Customer Segmentation Models in Retail

Welcome to the age of personalized retail, where one-size-fits-all is as outdated as last season’s fashion trends.

In today’s hyper-competitive retail landscape, understanding your customers is not just a necessity; it’s the backbone of your business success.

But how do you sift through the sea of data to find actionable insights? Enter Customer Segmentation Models—a game-changing strategy that can transform your generic marketing campaigns into laser-focused, ROI-boosting masterpieces.

In this guide, we’ll dive deep into the art and science of customer segmentation in retail.

We’ll explore various models that can help you categorize your customer base into distinct segments, each with its own needs, behaviors, and preferences.

Whether you’re a retail giant or a small boutique, implementing customer segmentation can elevate your marketing game, optimize your product offerings, and most importantly, enhance customer satisfaction.

So, buckle up as we embark on this journey to unlock the full potential of personalized retailing. Let’s start with a small list of what we’re going to cover.

 5 of the most powerful Ecommerce analyses out there:

1. Cohort analysis
2. Buyer segmentation (aka RFM analysis)
3. Sales + Margin Forecasting
4. Basket analysis
5. Retention & churn modeling

Just like no two customers are alike, every business is unique. That’s simply because of the different needs and requirements you’ll have.

The customer segmentation model you use must reflect those business needs. That way, you gain a deeper understanding of your ideal customers, understand customer behavior, and identify your target audience’s unique needs and preferences.

As a result, you can create tailored, targeted campaigns that address your customers’ requirements and interests. That personalized experience is essential if you want to rise above the competition in the retail industry. And here’s why!

Overview of Retail

Retail is a dynamic, rapidly changing industry that requires you to keep up with trends to stay competitive. Identifying and leveraging trends starts with tracking and understanding preferences and consumer behavior.

If you’re running an online store in the retail sector, you need to shape a quality, personalized digital experience. Your website is a digital storefront. Yes, there’s little to no human interaction while shopping online. But you can’t treat customers as numbers if you want your business to grow.

That’s where customer segmentation plays a significant role. It:

• Boosts customer satisfaction through improved overall service;
• Enhances customer loyalty by informing a personalized experience;
• Increases customer lifetime value and marketing ROI through more relevant offers;
• Promotes customer engagement and helps the business grow organically.

Below, find the different customer segmentation models you must consider for your business today!

You can use those analyses for user segmentation, which will help you with targeted marketing. Here are some of the most common models:

1. Demographic Segmentation: Age, gender, income, etc. Great for basic targeting but can be a bit broad.
2. Geographic Segmentation: Location-based targeting, useful for local promotions or shipping offers.
3. Behavioral Segmentation: Based on actions like past purchases, cart abandonment, and site interactions. Super useful for personalized marketing.
4. Psychographic Segmentation: Focuses on lifestyle, values, and interests. Think eco-friendly products for sustainability enthusiasts.
5. RFM (Recency, Frequency, Monetary) Model: Segments customers based on how recently they’ve purchased, how often, and how much they’ve spent. Great for identifying VIPs or at-risk customers.
6. Lifecycle Stages: New visitors, one-time buyers, repeat customers, etc. Tailor your messaging to where they are in the customer journey.
7. Customer Value Segmentation: High-value vs. low-value customers. Helps you allocate marketing resources more effectively.
8. Channel Preference: Some customers prefer email, others social media. Segmenting by channel can improve engagement rates.
9. Purchase Occasion: Segments customers based on when they typically buy—holidays, birthdays, back-to-school, etc.
10. Technology Segmentation: Desktop vs. mobile users. Helps in optimizing the user experience for different devices.

Here are some common analysis methods for ecommerce that you can use to extract business insights.

