According to Michael E. Porter, market and industry segmentation is an important part of firms’ competitive strategies. This technique is often used by companies who are trying to expand their market share and increase revenue. Interestingly, Stephen Carter, the author of L4M2 study guide, thinks that professional buyers can use the same technique to manage the supply market. However, not many purchasers grip this technique well. In this post, we introduce and explain the fundamentals of segmentation technique and how buyer can apply it to analyse the supply market.
Why does a company need segmentation?
Within an industry, it is very rare that all companies sell absolutely homogenous products and services, except some commodity markets. Usually, they often compete each other by selling different products which serve the same basic purposes. Such differences can create sub-industries within an industry. For example, mobile phone industry is very lucrative market with huge demands which attract a lot of manufacturers. Basically, the main purpose of a phone is communication (making calls and sending/receiving the text messages). Today many customers expect more than that. They may want a phone with high-resolution camera or durable battery or high-specification to play games smoothly. Each of these features can create a segment within the mobile industry. A competitor within a segment may increase the market share and threaten other broadly-targeted competing companies.
Since segmentation has strategic implications, a company should understand it to identify dissatisfied niche market or prevent competitors from accessing lucrative segments.
How to identify a segment within an industry
An industry is an market with many similar or closely-related products which are sold to a set of buyers. It can be illustrated by a graph with 2 axes: product varieties and buyers.
The way to produce and distribute a product/service variety may differ from producing and distributing the other varieties, thus each product variety may have distinctive value chain though they have the same purpose. For example, the value chain of tailor-made clothes is very different from of large-scale clothing industry. While the former requires producer to know about customer’s specific size, model and favourite colour, the latter inclines to standarisation and economies of scale.
Similarly, the way to satisfy a group of buyers may also differ from satisfying the other group.
Second, segments grow out of both differences in buyer behavior as well as differences in the economics of supplying different products or buyers. Simply speaking, an industry segment is formed if it meets at least one of the following conditions:
- The five forces that shape segment competitiveness is different from other segment’s. For example, producing high-quality products require different materials from different suppliers who have different level of bargaining power in compare with suppliers of low-cost materials.
- The value chain of producing a product variety or delivering a service or serving a group of buyer is distinctive from the rest within an industry.
Third, industry segments are rarely static. Innovation or buyer’s taste can shift the segment structure within an industry. The strategies should be flexible enough to adapt to changing industry.
Being able to identify segments is not enough for creating strategies. To set up strategies, a company must know how many segments there are within an industry and plan for each niche accordingly.
To segment anything, you must have variables. An industry is no difference. As we know so far, there are two axes defining an industry. So to segment the industry, we have to divide each axis based on some variables.
With product variety axis, the attributes of product itself can be variables. You can segment an industry by product size, or durability, or other additional features, or input used, etc.
With buyer axis, the variables are more diverse. It can come from buyer type (government, commercial, individual or house hold); or buyer demography (race, age, religion, income,…); or geographic area (local, national, international).
A company can segment their market by either product variety or buyers or both. For example, to analyse the cosmetic market, a manufacturer can segment by product price levels: low cost, medium, high end.
To a beer brewery, the segmentation can be a little bit more complicated. The brewery offers a range of beverages: draft beer, canned beer, zero-alcohol, etc. Each of these products aims at different buyer group: the brewery sells the canned beer through distributors before it reaches the consumers. The brewery also sells the draft beer to local bars, pubs, hotels and restaurants. You can see in this scenario, the brewery company segments the market by both product varieties and buyers.
How to apply segmentation to analyse the supply market
In my opinion, L4M2 study guide suggests a creative and interesting way to analyse the supply market. Buyers may use this segmentation technique to shape and manage their sourcing market.
If a procurement professional can segment the supply market, she will be able to estimate the number of available suppliers in the market, model their cost base and make plan accordingly. Does the organisation need to open a complex tendering procedure or go straight to negotiate with supplier? How will the negotiation be going? These questions can be answered easily if the procurement team segments and manages supply market appropriately.
On product variety axis, procurement professionals may purchase hundreds, or even thousands of product/service varieties on behalf of their organisation. Each product variety can be used as a variable for segmentation. Procurement professionals must know very well about attributes of product/service that they buy. This knowledge can be learned from specification writing, from other internal stakeholders or suppliers. The better you know about product attributes, the better you can segment the market.
On buyer axis, usually procurement professionals work for a commercial or government entity, then the only segment they need to focus is institutional type. However, if you are joining a board discussing the company’s competitive strategy, knowledge over other buyer group will be really helpful.
- Porter, Michael E.. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press. Kindle Edition.