Introducing customer segmentation
In this section, we will cover customer segmentation in detail. Initially, I provided just a brief introduction of customer segmentation so that you could understand the term a bit. Here, we will understand a lot more about customer segmentation, which will help us further when we build the customer segmentation analysis.
As mentioned earlier, customer segmentation is a process where we divide the consumer base of the company into subgroups. We need to generate the subgroups by using some specific characteristics so that the company sells more products with less marketing expenditure. Before moving forward, we need to understand the basics, for example, what do I mean by customer base? What do I mean by segment? How do we generate the consumer subgroup? What are the characteristics that we consider while we are segmenting the consumers? Let's answers these questions one by one.
Basically, the consumer base of any company consists of two types of consumers:
- Existing consumers
- Potential consumers
Generally, we need to categorize our consumer base into subgroups. These subgroups are called segments. We need to create the groups in such a way that each subgroup of customers has some shared characteristics. In order to explain how to generate the subgroup, let me give you an example.
Suppose a company is selling baby products. Then, it needs to come up with a consumer segment (consumer subgroup) that includes the consumers who want to buy the baby products. We can build the first segment (subgroup) with the help of a simple criterion. We will include consumers who have one baby in their family and bought a baby product in the last month. Now, the company launches a baby product that is too costly or premium. In that case, we can further divide the first subgroup into monthly income and socio-economic status. Based on these new criteria, we can generate the second subgroup of consumers. The company will target the consumers of the second subgroup for the costly and premium products, and for general products, the company will target consumers who are part of the first subgroup.
When we have different segments, we can design a customized marketing strategy as well as customized products that suit the customer of the particular segment. This segment-wise marketing will help the company sell more products with lower marketing expenses. Thus, the company will make more profit. This is the main reason why companies use customer segmentation analysis nowadays. Customer segmentation is used among other domain such as the retail domain, finance domain, and in customer relationship management (CRM)-based products. I have provided a list of the basic features that can be considered during the segmentation. You can refer to them in the following screenshot:
Figure 3.2: List of basic features used in customer segmentation
You may wonder how companies are making marketing strategies based on the customer segmentation analysis. The answer is companies are using the STP approach to make the marketing strategy firm. What is the STP approach? First of all, STP stands for Segmentation-Targeting-Positioning. In this approach, there are three stages. The points that we handle in each stage are explained as follows:
- Segmentation: In this stage, we create segments of our customer base using their profile characteristics as well as consider features provided in the preceding figure. Once the segmentation is firm, we move on to the next stage.
- Targeting: In this stage, marketing teams evaluate segments and try to understand which kind of product is suited to which particular segment(s). The team performs this exercise for each segment, and finally, the team designs customized products that will attract the customers of one or many segments. They will also select which product should be offered to which segment.
- Positioning: This is the last stage of the STP process. In this stage, companies study the market opportunity and what their product is offering to the customer. The marketing team should come up with a unique selling proposition. Here, the team also tries to understand how a particular segment perceives the products, brand, or service. This is a way for companies to determine how to best position their offering. The marketing and product teams of companies create a value proposition that clearly explains how their offering is better than any other competitors. Lastly, the companies start their campaign representing this value proposition in such a way that the consumer base will be happy about what they are getting.
I have summarized all the preceding points in the following diagram:
Figure 3.3: Summarization of the STP approach
We have covered most of the basic parts of customer segmentation. Now it's time to move on to the problem statement.
Introducing the problem statement
As you know, customer segmentation helps companies retain existing customers as well as acquire new potential customers. Based on the segmentation, companies can create customized products for a particular customer segment, but so far, we don't know how to generate the segments. This is the point that we will focus on in this chapter. You need to learn how to create customer segmentation. There are many domains for which we can build customer segmentation, such as e-commerce, travel, finance, telecom, and so on. Here, we will focus only on the e-commerce domain.
Here is a detailed explanation of the problem statement, input, and output for the e-commerce customer segmentation application that we will be building:
- Problem statement: The goal of our customer segmentation application is to come up with a solution for the given questions:
- Can we categorize the customers in a particular segment based on their buying patterns?
- Can we predict which kind of items they will buy in future based on their segmentation?
- Input: We will be using e-commerce data that contains the list of purchases in 1 year for 4,000 customers.
- Output: The first goal is that we need to categorize our consumer base into appropriate customer segments. The second goal is we need to predict the purchases for the current year and the next year based on the customers' first purchase.
You may wonder how we can achieve a prediction about the upcoming purchases using segmentation. Well, let me tell you how segmentation helps us! So, we don't know the purchase pattern of the new customer, but we know the customer profile. We also know which product the customer has bought. So, we can put the customer into one of the segments where all other customers have purchased similar items and share similar kinds of profile.
Let me give you an example. Say, a person has bought a Harry Potter book and that person lives in the UK. The age group of the customer is from 13-22. If we have already generated a customer segment that satisfies these characteristics, then we will put this new customer in that particular subgroup. We will derive the list of items that the customer may buy in future. We will also offer similar services that other customers in the subgroup have.
The approach that we will be using in order to develop customer segmentation for the e-commerce domain can also be used in other domains, but data points (features) will differ for each domain. Later on in the chapter, we will discuss what kind of data points you may consider for other domains, such as travelling, finance, and so on. I will provide the list of data points for other domains that will help you build the customer segmentation application from scratch.
Now it is time to understand the dataset for building customer segmentation for the e-commerce domain.