industrial mkt segmentation

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How to segmentindustrial

markets

With a nested approach,managers can determinethe bestsegmentation method

Benson P. Shapiro andThomas VBonoma

Industrial marketers canhardly be blamed for feel-ing that segmentation isvery difficult for them. Notonly has little been writtenon the subject as it affectsindustrial markets, butsuch analysis is also morecomplex than for con-sumer markets. The prob-lem is to identify the bestvariables for segmentingindustrial markets. Theauthors present here a"nested" approach toindustrial market segmen-tation. Separated accord-ing to the amount ofinvestigation required toidentify and evaluate dif-ferent criteria, the layersare arranged to begin withdemographics as the areaeasiest to assess. Thencome increasingly com-plex criteria, includingcompany variables, situa-tional factors, and per-sonal characteristics. Theauthors warn, however,that a nested approachcannot be applied in cook-book fashion but rathermust be adapted to indi-vidual situations andcircumstances.

Mr Shapiro and Mr.Bonoma teach marketingat the Harvard BusinessSchool. Each has written orcoauthored several pre-vious articles for HBR.This article is based ontheir book, published in1983, Segmenting theIndustrial Market (Lexing-ton Books). The researchfor this project was sup-ported by the MarketingScience Institute and theAssociates of the HarvardBusiness School.

As difficult as segmenting consumermarkets is, it is much simpler and easier than seg-menting industrial markets. Often the same industrialproducts have multiple applications; likewise, severaldifferent products can be used in the same application.Customers differ greatly and it is hard to discern whichdifferences are important and which are trivial fordeveloping a marketing strategy.

Little research has heen done on indus-trial market segmentation. None of the ten articles inthe fournal of Marketing Research's special August1978 section, "Market Segmentation Research," forinstance, deals with industrial market segmentation inmore than a passing manner. Our research indicatesthat most industrial marketers use segmentation as away to explain results rather than as a way to plan.

In fact, industrial segmentation canassist companies in several areas:

Analysis of the market. Better under-standing of the total marketplace, including how andwhy customers buy.

Selection of key markets. Rationalchoice of market segments that best fit the company'scapabilities.

Management of marketing. The devel-opment of strategies, plans, and programs to profitablymeet the needs of different market segments and togive the company a distinct competitive advantage.

In this article we integrate and build onprevious schemes for segmenting industrial marketsand offer a new approach that enables not only thesimple grouping of customers and prospects, but alsomore complex grouping of purchase situations, events,and personalities. It thus serves as an important newanalytical tool.

Consider the dilemma of one skilledand able industrial marketer who observed recently:

Industrial market segmentation 105

"I can't see any basis on which to segment my market.We have 15% of the market for our type of plasticsfabrication equipment. There are 11 competitors whoserve a large and diverse set of customers, but there isno unifying theme to our customer set or to anyoneelse's."

His frustration is understandable, but heshould not give up, for at least he knows that 15% ofthe market purchases one product and that knowledge,in itself, is a basis for segmentation. Segments exist,even when the only apparent hasis for differentiation isbrand choice.

At other times, a marketer may be baf-fled by a profusion of segmentation criteria. Customergroups and even individual customers within thesegroups may differ in demographics (including industryand company size), operating differences (productiontechnology is an example), purchasing organization,"culture," and personal characteristics. Usually, amarketer can group customers, prospects, and purchasesituations in different ways depending on the variablesused to segment the market. The problem is to identifyrelevant segmentation bases.

We have identified five general segmen-tation criteria, which we have arranged as a nestedhierarchy-like a set of boxes that fit one into the otheror a set of wooden Russian dolls. Moving from theouter nest toward the inner, these criteria are: demo-graphics, operating variables, customer purchasingapproaches, situational factors, and personal character-istics of the buyers.

