The Importance of Customer Segmentation

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It’s been on the horizon for TN. liquor stores for many years, law changes that allow Grocery Stores to sell Wine.  I’ve detailed out the business drama in the Case study:  Local Liquor stores fighting the sea change.

I argued that 100% of the Liquor Store owner’s energy should NOT be fighting the inevitable, but for preparing for this reality (fight or flight).

“If I owned a Liquor store I would put ZERO energy in fighting this legislation. ZERO.  I would put 100% of my energy preparing for the inevitable day when I have a 75,000 square foot store selling the same category I’ve been insulated on.  And if I couldn’t build a winnable plan, I’d be preparing for an exit.”

So the million dollar question is:  “HOW?”

Well, it starts with your biggest risk when massive competition comes your way:  Customer migration.

Said another way, fewer visits from existing customers, and fewer “new customer drop-ins” as more distribution options compete for your customer visits.

In Short, nothing matters more than customers.

  • Customers are the conduit to revenue.  Revenue is the conduit to margin.  Margin is what pays the bills.  
  • Enough quality customers + a sound business model = profit.  Not always, but usually.
  • Quality customers are meaningful, loyal and are your lifeline.
  • Have indifferent customers and who knows how many will leave you.  But you WILL have some losses.  The question is, will your business be OK as a result?

The question that keeps coming through my head is:  Do the stores even know their level of risk?

First Principle:  All Customers are not created equal.  

The “80/20” rule applies to all facets of life, where a very small % of customers create a large % of revenue.  It is amazing how consistent this rule is, and consumer analytics almost always proves this to be true.  

If the Grocery industry’s frequent shopper card bought us clutter to our key chains, it DID re-enforce this truth in marketing as the data proved category by category.  Given that, here’s the implications for liquor store owners, and all those in the Marketing Biz…

Know thy customers

image credit:  ideawall.com

Customer Segmentation

  • Is the business model broken down all the way to the “customer level?”.
    • How many customers drive the total revenue?
    • How many trips per year per customer?
    • $’s spent per customer trip?
    • Trips per customer * $’s/trip = Annual total customer $ value
  • Are they segmenting customers from “high to low” (based on some measure of lifetime value, such as ANNUAL expenditures)?
  • Are they modeling what the future could look like when competitive landscape changes?
  • Does the new landscape affect all customer segments equally?
  • What does that likely scenario mean to the businesses bottom line?

At first blush, many marketers or store owners may think:  “How can I possibly get that data without expensive CRM systems?  Natural Reaction.  But if you don’t have expensive systems, you only need a couple variables to get close, which all businesses should have:

Steps For Modeling Your Customer Segmentation Value Grid

1) Calculate your total # of annual transactions by taking your total $ sales annually / average $ per transaction.

Annual Revenue:  $1.5mm

$’s spent Per transaction (or average contract size for service business):  $30/transaction

$1,500,000 / $30 = 50,000 transactions

2)  Identify at least 4 total customer segments, from the lightest (one time a year buyers) to your most frequent “passionate” customers.

1X Customers

“Light”

“Medium”

“Heavy”

“Passionate”

3)  Apply the 80/20 rule to your total annual transactions.  In other words, allocate 100% of your total annual transactions with at least 80% of the total annual transactions going to your 2  lightest customer segments.

  • I would assume 50% of the transactions occur from “1 x a year buyers”.  This is common in retail and CPG.  

4) Apply your knowledge of “trip frequency” to each customer segment.  If you know your best customer buy nearly one time per month, you may want to be conservative and call your “average” trips per year  among your most passionate segment say 8 times per year

5)  Divide your transactions by segment by the # of trips per segment.  This gives you the total # of customers per segment.

  • The above assumptions translate to about 32k customers

6)  Apply your best knowledge of $’s spent per trip among each customer segment.   Multiply the $’s / trip per segment by the total customers in that segment to get total $’s purchased per segment.

  • If you know your most passionate customers spend $150 on each visit, maybe use $125.  Also, if you know the people you rarely see only buy a bottle of wine for $15, use that number for the 1x’s.  

7)  The fun part.  Sum up the totals from the above segments.  You will get your customer value break down.

In the above example we are dealing with a $1.5mm store.  The above 9 steps reveal the following.

  • A business with total customers of about 32,000
  • 78% of the customer count (25,000 customers) drive $350,000 annual $’s, or about 23% of the total.
  • This compares to the “Passionate” customers, who are about 300 customers and almost the same amount of total $’s.  Said another way, the top 1% of the best customers drive the same amount of $’s as the bottom 78% of the customers.

Why it Matters?

In the case of this liquor store, let’s assume the following:

This liquor store was “average” meaning that their Gross margins ran in the 35% range, and after all expenses they were able to generate a 4% bottom line profit, or about $60,000 per year on $1.5mm of sales.  Now the grocery stores sell wine and invade their turf.

  • What segment of customers are most likely to leave the establishment when the 75,000 ft. grocery store now sells wine?  The passionate buyers or the people that may come in only one time per year to buy a bottle of wine?  
  • I would venture to guess the casual buyer will migrate at the greatest rate.  Let’s say that the 1x & “light” buyers reduce their trips by -35% a year in the new world, everything else remains constant.

Now what happens to the liquor store, assuming no change in strategy and customer protection effort?

  • The loss of trips among the “most indifferent” customers only (lightest 2 segments) reduces revenue by -$280k.
  • The store that used to drive $1.5mm in sales and $60k of profit now generates $1.2mm in sales and is now in the read by ($22k).

Something tells me that there are 600 stores that are not working these numbers.  I personally know because I spread “passionate” type $’s around multiple stores in the area.  And I have the feeling every time I do that I get treated like a 1x buyer.

Customer Segmentation understanding is a gold mine for scenario planning.  If you do it, and ACT on it.

PS  The math is pretty easy, feel free to comment if you’d like the excel work-up behind the above example.  

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