In the current economic scenario, it is a tragedy that the sophisticated technology that businesses have invested in is not being used profitably.

In a survey of Massachusetts technology companies by The Gantry Group and Collaborative Insight, a clear majority indicated return on investment (ROI) as the most important step in combating any downturn in their businesses. These technology and service providers emphasize basic management approaches, including cash-flow management, revenue growth and profitability. To accomplish these objectives, a large number reported that among the technologies they would employ is better market segmentation.

The question, therefore, is how can segmentation produce a higher ROI? Furthermore, how can this ROI from segmentation be measured?

A company segments its customers to invest in the "right" customers to maximize ROI. Every catalog that is sent, every sales call, every contact made by a company to its customers represents an investment. The "right" customer is the one producing a respectable return.

Identifying the "right" customer and retaining that customer is customer relationship management's reason for being. Yet, in a study by Jupiter Research, only 17 percent of companies which have implemented customer relationship management (CRM) applications use modules for customer analytics. Furthermore, this study of 404 IT and marketing executives showed that only seven percent of those who planned to increase spending on CRM technology would use any of those dollars on profiling and targeting customers.

Certain measurements are required to determine how effectively one is organizing marketing around segments. One such measurement classifies each customer into a particular segment. Another measurement is the cost associated with marketing to that customer; and a last measurement quantifies the dollars generated by that customer.

Classifying Customers: Imprecise measurement is the biggest problem in classifying target markets and segments. The usual definition of a target market is encapsulated in one or two demographic variables, such as women age 18 to 34. Using this example, however, is it more important that the person be female or age 18 to 34? If it is twice as important to be female, then a certain number of females in other age groups may be just as qualified.

The best way to classify people into segments is using weighted scores which adjust measurements according to their importance. In such a case, a customer would be classified more accurately because, using our example, the criterion for female would be twice as important as that for age. Furthermore, using the analytic components found in many CRM systems, other classifying variables could be used to refine the classification's accuracy.

Measuring Profitability: Probably no business activity is more important and more difficult than measuring how profitable it is to do business with each customer. In my experience, managers have a much more accurate view of profitability at the product level than at the customer level. Because this measurement is so difficult, many managers do not even attempt to make an estimate.

The preferred approach is to calculate lifetime value (LTV) for each customer. This calculation requires estimation of return for each customer across the number of years this customer is expected to remain loyal to the enterprise. Without analysis of expected retention and customer value, there is no possibility of accurately determining ROI for CRM systems.

Measuring ROI: One should examine customers by both current and future profitability. If one has classified customers accurately and estimated a return from each, then determining which segments currently contribute the most profitability is straightforward. One simply looks at the estimated profitability by segment and perhaps product by segment.

Future ROI of marketing to a segment is a little more difficult to calculate. Questions need to be asked to determine the size of each segment, the likelihood that members of the segment will respond to campaign offers and how profitable each transaction will be.

The classic approach to determining the answers to these questions in a campaign is by test marketing. One makes an offer to two groups. One group could be a random selection of customers serving as a control group; the other would be a carefully chosen set from the target segment. After making the offer to both groups, the results are measured. If the customers have been correctly classified and the product accurately positioned for that segment, the test group should yield a significantly higher prediction of profitability over the control group.

Having sophisticated computer and segmentation systems in place does not guarantee profitability. Achieving segmentation's best results requires the use of analytic systems built into the better CRM systems. If management would invest in hiring and training personnel to use many of the software processes they already own, their marketing efforts would be more precise ­– and more profitable.

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