What is the role of segmentation in building growth and profitability?.

Segmentation increases profit opportunities because different groups of consumer attach different economic or psychological values to the solutions (products, services or experiences).

I love to give examples and stories. I hope you like to read them. I consider it is precious and a wonderful “goldmine” to listen to true stories when we are learning.

Let´s see an example. There is this  European chemical company, which has been developing a new organic herbicide line of products, which were patented for crop production.

Organic production systems include all the organic products needed for fertility, weed control, disease control and pest control. Traditionally chemical conventional herbicides have been used for weed control, but this innovative European company has developed a new herbicide, which is 100% composed of organic inputs and the price is affordable and can compete with the conventional herbicides. The European company has to decide if they will sell an undifferentiated price for all the crops, or if the differentiated pricing strategy (segmented) is the best one. The company needs to know which pricing strategy is the best one to increase the profits.

For simplicity of this example, just remember: The variable costs totals vary directly with a number of units sold. The variable costs are direct material and direct labor.  The fixed costs are the Selling, General, and Administrative expenses, which are fixed and not affected by the volume of acres.

Scenario I: An undifferentiated pricing strategy.

Let´s assume the organic herbicide will be used totally for field crops (alfalfa, tomato and field corn). Per acre, the variable costs per unit are $ 30.0 per acre. The total fixed costs are $20 Million. Let´s suppose the market land is a total of 3 million acres. The chemical company has decided to sell the product for field crops at a price of $40/acre.  The total revenues at this price level will be US$40/acre x 3 Million acres: $120 Million.

Now let´s go to the costs: The Variable costs are $30/acre x 3 million acres: $90 million plus the total fixed costs of US$ 20 Million. The total costs are: Fixed+Variable: $90+20: $110 million. And the profit which is nothing less than Revenues minus Costs will reach US$ 10 million.

An alternate strategy would be to concentrate solely on the high productivity of tree nuts crops (Almonds and walnuts). The tree nuts farmers have only a 1 Million acres land. The organic herbicides price/acre is US$150/acre. This strategy would increase the profit potential to US$100 million.

Scenario II. Differentiated Strategy (segmented)

Let’s analyze the differentiated strategy: The European company marketer decides to segment the farmers in three types: Field Crops (Alfalfa, tomato and field corn), Vegetables (broccoli and cabbage) and Tree Nuts (Almonds and walnuts).

The Marketer and the Pricing Manager establish a differentiated pricing strategy:  for field crops, the price will be maintained atUS$ 40 per acre. For Vegetables, the price will be $80 per acre, and for the Tree nuts, it is $150 per acre. If the land consisted of 3 Million acres split evenly between the three crops. This strategy will involve selling at three different prices, to each of the three segments. The organic herbicide product will attract different three types of farmers/customers. In this case, the company would have three different segments covering the whole market, but still, tap the value surplus in the premium segments. The total expected profits for this second scenario will be US$160 Million, which is 16 times more than the first scenario where the product was sold at $40/acre.

Another example:

To demonstrate the central role of segmentation in building growth and profitability, the strategy of an airline is shown. In the early days, airlines did not segment their market. This strategy is followed today by low-cost airlines, which expect to do profits selling more seats (by volume).

Economy Class

With time the companies realized that passengers differ in their expectations. Business travelers valued convenience, comfort, and services, while leisure passengers were more interested in low price. The following table illustrates the pricing and cost options for a carrier flying from London to Paris using a 300 seats plane and anticipating an average load factor of 80%.  If it pursued an undifferentiated one class plane, the management believed that the highest price chargeable is US$250 to achieve 80% occupancy.  In this case, the budgeted profit from the trip would be US$5,200.

A first-class Airbus A380 cabin

However, for the management, it was obvious that while a price of US$250 already begins to lose the business of low budget travelers, business people and more affluent customers would be willing to pay more for superior service and comfort. The result was the airlines moved to a differentiated strategy whereby they offered three levels of service on the plane: economy, business, and first class. At very different price levels.  As shown in the table above the first observation we can see how the revenue and profitability increase massively with segmentation. Second, the differentiated service better meets the needs of all customer by offering different services that the particular type of passenger prioritizes. These examples are analogous to the segmentation strategies pursued by most of the sophisticated marketing companies of today, and a few examples can demonstrate it in the following industries:

• Scotch Whisky:
• Credit Cards
• Pharmaceuticals
• Cars
• Others…

Tomorrow we will continue to the next topics:  Why segment markets? Bases for Consumer Segmentation: geographic, demographic, psychographic and behavioral.

Couples that Jeep Together, Stick Together: Tomorrow I hope to use an example of cars segmentation. I adore thinking about my fiance´s  when I write. Alejandro Guillermo Lozano Artolachipi is my source of inspiration. His lifestyle is adventurous.  He loves Jeep cars. I love him. He enjoys off-road driving. I adore him with all my soul. Picture Source: Pinterest.com

Source References:

https://www.amazon.co.uk/Marketing-Management-Strategy-Peter-Doyle/dp/0273693980

Note: All the pictures shown on this blog do not belong to me. I do not own any of the lovely photos posted unless otherwise stated.

Published by eleonoraescalantestrategy

Corporate Strategy Artist, San Salvador, El Salvador View all posts by eleonoraescalantestrategy