Exhibit I shows how the criteria relateto one another as nests. The segmentation criteria ofthe largest, outermost nest are demographics - general,easily observable characteristics about industries andcompanies; those of the smallest, inmost nest are per-sonal characteristics-specific, subtle, hard-to-assesstraits. The marketer moves from the more general, eas-ily observable segmentation characteristics to themore specific, subtle ones. This approach will becomeclearer as we explain each criterion.

We should note at this point that it maynot be necessary or even desirable for every industrialmarketer to use every stage of the nested approach forevery product. Although it is possible to skip irrelevantcriteria, it is important that the marketer completelyunderstand the approach before deciding on omissionsand shortcuts.

Exhibit I Nested approach

Demographics

We begin with the outermost nest,which contains the most general segmentation crite-

ria, demographics. These variables give a broad descrip-tion of the company and relate to general customerneeds and usage patterns. They can be determinedwithout visiting the customer and include industryand company size, and customer location.

The industry. Knowledge of the industryaffords a broad understanding of customer needs andperceptions of purchase situations. Some companies,such as those selling paper, office equipment, business-oriented computers, and financial services, market to awide range of industries. For these, industry is animportant basis for market segmentation. Hospitals,for example, share some computer needs and yet differmarkedly as a customer group from retail stores.

Marketers may wish to subdivide indi-vidual industries. For example, although financial ser-vices are in a sense a single industry, commercialbanks, insurance companies, stockbrokerage houses,and savings and loan associations all differ dramati-cally. Their differences in terms of product and serviceneeds, such as specialized peripherals and terminals,data handling, and software requirements make a moredetailed segmentation scheme necessary to sell com-puters to the financial services market.

Company size. The fact that largecompanies justify and require specialized programsaffects market segmentation. It may be, for example,that a small supplier of industrial chemicals, after seg-menting its prospective customers on the basis of com-pany size, will choose not to approach large companieswhose volume requirements exceed its own produc-tion capacity.

106 Harvard Business Review May-June 1984

Customer location. The third demo-graphic factor, location, is an important variable indecisions related to deployment and organization ofsales staff. A manufacturer of heavy-duty pumps forthe petrochemical industry, for example, would wantto provide good coverage in the Gulf Coast, where cus-tomers are concentrated, while putting little effort intoNew England. Customer location is especially impor-tant when proximity is a requirement for doing husi-ness, as in marketing products of low value-per-unit-weight or volume (corrugated boxes or prestressedconcrete), or in situations where personal service isessential, as in job shop printing.

As noted, a marketer can determine allof these demographic variables easily. Industry-orientedand general directories are useful in developing lists ofcustomers in terms of industry, size, and location. Gov-emment statistics, reports by market research compa-nies, and industry and trade association publicationsprovide a great deal of demographic data.

Many companies base their industrialmarketing segmentation approach on demographicdata alone. But while demographics are useful and eas-ily obtained, they do not exhaust the possibilities ofsegmentation. They are often only a beginning.

Operating variables

The second segmentation nest containsa variety of segmentation criteria called "operatingvariables." Most of these enable more precise identifi-cation of existing and potential customers withindemographic categories. Operating variables are gener-ally stable and include technology, user-nonuser status(by product and brand), and customer capabilities(operating, technical, and financial).

Company technology. A company'stechnology, involving either its manufacturing processor its product, goes a long way toward determining itsbuying needs. Soda ash, for example, can be producedby two methods that require different capital equip-ment and supplies. The production of Japanese colortelevisions is highly automated and uses a few, largeintegrated circuits. In the United States, on the otherhand, color TV production once involved many dis-crete components, manual assembly, and fine tuning.In Europe, production techniques made use of a hybridof integrated circuits and discrete components. The

1 See E. Raymond Corey,"Should CompaniesCentralize Procurement?"HBR November-December 1978, p. 102.

technology used affects companies' requirements fortest gear, tooling, and components and thus, a market-er's most appropriate marketing approach.

