We define a “need” as the potential for a change in consumption. This idea is a little abstract but it captures in completely general terms the elusive starting point for any new venture.
Once an entrepreneur has validated that his/her idea is in fact connected to a real need, the process of selecting a target customer can begin. The choice of target customer is the most important strategic decision. The target customer is the anchor or reference for all the business model decisions: product, pricing, marketing, and distribution.
This is the critical first step in choosing a target customer. The choice is actually of a customer segment, so in order to have a choice one must first have segments.
Segmentation begins with the observation that there are relevant differences among prospective customers. Some differences may be obvious: consumers may be tall or short, young or old, educated or not, rich or poor, etc. But obvious differences may not be relevant to the entrepreneur’s business idea.
Relevant differences are attributes that determine purchase and use.
Relevant differences are differences in:
· The specific nature of the need (i.e. in the details),
· The severity of the perceived need,
· How a solution will be implemented or used,
· The context or environment of use,
· The perceived value of a solution,
· The buying decision and who influences it,
· Willingness to experiment and willingness to forgive early missteps,
· Available alternatives.
The entrepreneur notices these differences through deep engagement with potential customers.
The important next step is to correlate relevant differences with observable attributes. Observable attributes are, in the case of consumers, things like demographics, interests, activities. In the case of organizations, observable differences are things like size, mission, activities, location. Correlating the relevant differences (or attributes) with observable attributes is essential because the details of the need and how the entrepreneur’s product will be evaluated and used are still in the future. The entrepreneur needs a way of identifying the customers in various segments so they can be targeted by marketing and sales efforts. Moreover, identifying the potential customers is the basis of sizing the market.
Observable attributes allow customers to be identified and counted.
Personas are a useful device for describing the important features of a segment. A persona captures the important characteristics of a segment in the form of an actual or hypothetical person. A helpful description of the process of constructing personas can be found at https://www.usability.gov/how-to-and-tools/methods/personas.html.
The steps involved in market segmentation can be summarized in the following diagram.
Steps in the market segmentation process
With a segmentation in hand, the entrepreneurs can consider which segment to address first. Entrepreneurs generally face a severe resource constraint. Their objective should almost always be to getting paying customers as quickly and for as little capital as possible. This is usually the primary consideration in deciding which segment to target first.
To choose the initial segment, the entrepreneur must consider three factors.
1. Severity of the need for a particular customer set: This factor will relate directly to the value that the customers will derive from the new venture’s product, hence should relate to willingness to pay. In addition, when the need is great, the customer will be more inclined to accept a less than perfect solution and be more tolerant of the shortcomings of the product or the company.
2. The cost to the company to create and deliver a solution: Here the entrepreneur considers first the cost to produce a solution — usually engineering and possibly operations expenses. Then the entrepreneur must consider the cost to create awareness, generate demand, and fulfill that demand — this is the cost of acquiring a customer. The entrepreneur must think comprehensively about all the costs associated with a particular market segment.
We can lay out these first two factors on a simple graph.
The two primary dimensions for comparing market segments
In this simplified example, segment C seems to be the obvious choice to be the new venture’s initial target. For relatively low cost, the company can deliver a solution of high value to this customer set. This should translate into faster adoption. Segment A can be addressed for the same cost, but the lower value to the customer indicates that adoption will be both slower and lower. Segment B represents equally high value, but the time and capital to capture this market are much higher.
The third factor is the size of the market opportunity represented by each customer segment.
3. Segment size: If a particular segment demonstrates high need that can be addressed at low cost (i.e., upper left on the graph), the entrepreneur must still be confident that either this segment is large enough to justify the investment or represents a starting point from which to address other market segments.