to localize their marketing efforts.
For example, a clothing retailer may use geographic segmentation to offer different styles or promotions depending on the weather patterns of specific regions.
While the advantages of geographic segmentation are numerous for businesses with physical locations, they may be less relevant for online-only retailers seeking a broad, international audience.
Psychographic segmentation categorizes customers based on their values, lifestyle choices, and opinions. This provides key insights for businesses to connect with shoppers on a deeper, more emotional level.
Here are some examples of psychographic segmentation in action:
The catch? Data for psychographic segmentation is often harder or more expensive to collect and analyze.
By leveraging behavioral segmentation variables like spending habits and product usage rates, companies can create personalized campaigns that compel shoppers to take particular actions.
For example, businesses can use this segmentation model to:
Like psychographic segmentation, behavioral segmentation typically requires extensive data collection and analysis, which may not be feasible for all businesses.
Technographic segmentation categorizes customers based on their relationship with technology. This includes the specific technologies they use, how often they use them, their proficiency level, and even their attitudes towards adopting new technologies.
Technographic segmentation is particularly valuable when:
An example of technographic segmentation is a software company identifying customers who primarily use Apple devices versus Android devices, allowing them to tailor marketing campaigns and product features to each group's preferences.
Firmographic segmentation is a strategy used primarily in B2B marketing to categorize companies based on shared attributes such as:
An example of firmographic segmentation could involve a technology company targeting cloud-based service providers with a substantial workforce and significant annual recurring revenue, located within a specific country.
Needs-based segmentation groups customers based on their specific needs, pain points, and desired outcomes.
Unlike demographic or firmographic segmentation, which focus on attributes like age or company size, needs-based segmentation digs deeper into the underlying motivations and challenges that drive customer behavior. From there, brands can tailor their products, services, and marketing messages to directly address those needs.
Needs-based segmentation is particularly effective when:
Given these benefits, this type of segmentation is most applicable to B2B companies with complex solutions, service providers, and ecommerce businesses.
Value-based segmentation groups customers based on their economic value to your business. It's about identifying which customers are the most profitable and prioritizing them in your marketing and customer service efforts.
Unlike other segmentation methods that focus on demographics or behavior, value-based segmentation directly ties into your bottom line, making it a powerful tool for maximizing revenue and profitability.
How it works is simple: you start by analyzing customer data to determine their lifetime value (LTV), which is the total revenue a customer is expected to generate over their relationship with your company. Based on this LTV, you can then group customers into segments, with high-value customers receiving more attention and resources.
Value-based segmentation is especially beneficial for:
Data is naturally the bedrock of effective customer segmentation — keep these considerations in mind when developing your data collection and analysis processes.
Here are some common customer data sources for the different segmentation models:
Once you have your insights for each segment, it’s time to apply them to your customer-based marketing strategies. Use these tips to fine-tune your marketing efforts:
Customer segmentation is not just a buzzword. It's an essential strategy that can significantly influence a growing business's success.
By understanding your customers' unique characteristics, behaviors, and preferences, you have the opportunity to tailor your marketing campaigns – ultimately unlocking increased conversions, heightened customer loyalty, and a boost in revenue growth.
Learn more about PayPal's business solutions to discover tools and resources.
There's no magic number when it comes to the ideal number of customer segments. The right amount will depend on your business size, industry, and target market.
The goal is to find the sweet spot of "optimal segmentation." This means creating enough segments to effectively personalize your marketing efforts without overcomplicating your strategy. Too few segments can lead to generic messaging that doesn't resonate with anyone, while too many segments can strain your resources and make it difficult to manage campaigns effectively.
Try to start simple: begin with a few broad segments based on your most obvious customer differences. Next, make sure each segment provides meaningful insights that guide your marketing decisions. If a segment doesn't lead to distinct strategies, it might not be necessary. You can always refine and expand later as you gather more data.
Market segmentation divides the broader potential market into smaller groups based on shared demographics, geography, or industry. Its goal is to identify promising segments for growth and tailor marketing strategies to reach them.
Comparatively, customer segmentation focuses on your existing customer base, categorizing them based on various factors like demographics, behavior, or needs. This lets you personalize marketing messages, improve customer service, and enhance retention.
In many cases, businesses combine both approaches. Market segmentation initially identifies potential customers, and then customer segmentation is applied to those acquired customers to optimize engagement and foster long-term loyalty.
Implementing a customer segmentation strategy involves a few key steps:
In partnership with three expert business owners, the PayPal Bootcamp includes practical checklists and a short video loaded with tips to help take your business to the next level.
*Required fields.