Product and brand-use status. One ofthe easiest ways, and in some situations the only obvi-ous way, to segment a market is by product and branduse. Users of a particular product or brand generallyhave some characteristics in common; at the veryleast, they have a common experience with a productor brand.

Manufacturers who replace metal gearswith nylon gears in capital equipment probably shareperceptions of risk, manufacturing process or coststructure, or marketing strategy. They probably haveexperienced similar sales presentations. Having usednylon gears, they share common experiences includ-ing, perhaps, similar changes in manufacturingapproaches.

One supplier of nylon gears might arguethat companies that have already committed them-selves to replace metal gears with nylon gears are bet-ter customer prospects than those that have not yetdone so, since it is usually easier to generate demandfor a new brand than for a new product. But anothersupplier might reason that manufacturers that havenot yet shifted to nylon are better prospects becausethey have not experienced its benefits and have notdeveloped a working relationship with a supplier. Athird marketer might choose to approach both usersand nonusers with different strategies.

Current customers are a different seg-ment from prospective customers using a similarproduct purchased elsewhere. Current customers arefamiliar with a company's product and service andcompany managers know something about customerneeds and purchasing approaches. Some companies'marketing approaches focus on increasing sales vol-ume from existing customers, via either customergrowth or gaining a larger share of the customer's busi-ness, rather than on additional sales volume from newcustomers. In these cases, industrial sales managersoften follow a two-step process: first, they seek to gainan initial order on trial and then, to increase the shareof the customer's purchases. Banks are often morecommitted to raising the share of major customers'business than to generating new accounts.

Sometimes it is useful to segment cus-tomers not only on the basis of whether they huy fromthe company or from its competitors, but also, in thelatter case, on the identity of competitors. This infor-mation can be useful in several ways. Sellers may findit easier to lure customers from-competitors that areweak in certain respects. When Bethlehem Steelopened its state-of-the-art Bums Harbor plant in theChicago area, for example, it went after the customersof one local competitor known to offer poor quality.


Customer capabilities. Marketers mightfind companies with known operating, technical, orfinancial strengths and weaknesses to be an attractivemarket. For example, a company operating with tightmaterials inventories would greatly appreciate a sup-plier with a reliable delivery record. And customersunable to perform quality-control tests on incomingmaterials might be willing to pay for supplier qualitychecks. Some raw materials suppliers might choose todevelop a thriving business among less sophisticatedcompanies, for which lower-than-usual average dis-counts well compensate added services.

Technically weak customers in thechemical industry have traditionally depended on sup-pliers for formulation assistance and technical sup-port. Some suppliers have been astute in identifyingcustomers needing such support and in providing it ina highly effective manner.

Technical strength can also differentiatecustomers. Digital Equipment Corporation for manyyears specialized in selling its minicomputers to cus-tomers able to develop their own software, and PrimeComputer sells computer systems to business userswho do not need the intensive support and "hand hold-ing" offered by IBM and other manufacturers. Bothcompanies use segmentation for market selection.

Many operating variables are easilyresearched. In a quick drive around a soda ash plant, forexample, a vendor might be able to identify the type oftechnology being used. Data on financial strength is atleast partially available from credit-rating services.Customer personnel may provide other data, such asthe name of current suppliers; "reverse engineering"(tearing down or disassembly) of a product may yieldinformation on the type and even the producers ofcomponents, as may merely noting the names on de-livery trucks entering the prospect's premises.

Purchasing approaches

One of the most neglected hut valuahlemethods of segmenting an industrial market involvesconsumers' purchasing approaches and companyphilosophy. The factors in this middle segmentationnest include the formal organization of the purchasingfunction, the power structure, the nature of huyer-seller relationships, the general purchasing policies,and the purchasing criteria.

Purchasing function organization. Theorganization of the purchasing function to some extentdetermines the size and operation of a company's pur-chasing unit. A centralized approach may merge indi-

vidual purchasing units into a single group, and vendorswith decentralized manufacturing operations may findit difficult to meet centralized buying patterns.' Tomeet these differing needs, some suppliers handle salesto centralized purchasers through so-called nationalaccount programs, and those to companies with a de-centralized approach through field-oriented salesforces.