1. Sales Analysis: Tracking metrics like average order value, conversion rate, and sales by product or category.
2. Customer Lifetime Value (CLV) Analysis: Calculating the total value a customer brings over their entire lifecycle to prioritize high-value segments.
3. Cart Abandonment Analysis: Identifying at what stage customers are leaving the checkout process and why.
4. Funnel Analysis: Examining the customer journey from landing page to purchase to identify drop-off points.
5. Cohort Analysis: Grouping customers based on shared characteristics or behaviors over a specific time frame.
6. RFM Analysis: Using Recency, Frequency, and Monetary metrics to segment customers.
7. Churn Rate Analysis: Calculating the percentage of customers who leave or stop buying from you over a certain period.
8. Multi-Channel Attribution: Understanding how different marketing channels contribute to conversions.
9. Heatmaps: Visual representations of where users click, scroll, or hover on a page, helping to understand user behavior.
10. A/B Testing: Comparing two versions of a webpage or app to see which performs better in terms of conversions or other KPIs.
11. Sentiment Analysis: Using customer reviews and social media mentions to gauge public opinion about your brand or products.
12. Price Elasticity: Understanding how sensitive demand for a product is to a change in price.
13. Inventory Turnover: Analyzing how often inventory is sold and replaced over a specific period.
14. Customer Segmentation Analysis: Using data to create different customer groups for targeted marketing.
15. Net Promoter Score (NPS): Measuring customer loyalty by asking how likely they are to recommend your brand.

But let’s go back to our top ecommerce analyses:

Cohort analysis

Cohort analysis is a game-changer in ecommerce. It groups customers into “cohorts” based on shared characteristics or behaviors over a specific time frame. Here’s the lowdown.

How is Cohort Analysis used?

1. Customer Retention: Track how many customers from a specific cohort return over time.
2. Lifetime Value: Understand the long-term value of different customer groups.
3. Product Adoption: See how new features or products affect specific cohorts.
4. Seasonal Trends: Identify buying patterns during holidays or seasons.

There are multiple Cohort Types, based on different factors:

1. Time-Based Cohorts: Group customers by the time they made their first purchase. Useful for tracking retention and churn.
2. Behavior-Based Cohorts: Group customers based on behaviors like frequent purchases, high spending, or frequent site visits.
3. Size-Based Cohorts: Group customers based on the size of their first purchase or average purchase size.
4. Multi-Dimensional Cohorts: Combine multiple variables like time and behavior to create more complex cohorts.

Cohort Analysis Techniques:

1. Survival Analysis: Predict the time a customer will remain active before churning.
2. Sequence Analysis: Track the sequence of actions leading to a specific outcome like a purchase or churn.
3. Clustering Algorithms: Use machine learning to automatically group customers into cohorts.
4. Predictive Modeling: Use historical data to predict future behaviors of cohorts.

RFM Analysis (Buyer Segmentation)

RFM stands for Recency, Frequency, and Monetary Value. This method helps you identify who your most valuable customers are, how recently they’ve made a purchase, and how often they buy from you.

Using RFM Analysis, you can tailor your marketing strategies to target the right people with the right messages, ultimately boosting your revenue.

RFM and cohort analysis are both ways to understand your customers better, but they’re not exactly the same thing.

• RFM Analysis: This is like sorting your LEGO blocks by color, size, and shape. You’re looking at each customer’s most recent purchase (Recency), how often they buy (Frequency), and how much they spend (Monetary). It’s a snapshot of individual behavior.
• Cohort Analysis: This is more like watching a movie with a group of friends who all came into the theater at the same time. You’re looking at how a group of customers, who started shopping at the same time or did the same thing, behave over a period.

So, RFM is more of a “sorting tool” to quickly identify your best customers right now. Cohort analysis is like a “movie” that shows you customer behavior over time.

They can work together, though! For example, you could look at a cohort of customers who first shopped with you last Christmas and then use RFM to see who among them are your best customers this year.

Let’s explain RFM Analysis differently.

Imagine you have a lemonade stand, and you want to know who your best customers are so you can give them special treats or stickers.

• R for Recency: This is like asking, “Who came to buy my lemonade just yesterday or today?” These are your fresh, new customers!
• F for Frequency: This is like counting how many times Sarah, Tim, or any other kid comes to buy your lemonade. The more they come, the more they like your lemonade!
• M for Monetary: This is about how much money they spend. Maybe Sarah always buys just one cup, but Tim buys four cups every time. Tim is spending more money!

