Thursday, August 31, 2006

Is fragmentation of markets a real problem?

Companies today are, after selecting and defining a market segmenting the market into smaller groups of customers that they then choose to serve. Market segmentation can be done in numerous ways, and is usually used in a way that explain the differences in the market in relation to the specific services and products the company is marketing.

One excellent article, and the rationale behind market segmentation was published by Journal of Marketing in 1956. The article was written by Wendell R. Smith, and explain that market segmentation, in those days, was an increasingly important tool be used for markets in which the company needs to accept that there are divergent needs. Before, firms were accustomed to strive in production for standardization and mass production.As Wendell R. Smith writes: “Segmentation is based upon the developments on the demand side of the market and represents a rational and more precise adjustment of product and marketing effort to consumer or user requirements. In the language of the economist, segmentation is a disaggregative in its effects and tends to bring about recognition of several demand schedules where only one was recognised before.”

As already discussed before there has been two different developments in marketing thought that has had its effect on the way segmentation is done. First, customers have been seen in increasingly more complex terms that has had the effect that more specific extraordinary needs and characteristics have been seen in customer bases. Second, companies have seen an increasingly urge from the customer side to be involved in the process of “production” to customize their services. These theme is currently referred in the literature as co-production meaning that both customer and provider is involved in the process of production that should result in value co-creation. Both of these developments has resulted in perhaps more fragmented marketing strategies, in which offering differentiation and personalisation is the core idea.

Differentiation and personalization is the antithesis to standardization, which stresses differences in the customer base. Nevertheless, complexity is in most companies a problem, and as 70% of 900 executives claims that excessive complexity causes costs, and also hurting profits. In those terms it is evident that it would be beneficial for companies to serve universal needs rather than fragment themselves into a range of needs that varies between different customers. Numerous publications, however, claim that differences between people are becoming larger, which in the final analysis requires the company to adapt to these differences. The market appears fragmented, especially if use customer as the unit of analysis, and basis for segmentation of the market. According to practice theory, people form their identities, needs and wants in practice. While people move between different practices, they appear from a company perspective very hard to understand, almost schizophrenic as they can change their views depending on what they are in the process of doing. Another problematic feature with most market segmentation is that they aim for a description of customers in a non-contextual manner. Customers are in that way presented on a general level as being of certain nature. Such descriptions may not be possible to do.

The fragmentation and contextual nature of customer behavior makes market segmentation rather difficult overall as a starting point for business development. One could, however, argue that difficulties with customer segmentation is not a “real problem”, but mere a problem of perspective. As discussed in this blog, being customer focused may be problem in contemporary society, but there are opportunities to see consumption, and segment markets in more stable and understandable ways. The way to approach to this is to simply de-emphasize the fragmented nature of customers, and turn the view on the market to more universal nominators that would help the company to focused on those issues that can constitute in practical terms a market for the company.


At 4:05 PM, Anonymous Anonymous said...

Fragmentation is a problem if it causes divergence. I have written about this in my soon to be published book (Storbacka (2006): Driving Growth with Customer Asset Management, WSOY Pro, Helsinki).
Customers are different and thus success in the markets requires that a company differentiates its own activities in order to create offerings suitable for various customer needs. Differentiation may, however, be dangerous for the company’s cost position. Differentiation of business models can cause uncontrolled divergence. Divergence holds many connotations, but in this context it means that there is uncontrolled variation in all internal processes. This kind of uncontrolled divergence is created when people are forced to come up with their own ways of solving their customers’ problems on an ad hoc basis, as the situations occur. This creates an “ad hoc mentality“ in which processes are not harmonized or consistent, but instead the processes are always unique, depending on the persons carrying them out.

Process divergence should not be confused with complexity. Many production processes are highly complex these days, but they do not include unintentional divergence. For example, when a customer goes into a car dealership to purchase a new BMW, she or he does not find a car ready in the shop but instead defines the soon-to-be purchased vehicle by choosing from various alternatives of colours, interiors, motors, etc. When the customer has chosen the best combination to suit her/his specific needs, the car becomes a unique product: the customer receives a mass-tailored product. Producing these mass-tailored cars is naturally complex, but the process does not contain unintentional or unnecessary divergence. A divergent process would mean that the customers could walk into a shop and suggest that they would prefer a vehicle with the steering wheel located in the middle, while the engine could be moved from the front to the back, for example.

The problem with divergence is that its relation to the total cost of delivery is exponential. Too much divergence may lead to an unattractive cost position.

One of the central goals in defining business models is to avoid redundant divergence. The more specifically defined the processes are, the lesser the risk that they contain pointless divergence.

The basic idea of differentiation is to better adapt to customer needs. The basis for this aspiration is the notion that the better a company is at providing benefits, which the customers’ genuinely appreciate, the more likely it is for the customer to be willing to pay more for the product or service. Differentiation (even though it adds divergence) is always advantageous, providing that the price benefits of the differentiation outweigh the costs of the divergence.

The price benefits of differentiation decrease as the level of divergence grows. It would be advantageous for a company to be able to identify the optimum level between the price benefits brought forth by differentiation and the costs caused by divergence and, as a consequence, maximise profits.

Differentiation and its impact on profits have not been studied extensively. One study that included the analyses of how 50 large European and American companies tailored their offerings to meet customer needs, showed that there was a 2:1 difference between the economic performance of ”intelligent” and ”normal” differentiators . Also, two thirds of the companies that had a tailoring program were not successful in their attempts to increase their turnover or revenues. For the most part, the tailoring attempts seemed to be prime examples of too much divergence: tailoring without intelligence shifts the attention of sales and marketing from the genuinely valuable offerings and profitable customers, thus causing vast costs with no profits to match.

How to avoid these pitfalls? Companies must succeed in three things to mould the differentiation cost benefit curve to its liking.

First, companies must understand how differentiation creates value to not only the customer, but to the company itself as well. Companies recurrently aspire to set themselves apart from competition and create value by adding differentiation/tailoring and specifying their segmenting. Doing this will generate greater profits – to a certain point. Problems arise if competitors decide to go into an arms race in tailoring: in these cases the ever-growing costs of tailoring start affecting the margins of the products and services. Companies must, in fact, try to maximise their profits by comparing the potential of their chosen customer portfolios to the cost effect of tailoring.

Second, companies must concentrate on controlling or managing divergence. Instead of pointlessly adding the amount of tailoring, a company should create differentiation concepts, built on modularized offerings. Gaining an in-depth understanding of the needs of different customer segments helps companies create offerings, which increase customer share and deepen strategic customer relationships, without endangering the economies of scale.

Third, companies should control the costs differentiation causes - they should strive to create value with the lowest possible costs. This can be achieved by focusing on building business models for the most important customer segments, and by crafting key processes, in order to efficiently fulfil customer needs whilst simultaneously decreasing total costs.


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