There are differences between customers and customer groups (market segments). When a firm serves all its target segments with the same uniform product, it fails to exploit these differences. In addition, because all the segments are served with the same product, segments which incur a higher cost to serve are “buried” due to cost averaging.
Identifying the differences in costs to serve and user needs between segments allows a firm to improve its profitability. Segments with specialized needs (and therefore higher costs to serve) can be served with a product or service more tailored to those needs, extracting a price premium in the process. Segments with particularly high costs to serve and limited volumes can be identified and perhaps dropped from the customer portfolio.
How a firm segments its market is critical to profitability. Standard methods of segmentation, such as grouping customers by industry, may obscure the particular needs of a customer group. If an entire industry is using the same method of segmentation, this problem may be pervasive, leading to unmet or underserved needs. Using a different method of segmentation can open a new window on these needs and provide significant opportunities for differentiation.
“Average” segmentation leads to average costing and average pricing. Profitability is diminished by failing to offset higher costs to serve with a price premium. This is a trap to avoid.