Power structures. These also varywidely among customers. The impact of influentialorganizational units varies and often affects purchas-ing approaches. The powerful financial analysis unitsat General Motors and Ford may, for example, havemade those companies unusually price-oriented intheir purchasing decisions. A company may have apowerful engineering department, for instance, thatstrongly influences purchases; a supplier with strongtechnical skills would suit such a customer. A vendormight find it useful to adapt its marketing program tocustomer strengths, using one approach for customerswith strong engineering operations and another forcustomers lacking these.

Buyer-seller relationships. A supplierprobably has stronger ties with some customers thanothers. The link may be clearly stated. A lawyer, com-mercial banker, or investment banker, for example,might define as an unattractive market segment allcompanies having as a board member the representa-tive of a competitor.

General purchasing policies. A finan-cially strong company that offers a lease programmight want to identify prospective customers who pre-fer to lease capital equipment or who have meticulousasset management. When AT&T could lease but notsell equipment, this was an important segmentationcriterion for it. Customers may prefer to do businesswith long-established companies or with small inde-pendent companies, or may have particularly potentaffirmative action purchasing programs (minority-owned businesses were attracted hy Polaroid's widelypublicized social conscience program, for example). Orthey may prefer to buy systems rather than individualcomponents.

A prospective customer's approach tothe purchasing process is important. Some purchasersrequire an agreement based on supplier cost, particu-larly the auto companies, the U.S. govemment, andthe three large general merchandise chains. SearsRoehuck, Montgomery Ward, and J.C. Penney Otherpurchasers negotiate from a market-based price andsome use bids, Bidding is an important method forobtaining govemment and quasi-government business;but because it emphasizes price, bidding tends to favorsuppliers that, perhaps because of a cost advantage.


prefer to compete on price. Some vendors might viewpurchasers that choose supphers via hidding as desir-able, while others might avoid them.

Purchasing criteria. The power struc-ture, the nature of huyer-seller relationships, and gen-eral purchasing policies all affect purchasing criteria.Benefit segmentation in the consumer goods market isthe process of segmenting a market in terms of the rea-sons why customers buy. It is, in fact, the most insight-ful form of consumer goods segmentation because itdeals directly with customer needs. In the industrialmarket, consideration of the criteria used to make pur-chases and the application for these purchases, whichwe consider later, approximate the benefit segmenta-tion approach.

Situational factors

Up to this point we have focused on thegrouping of customer companies. Now we considerthe role of the purchase situation, even single-lineentries on the order fonn.

Situational factors resemble operatingvariables but are temporary and require a more detailedknowledge of the customer. They include the urgencyof order fulfillment, product application, and the size oforder.

Urgency of order fulfillment. It is worth-while to differentiate between products to be used inroutine replacement or for building a new plant andemergency replacement of existing parts. Some compa-nies have found a degree of urgency useful for marketselection and for developing a focused marketing-manufacturing approach leading to a "hot-order shop"- a factory that can supply small, urgent orders quickly.

A supplier of large-size, heavy-dutystainless steel pipe fittings, for example, defined its pri-mary market as fast-order replacements. A chemicalplant or paper mill needing to replace a fitting quicklyis often willing to pay a premium price for a vendor'sapplication engineering, for flexible manufacturingcapacity, and for installation skills that would beunnecessary in the procurement of routine replace-ment parts.

Product application. The requirementsfor a 5-horsepower motor used in intermittent ser-vice in a refinery will differ from those of a 5-horse-power motor in continuous use. Requirements for anintermittent-service motor would vary depending onwhether its reliability was critical to the operation or

safety of the refinery. Product application can have amajor impact on the purchase process, purchase crite-ria, and thus on the choice of vendor.

