How To Do Customer Segmentation Right

How To Do Customer Segmentation Right

Many segmentation efforts today are an exercise in futility because companies are basing their segments on inappropriate criteria.

The Royal Bank Way

Determining your customers' needs is not a onetime exercise. Although this means you can never be done with the process of needs identification, the good news is that you don't have to be perfect on the first go-round. Effective segmentation is an exercise in fine-tuning. For instance, RBC started back in 1992 with just three customer segments: high, medium or lower profitability. Over time, RBC's segmentation process has become much more sophisticated. Today the bank has more than 80 customer models in its data warehouse, and each month it scores all of its eligible customers on all relevant strategic and tactical models. (Someone who already has a line of credit at RBC, for example, would not be scored against a model that predicts the likelihood of acquiring a line of credit. And customers who have opted out of having RBC use their information for promotional purposes aren't scored at all.) Strategic models - including profitability, life stage, potential, defection risk, client commitment or loyalty and overall risk - help the bank home in on customers' needs and priorities. Tactical models - such as propensity to buy, the likelihood of a customer cancelling a product or service, and the degree to which a customer uses the products he's acquired - are used to identify revenue opportunities and generate lead lists for employees who deal directly with customers. Scoring customers monthly on the 80-plus models is helping RBC generate more than 13 million targeted leads each month. Roughly 6 million leads are used by salespeople to reach out to customers. The other 7 million are called "sales opportunities" to be used when the customer initiates contact with RBC. That means customer service reps and branch employees have targeted product pitches to offer customers after they've handled the customer request.

The three most critical models that drive RBC's business are profit potential, current profitability and life stage, says Gaetane Lefebvre, vice president of client knowledge and insights at RBC Financial Group. "If you have these three things, you can fundamentally manage your business very well," she says. "Those are the ones we've been using as a proof of concept since as early as 1996." RBC's method of projecting potential for each customer is so proprietary that Lefebvre won't even discuss it, aside from saying that it is not simply a lifetime value calculation (see "The Lifetime Value Equation", above ). "Profitability is extraordinarily important and it's where you want to start," says Lefebvre. "But it's not very informative for understanding client needs." For that, RBC relies heavily on its life-stage model. Using this model (supplemented by focus groups, surveys and third-party research) divides individual clients into five strategic life-stage segments:

1. Youth: These clients are younger than 18.

2. Getting Started: These clients, generally between 18 and 35, are going through first experiences: graduation, first credit card, first car, first loan, marriage, first child.

3. Builders: These clients, usually between 35 and 50, are in their peak earning years. Typically they borrow more than they invest, as they build families and careers. With many expenses, their primary goal is to manage their debt load effectively.

4. Accumulators: Typically between 50 and 60, these clients are worried about saving for retirement and investing wisely. They want to know if they've saved enough to retire, if they'll have to change their lifestyle when they retire and if they'll need to work to supplement their retirement income.

5. Preservers: The primary needs of these clients, who are usually older than 60, are to maximize retirement income and maintain the lifestyle they desire. They typically manage multiple income sources and are starting to do estate planning.

Lefebvre and her team overlay these life-stage segments with other strategic models such as profitability, potential, client credit risk and client vulnerability (risk of leaving the organization) onto the bank's objectives: retaining profitable customers, growing customers with potential, managing and controlling customers with higher credit risk profiles and optimizing the costs of less profitable customers. By doing so, they can identify opportunities to make a difference in the market, she says. Once the bank has identified a high-potential opportunity, it models the opportunity to see how much it might grow the business. Then RBC fine-tunes and validates the offer with 100 to 200 customers in focus groups or client interviews. If the offering is complex or demands significant investments of bank resources, RBC will often verify the results through further qualitative research or a pilot, testing different offers and creative among thousands of customers before rolling out the optimal version on a larger scale.

Targeting the Snowbirds

Once you've identified a group of customers who appear to have common needs, you have to determine if you can profitably offer a value proposition to meet those needs. It's all about finding the ideal middle ground between segments of one (it would be too expensive to address customers' needs individually) and segments that are so large and heterogeneous that you can't tailor offerings to customers' needs. Sometimes it's not worth subsegmenting your customers. (Selden observes that Wal-Mart essentially has one segment of 200 million, based on the assumption that everyone just wants low prices, period.)

"Normally, companies start with a relatively small number of segments, which are fairly coarse," says Selden. "But if you have 40 million customers and five segments with 8 million customers per segment, the chances of those being highly homogeneous are very limited." The goal, then, should be to evolve those segments into more precise subsegments that allow you to deliver more targeted value propositions.

"Subsegmenting," Selden says, "is where the gold is."

Defining a useful subsegment generally involves doing a deep dive into the most profitable end of the segment to tease out distinct behaviour patterns. On delving deeper into RBC's preservers segment, Lippert says, RBC noticed a subsegment of people who spent a lot of time out of the country in certain months. Many of these were snowbirds escaping to Florida to avoid the harsh Canadian winters. Because RBC has branches in the United States, the bank quickly realized that snowbirds represented a sweet spot of untapped potential for the bank.

To address these customers' unmet needs, RBC put together a "snowbird package" that included travel health insurance, easy access to Canadian funds, online consolidated account review, real-time transfers, the ability to leverage a Canadian credit history to secure mortgages in the US and a toll-free number for cross-border banking questions. RBC also began introducing customers in the snowbird subsegment to personal bankers in the US, making it clear that the institution knows its customers and understands the importance of their business.

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