So, with RFM, you can figure out who your best customers are. Maybe it’s the kids who came yesterday, come all the time, and always buy lots of cups.

RFM Analysis Marketing Ideas

Why would you do the analysis if not for marketing? Here are some top of the mind ways to use RFM Analysis results to run Marketing Campaigns

1. VIP Customers: Target those with high RFM scores with exclusive offers or early access to new products. Make them feel special.
2. Win Back Campaigns: For customers with high Monetary and Frequency but low Recency scores, use re-engagement emails or special discounts to bring them back.
3. Upsell/Cross-Sell: Customers with high Frequency but low Monetary scores are ripe for upsell or cross-sell campaigns. Recommend products that complement their previous purchases.
4. Loyalty Programs: Use RFM to identify candidates for a loyalty program. High Frequency and Monetary scores are a good indicator they’ll engage.

Sales & Margin Forecasting

Sales and margin forecasts are like the weather forecasts for your business. They help you predict what’s coming so you can plan better.

• Sales Forecast: This is an estimate of how much money your store will make in the future. It’s like saying, “We think we’ll sell 100 lemonades next week.” This helps you know how much lemonade to make, how many cups you need, and so on.
• Margin Forecast: This goes a step further and predicts how much profit you’ll make after covering all your costs. So, if each lemonade costs you $1 to make and you sell it for $3, your margin is $2. The margin forecast helps you figure out if you’ll make enough profit to, say, buy a new lemonade stand or pay for an ad.

Both are super important for making smart business decisions. While sales forecasts help you prepare for customer demand, margin forecasts ensure you’re actually making money.

Basket analysis

Basket analysis for a retail store is like peeking into your customers’ shopping carts to see what they usually buy together. Here’s what it should contain:

1. Frequently Bought Together: Identify items that are often purchased in the same transaction. Great for bundling deals.
2. Substitute Products: Find out what items are bought instead of others. Useful for managing stock and promotions.
3. Complementary Products: Identify items that, while not bought together, enhance the use of the main product. Think batteries for electronic toys.
4. Customer Segments: Break down the analysis by different customer groups to tailor promotions. For example, new moms might buy baby formula and diapers together.
5. Seasonal Trends: Note any seasonal patterns in basket combinations. Like sunscreen and beach towels in the summer.
6. Price Sensitivity: Analyze how discounts or price changes in one product affect the sales of others in the basket.
7. Basket Value: Average transaction value and how it changes based on different product combinations.
8. Purchase Frequency: How often certain product combinations are bought. Useful for inventory planning.
9. Margin Impact: Understand how different basket combinations affect your profit margins.
10. Location Data: If you have multiple stores, compare basket trends by location to tailor local promotions.
11. Online vs In-Store: If you have both, compare online and in-store baskets to understand different shopping behaviors.
12. Recommendations: Based on the analysis, suggest actionable strategies like targeted promotions, cross-selling, or rearranging store layout.

Use well-done basket analysis gives you the insights to boost sales, improve customer experience, and optimize inventory. 🛒

Retention & churn modeling

Retention and churn modeling are like the two sides of a coin in customer relationship management. Let’s break it down:

Retention Modeling

Retention Modeling his predicts which customers are likely to stick around. It’s like figuring out which friends are likely to come to all your parties.

Use the retention modeling model to tailor loyalty programs, personalized offers, or customer engagement strategies.

Key Metrics: Customer Lifetime Value (CLV), Retention Rate, and Net Promoter Score (NPS) are some big ones.

Retention Modelling Methods:

• Logistic Regression: To predict the likelihood of a customer staying.
• Cohort Analysis: To see how well you retain customers over time.
• RFM Analysis: To identify high-value customers you should focus on retaining.

Churn Modeling

Churn Modeling predicts which customers are likely to leave your service or stop buying your products. It’s like knowing which friends might not show up at your next party.