Size of order. Market selection can bebased at the level of individual line entries on the orderform. A company with highly automated equipmentmight segment the market so that it can concentrateonly on items with large unit volumes. A nonautomat-ed company, on the other hand, might want only smallquantity, short-run items. Ideally these vendors wouldlike the order split up into long-run and short-runitems. In many industries, such as paper and pipe fit-tings, distributors break up orders in this way.

Marketers can differentiate individualorders in terms of product uses as well as users. Thedistinction is important as users may seek differentsuppliers for the same product under different circum-stances. The pipe-fittings manufacturer that focusedon urgent orders is a good example of a marketingapproach based on these differences.

Situational factors can greatly affectpurchasing approaches. General Motors, for example,makes a distinction between product purchases-thatis, raw materials or components for a product beingproduced-and nonproduct purchases. Urgency oforder fulfillment is so powerful that it can change boththe purchase process and the criteria used. An urgentreplacement is generally purchased on the basis ofavailability, not price.

The interaction between situationalfactors and purchasing approaches is an example ofthe permeability of segmentation nests. Factors in onenest affect those in other nests. Industry criteria, forinstance, an outer-nest demographic description, influ-ence but do not determine application, a middle-nestsituational criterion. The nests are a useful mentalconstruct but not a clean framework of independentunits because in the complex reality of industrial mar-kets, criteria are interrelated.

The nesting approach cannot be appliedin a cookbook fashion but requires, instead, careful,intelligent judgment.

Buyers' personalcharacteristics

People, not companies, make purchasedecisions, although the organizational framework inwhich they work and company policies and needs mayconstrain their choices. Marketers for industrial goods,like those for consumer products, can segment marketsaccording to the individuals involved in a purchase in


Demographics Operating_ . - variablesPurchastngapproach

terms of buyer-seller similarity, buyer motivation, indi-vidual perceptions, and risk-management strategies.

Some buyers are risk averse, others riskreceptive. The level of risk a buyer is willing toassume is related to other personality variables such aspersonal style, intolerance for ambiguity, and self-confidence. The amount of attention a purchasingagent will pay to cost factors depends not only on thedegree of uncertainty about the consequences of thedecision but also on whether credit or blame for thesewill accrue to him or her. Buyers who are risk averseare not good prospects for new products and concepts.Risk-averse buyers also tend to avoid untestedvendors.

Some buyers are meticulous in theirapproach to buying-they shop around, look at a num-ber of vendors, and then split their order to assuredelivery Others rely on old friends and past relation-ships, and seldom make vendor comparisons.^ Compa-nies can segment a market in terms of thesepreferences.

Data on personal characteristics areexpensive and difficult to gather. It is often worthwhileto develop good, formal, sales information systems toensure that salespeople transmit the data they gatherto the marketing department for use in developing seg-mented marketing strategies. One chemical companyattributes part of its sales success to its sales informa-tion system's routine collection of data on buyers.

Such data-gathering efforts are most justified in thecase of customers with large sales potential.

Reassembling the nest

2 For further discussionof ihese, seeThomas V Bonoma,

"Maror Sales:Who Really Does the Buying?"HBRMay-Iunfl982,p.lll,and

Benson P. Shapiro andRonald Posncr,

"Making the Major Sale,"HBR March-April 1976, p. 68.

Marketers are interested in purchasedecisions that depend on company variables, situa-tional factors, and the personal characteristics of thebuyers. The three outer nests, as Exhibit II shows,cover company variables, the fourth inner-middle nest,situational factors, and the inmost nest, personalcharacteristics.

As we move from the outer to the innernests, the segmentation criteria change in terms ofvisibility, permanence, and intimacy. The data in theouter nests are generally highly visible, even to outsid-ers, are more or less permanent, and require littleintimate knowledge of customers. But situationai fac-tors and personal characteristics are less visible, aremore transient, and require extensive vendor research.

