Customer Segmentation

Why customer segmentation? People with similar attributes tend to display similar patterns in various ways. This fact is particularly important in customer relationship management, marketing, and risk management. For example, people with certain life-styles tend to buy certain-types of products. Promoting products particularly targeted towards the demographic group can lead to successful marketing. In credit and insurance industry, good customer segmentation can lead to minimum exposure to risk involved in credits and insurances. Similarly, in catalog sales, customers can be selectively targeted to reduce marketing cost. Customer segmentation can be used in various ways. Note that customer segmentation is a very important tool for customer lifecycle management - CLM.

Technically speaking, customer segmentation is a process that divides customers into smaller groups called segments. Segments are to be homogeneous within and desirably heterogeneous in between. In another words, customers of the same segments possess the same or similar set of attributes. But customers of different segments have differing sets of attributes. Segmentation process can be very complicated. Therefore, it's best to use advanced analytic tools.

What information is used in customer segmentation?

Segmentation is normally performed along with the following demographic, geographic, psychographic, and behavioral variables;

  • Demographic segmentation variables describe characteristics of customers and include age, gender, race, education, occupation, income, religion, marital status, family size, children, home ownership, socioeconomic status, and so on. Note that demographic segmentation normally refers to segmentation with these demographic variables.
  • Geographic variables include various classification of geographic areas, for example, zip code, state, country, region, climate, population, and other geographical census data. Note that this information can come from national census data. For more, see geographic segmentation.
  • Psychographic segmentation variables describe life style, personality, values, attitudes, and so on. Note that psychographic segmentation normally refers to segmentation with these psychographic variables.
  • Behavioral segmentation variables include product usage rate and end, brand royalty, benefit sought, decision making units, ready-to-buy stage, and so on.
  • Past business history, Customers' past business track records can be extremely useful for segmentation. This may include total amounts purchased, purchasing frequency, (credit) default records, (insurance) claims, responsiveness for marketing campaigns, and so on.

What is your motivation for Customer Segmentation?

This is very important since there are many ways you can segment customers. Without clearly defined motivation, no clear segmentation objectives. Segmentation is meaningless. You need to have clearly defined motivation and objectives to achieve. For example, to optimize profits for campaign marketing, or to monitor customer or market trends, or to manage customer loyalty programs, or to use for customer lifecycle management, and so on. Depending on your motivation, different segmentation techniques are employed. Note that CMSR Data Mining Software provides several segmentation and segment monitoring tools such as decision tree, neural clustering, etc.

Customer Segmentation for Trend Analysis and Forecasting

Timely identification of newly emerging trends is very important to businesses. For example, sales patterns of various customer segments indicate market trends. Upward and downward trends in sales signify new market trends. The same can be applied to loans, mortgages, credits, and so on. Trend analysis and forecasting over well-designed customer segmentation is a powerful tool for monitoring and detecting newly emerging trends. For more, please read Trend Analysis and Forecasting.

market segmentation and trend analysis.

Customer segmentation using Neural Clustering (SOM)

Neural clustering segments customers MxN cells in such a way that customers with similar attributes are clustered together in a cell or nearby cells. In the left figure, colored circles are pie charts representing distribution for combination of gender and race. Notice that all cells contain objects of the same single type. Furthermore, nearby cells of the same type objects are clustered together. An example of perfect clustering! The middle figure shows histograms for a numerical variable. You will notice that nearby cells have similar distributions. The right is all-in-one distribution charts for a specific cell segment.

Segmentation cluster analysis. Clustering segment analysis. Cell segment analysis.

The following figure shows an example of 6x6 neural clustering. Customers are clustered using 6x6 cells. Each cell contains customers with similar attributes. Cells show pie charts where green pies represent customer proportions who bought products before (or customers churned if it's churn management, etc.). There are two cells containing green proportions. Now customer care can be focused on those customers of the greeny cells, ignoring customers in other cells.

customer segmentation example.

For information about Neural Clustering, please read Data Mining Software. Software download is available from the page.

Customer segmentation using Decision Tree

Decision tree divides populations into smaller segments repeatedly. At a node, it selects a single variable in such a way that segmentation boosts proportions of the largest categorical value in each resulting segment. There are many applications that this type of hierarchical segmentation is useful, especially for direct marketing and customer targeting. The following figure shows CMSR decision tree;

decision tree customer segmentation
Marketing Response Analysis with Gains & Profit Charts

Breakdown of populations into smaller segments induces segments having concentration of certain values. This provides means for cost-effective customer selection methods. For example, for catalog marketing, segments can be visualized with a special response and profit gains chart as shown at the right figure. The blue curve indicates response capture ratios. The green curve shows quantity (or volume) capture ratios. Similarly, the red curve describes profit and loss amounts. Steep rising curves at the left end are a good indication of good segmentation, since selecting a small number of left-end customer segments can capture most potential responses. This will lead to a small number of catalog mailings, and therefore result in efficient marketing campaigns. For more, read Direct Mail Catalog Marketing.

decision tree customer segmentation. Gains chart for Response Modeling.

For information about Decision Tree, please read Data Mining Software. Software download is available from the page.


Handbook of Database Marketing
If you are interested in methods described in this page, please register from here. We will send you free "Handbook of Database Marketing". It describes the procedures described here such as customer profiling, customer segmentation, targeted marketing customer selection, RFM segmentation marketing, cross-sell marketing, customer churn detection modeling, gains and profit analysis, data preparation, and more. If you are interested, please register from here.