Use the model to develop targeted re-engagement campaigns, special offers, or customer surveys to understand why they’re leaving.

1. Key Metrics: Churn Rate, Average Revenue Per User (ARPU), and Customer Satisfaction scores.

Churn Modeling Methods:

• Survival Analysis: To estimate the time until a customer will churn.
• Decision Trees: To identify key factors that influence churn.
• Machine Learning Algorithms: Like Random Forest or Gradient Boosting for more complex predictions.

Both models help you understand your customer base better.

Retention modeling helps you keep the customers you want, while churn modeling helps you understand why you’re losing others.

By using both, you can fine-tune your marketing and customer engagement strategies to keep your customer base strong and growing. 📈💡

Benefits of Customer Segmentation Models

Personalization is the name of the game today. Retailers strive to create specific and relevant marketing campaigns in a never-ending struggle for customer attention. All that’s possible only by using meaningful customer segmentation models. Here are the benefits they create:

A. Improve Targeted Marketing

Distinct customer segments allow retailers to carry out highly targeted marketing campaigns. That encompasses personalized messages and relevant offers that resonate with customers. As a result, you get enhanced engagement and improved conversion rates.

Such distinct segments, whether demographic, geographical, behavioral, etc., improve the returns on marketing investments for paid and organic activities.

B. Increase Marketing Efficiency

When using customer segmentation models, retailers can identify the most valuable segments. You can focus marketing efforts on them and stop wasting time on audiences that aren’t receptive to your offers and messages.

Once you prioritize valuable segments, marketing efforts become more efficient. You stop wasting marketing budgets and further improve ROI through optimized resource allocation.

C. Monitor Customer Satisfaction

The segments you create allow you to track your most valuable customers’ satisfaction levels. Like that, you identify how and where to focus customer retention efforts.

By proactively collecting feedback or monitoring customer behavior in your most valuable segments, you can detect problems and immediately address concerns. You must adopt such an approach to enhance customer loyalty and increase retention – through an improved customer experience.

Challenges with Implementing Customer Segmentation Models

Customer segmentation models work like magic for cutting costs, improving ROI, and enhancing loyalty. But they require focused efforts to overcome some of the most prominent challenges of customer segmentation. These include:

A. Insufficient Data

If you don’t use tools to collect and aggregate customer data or have insufficient traffic, you might not have enough information to create meaningful segments. That’s where instruments like customer data platforms can prove invaluable.

Such tools collect data from multiple sources and allow you to explore specific details about your customers, if available, from one place. You can use paid ads on social media, display ads, or in SERP to increase website traffic to overcome the lack of data.

B. Lack of Resources

Building and maintaining segmentation models is a resource-intensive activity. You require people well-versed in web analytics and working with tons of data. Creating meaningful customer segments requires business acumen and for you to understand business and customer needs alike.

If you lack the resources, it’s still advisable to create the most basic of segments to optimize marketing spend.

C. Expensive to Implement

Outlining and maintaining distinct segments requires investment both in time and money. To streamline and optimize the process, you must invest in the necessary technology and experts. Alternatively, you can learn to do it on your own. That also requires time and money to educate yourself and apply the acquired knowledge.

But if done accurately, that one-off marketing investment can repay tenfold in revenues generated by meaningful segments that work for your business. Let’s see how the field leaders do it!

Examples of Customer Segmentation within Retail

Even though big retailers can capture anyone, they use customer segmentation models to reduce marketing investments and acquisition and retention costs. Here are some key examples from industry leaders:

A. Amazon

Amazon has millions of customers and operates in more than a hundred countries. It relies on complex and in-depth audience segmentation to reach the desired customer with the right offer. The company processes a massive amount of data points on all its customers to make a single recommendation.

That vast amount of data allows them to make these recommendations as relevant as possible. It also shows how significant segmentation is for knowing their customers and making data-driven offers.