An industrial marketing executive canchoose from a wide range of segmentation approachesother than the nested approach and, in fact, the myriadof possibilities often has one of the four followingoutcomes:

n No segmentation. "The problem is toolarge to approach."

n After-the-fact segmentation. "Our mar-ket research shows that we have captured a high shareof the distribution segment and low shares of the


Others; thus we must be doing something right forcustomers in high-share segments."

D Superficial segmentation. "While weknow all banks are different, it's easier to organize mar-keting plans around banks because we can identifythem and tell the salespeople whom to call on." Thisdangerous outcome gives a false sense of security.

Q Obtuse, convoluted, and disorganizedsegmentation. "We have a 300-page report on marketsegmentation and customer buying patterns, but thereis just too much data in there. So we have decided tofocus on insurance companies and hospitals to avoidanother two-day market planning meeting."

Our approach using a hierarchical struc-ture is easy to use. Marketers can, in most cases, worksystematically from the outer nests to the inner nests.They can run through the whole set of criteria andidentify important factors that otherwise might beneglected. And they can balance between reliance onthe easily acquired data of the outer nests and thedetailed analyses of the inner nests.

We suggest that a marketer hegin at theoutside nest and work inward because data are moreavailable and definitions clearer in the outer nests. Onthe other hand, the situational and personal variablesof the inner nests are often the most useful. In our ex-perience, managers most frequently neglect situation-al criteria. In situations where knowledge and analy-sis exist, a marketer might decide to begin at a mid-dle nest and work inward or, less probably, outward.

After several attempts at workingcompletely through the process, companies wili dis-cover which segmentation criteria are likely to yieldgreater benefits than others and which cannot be con-sidered carefully without better data. A warning is nec-essary, however. A company should not decide that anapproach is not useful because data are lacking. Thesegmentation process requires that assessments of ana-lytic promise and data availability be made indepen-dently The two steps should not be confused. Whenthe necessary data are gathered, managers can weighsegmentation approaches.

A fine line exists between minimizingthe cost and difficulty of segmentation by staying inthe outer nests on the one hand and gaining the usefuldata of the inner nests at appreciable direct and indi-rect cost on the other. The outer-nest criteria are gener-ally inadequate when used by themselves in all but themost simple or homogeneous markets because theyignore buying differences among customers. Overem-phasis on the irmer-nest factors, however, can be tooexpensive and time-consuming for small markets. Wesuggest achieving a sense of balance between the sim-plicity and low cost of the outer nests and the richnessand expense of the inner ones by making the choicesexplicit and the process clear and disciplined. ^

Executivedecision making

"Unless we admit that rules of thumb, the limitedexperience of the executives in each individualbusiness, and the general sentiment of the street,are the sole possible guides for executive deci-sions of major importance, It is pertinent to inquirehow the representative practices of businessmengenerally may be made available as a broaderfoundation for such decisions, and how a propertheory of business is to be obtained. The theory ofbusiness, to meet the need, must develop to sucha point that the executive, who will make thenecessary effort, may learn effectively from theexperiences of others in the past what to avoid andhow to act under the conditions of the present.Otherwise, business will continue unsystematic,haphazard, and, for many men, a pathetic gamble,with the failures of each serious business depres-sion made up largely of the best moral risks.

No amount of theory can be a substitute forenergy, enthusiasm, initiative, creative ability, andpersonality, nor will it take the place of technicalknowledge. Now, however, all of these personalqualities may be coupled with an adequate tech-nical equipment, and yet the executive of wideexperience may fail through our inability to graspthe broad underlying forces controlling business,a knowledge of which would give a sound basisfor judgment. It is a serious criticism of our busi-ness structure that it so long lacked an adequatemethod by which these broad forces may beappraised, their probable course charted, andtheir applications to individual executive prob-lems made reasonably clear."

From:"Essential Groundwork (or a Broad Executive Theory"by Wallace B Oonham.Oean,Harvard Business School, HBR Oclotor 1922, p. 1.