Homburg & Partner Q&A: Customer segmentation

Why is customer segmentation important for private equity investing?

Lüring: Private equity firms are strongly focused on growth and profitability but from my experience they sometimes forget about market orientation and focus more on cost reduction. But the market side is equally important and a customer segmentation is an important piece to successfully approach the target markets. Therefore private equity firms should make sure that the most important part for growth – the customer – becomes approached optimally.

Why do companies struggle to carry out thorough customer analysis? What are the biggest challenges?

Lüring: From our experience, the main challenge is that after a private equity investment, portfolio companies tend to lean back slightly and lose their focus on marketing activities.

The marketing and sales function is crucial for properly focusing on the market. There are some decisive factors that everyone should be able to answer, such as: which customers offer the biggest potential and should therefore be prioritised? What is the percentage of customers growing faster than the market? What is the actual net profitability that can be earned through the customer? From our experience it is very important in terms of customer allocation to be able to focus on these questions. And to enable portfolio companies to be stronger on growth and focus on the right customers.

One challenge is that portfolio companies often struggle to explore such information. The best way to gather needed information is to ask the customer directly. From our experience, when interviewing and then segmenting customers,  those businesses turn out to have a better customer performance and subsequently better profitability growth.

From working with various private equity companies we believe that it is very important that consumer-facing portfolio businesses really go into the market and speak with their customers and finally develop a suitable customer segmentation to individually approach different types of customers.

What are the different methods used for customer segmentation?

Staudt: Basically, you can divide these methods into two different groups. The first is one-dimensional and the second is multi-dimensional. The one-dimensional approach only focus on one item, such as turnover, profitability or growth. The idea behind the multi-dimensional methods is to combine quantitative criteria, such as growth or profitability, with qualitative elements, such as customer needs and perceptions. If you really want to approach a customer with a good value proposition you need to know and understand their needs.

Through systematic customer interviews, you can explore their needs as well as further elements such as expectations, perceptions or purchasing structures. Dominant descriptive items can then be used to build segments and to develop tailored value propositions. Also, identified segments can be evaluated based on attractiveness and ability to win, enabling a focus on economically efficient customers. Approaching customers in individual clusters is therefore much more effective and cost-efficient for the company's approach to its markets.

How does a need-based customer segmentation help private equity and why? Does it suit limited investment periods?

Lüring: The customer segmentation helps the portfolio company itself in the first instance. Second, it helps private equity because buyout firms invest with the objective of growth – investors want to boost profitability, turnover and market share. Overall, growth and profitability are the main drivers behind customer segmentation. If private equity firms really want to implement growth, they need to focus on the markets the portfolio company is operating in, which requires good customer segmentation, good market knowledge and good customer orientation.

With regards to timing, we carry out commercial due diligence on the portfolio company prior to investing, where we always include a customer analysis and interviews that can be used for goals like a customer segmentation. Then we recommend repeating the customer analysis two or three years after the investment, so that within the investment period a minimum of two analyses have been done. This ensures a permanent customer orientation, and adaptation and flexibility become possible.

What are the key factors that help companies ensure suitable customer segmentation and therefore a successful market focus?

Staudt: From our experience there are three major success factors. The first is efficient implementation. This requires that the sales department is being involved in the segmentation – all experiences from the sales department should be integrated into customer segmentation.

The second factor is what we call the practicality of the results. While it is nice to have management charts with bubbles showing needs, attractiveness and growth potential, insights must be provided to the portfolio company. This requires the accessibility of contact persons, telephone numbers and company-specific information the sales department can use to approach target segments.

The third factor is the acceptance of this method and the approach by the company. If customer segmentation insights and market approach are not communicated to relevant parts of the business such as the manufacturing or the technical R&D side, an ideal alignment of company activities with market expectations is unlikely to take place.

How can these factors be implemented in practice?

Lüring: From my experience, successfully implementing these factors is best handled by a dedicated manager in the marketing or business development department. That way one person is responsible for communicating the findings and new activities based on customer research, and that person can focus on integrating the different views and opinions into the customer segmentation approach. Furthermore, that dedicated person needs management support.

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