Here are several examples of how Amazon relies on the four basic segmentation models, according to available Amazon segmentation data:

• Demographic Segmentation – their largest segment is customers in the 35-49 age group, with more than 76 million households in the US using an Amazon Prime subscription.
• Geographic Segmentation – the leading geographical segment for Amazon is the US, with 60% of the website traffic and 38% of sales originating in the States.
• Behavioral Segmentation – data shows that non-Prime customers make multiple purchases, but 48% of those with a Prime subscription purchase at least once a week. Essential for customers have proven to be the free shipping for Prime members, the variety of products, and the highly accurate recommendations and personalization efforts.
• Psychographic Segmentation – Amazon provides a broad spectrum of pricing strategies and accessibility options. That attracts people from all walks of life, strengthening the company’s leading position.

B. Walmart

Walmart focuses its customer segmentation strategies on building trust and establishing reliability. The company uses the models to meet the needs and preferences of people from various locations. As a result, Walmart successfully localizes the customer experience and positions itself in diverse markets.

The company targets low to middle-class families and customers that seek the convenience of shopping at a single location. They target discount shoppers and coupon lovers to build loyalty and retain customers. As a result, one of their prominent segments is based on income – lower to middle class.

Regarding behavioral segmentation, Walmart tries to appeal to and attract people who seek cost advantages. They focus on cost-conscious people of all ages.

C. Target

Research shows that Target’s customers are predominantly married white women in their 30s. The company attracts middle to upper-class customers who spend, on average, $50 per visit.

Regarding demographic segmentation, the retailer focuses on customers in the 18 to 44 age group. Repeat-purchase behavior is encouraged through variety and convenience, as well as through loyalty programs and rewards.

Target has a prominent loyalty program that offers specific discounts, redeemable earnings, and hundreds of special deals. Participants get birthday gifts and can vote on the nonprofits which Target supports.

Source: Target Circle

That also helps them identify socially engaged customers and outline psychographic segments with specific inclinations and passion for charitable causes. That only makes sense since their ideal buyers are middle to upper-class customers.

What to Consider When Creating Your Segmentation Model?

Customer segmentation models can change the way you conduct your retail business. Efficient segmentation cuts costs and boosts ROI. But that requires thoughtful analysis and planning that considers various aspects. That’s why you must:

A. Determine Your Goals

You must define OKRs and KPIs clearly to measure success. Try to define SMART goals to inform customer segmentation and guide specific marketing campaigns and efforts.

B. Choose the Right Tools

Web analytics, e-commerce reporting tools, and customer data platforms will determine how efficiently you gather, aggregate, and analyze data. All-in-one marketing platforms like VibeTrace allow for data integration, meaningful segment creation, and the generation of actionable insights.

C. Analyze Your Data

Ensure you have the knowledge and capacity to analyze available data. The accuracy of data analysis is foundational for creating meaningful segments. Learn how to clean and manage data before you break it into segments.

Address these aspects proactively to derive meaningful customer segmentation models. As a result, you can apply personalized marketing strategies with the help of sophisticated tools like product recommendations engines and web personalization.Finally, you’ll achieve higher customer satisfaction, enhance customer retention, and drive business growth and success.

Conclusion: Segment to Succeed

Customer segmentation models are invaluable for retailers chasing sustainable growth and a competitive edge in the cutthroat competition of the retail landscape.

That’s how you make data work in your favor.Use what you gather to deliver delightful, personalized experiences and strengthen customer relationships.

After all, that’s what leads to long-term success in the dynamic and competitive field of retail. And to manage it all in one spot, don’t hesitate to contact our experts for a consultation and a free VibeTrace demo!

Some interesting links you might want to read:

https://medium.com/think-with-startupflux/customer-segmentation-models-52ef7738823a
9 Customer Segmentation Models & How to Use Them for Smarter Marketing

https://www.gfk.com/brand-and-marketing-performance/segmentation-and-targeting/customer-segmentation
https://medium.com/analytics-for-humans/what-is-cohort-analysis-and-how-should-i-use-it-3ac7c39c50dd