Venture Capitalist at Theory

About / Categories / Subscribe / Twitter

3 minute read / Dec 15, 2014 /

The Importance of Segmentation for Your SaaS Startup

Are you a Barry, Jill, Buzz, Angel or a Devil? This is the question Best Buy store managers posed each time a potential customer walked into one of its stores when the company decided to segment its customer base in 2005. Barrys are high-income family men. Jills are soccer moms. Buzzes are gadget lovers. Angels are the best, most-profitable, customers and buy new products at full price. Devils, on the other hand, erode Best Buys’ profits because they use coupons, find the best deals and return products frequently. After launching this segmentation, restructuring its stores to meet the needs of these segments, and focusing on the profitable segments, Best Buy’s revenue increased 8%, an impressive figure for a retailer.

As your startup scales, customer segmentation can become an important tool for the entire company, just like it was for Best Buy. Personas anchor product design and development, marketing and sales, and even customer success to tangible user archetypes. Personas define the company’s strategy of which customers to pursue and which not to.

Best Buy’s segmentation unites two classic segmentation types, needs-based and profitability based segmentation. The Jills, Barrys and Buzzes in the Best Buy example are need-based segments. The canonical enterprise segmentation of Small Business, Mid-Market, and Enterprise used by many SaaS startups fits this pattern.

But there is another important customer taxonomy: segmentation by profitability. Angels and Devils are profit-based divisions for Best Buy. More common in industries with little growth, profitability segmentation can be a powerful tool to help startups focus on the right customers to grow more profitably.

Profitability segments are first-pass filters. They answer the question, which customers should I be acquiring? Which are the most profitable for the business? While they may be less attractive, unprofitable customers need not be be shunned; Best Buy didn’t turn away the Devils. Instead, Best Buy crafted pricing mechanisms to convert Devils into profitable customers by charging a restocking fee and upselling much higher margin products such as extended product warranties. The same idea holds for SaaS products. For the lowest price customers, prioritizing sales leads, tiering customer support, charging for customer success may radically change the business’ cost to serve and unit profitability. Lemons become lemonade.

The second-pass filter, needs-based segments, divide the most profitable user segments into personas for the go-to-market teams. They identify the company’s core customer, define personas, and enable the business focus on these customers’ needs first.

Developing the right segments is critical. Wikipedia has a great list on the criteria for determining whether a segment is a useful one: is segment measurable, addressable, stable and consistent? But the most basic is the first. Is there enough data? Segmentation is a powerful tool to be employed by startups once the customer base becomes large enough, which probably means at least a few hundred customers.

At that point, the business will have enough data to divide the customer base into meaningful slices. Then, it’s time to analyze the data, affirm the conclusions with user research and then employ the segments in product development, sales and marketing. One more bit of advice on segments: choose your personas’ names wisely. A moniker like Devil doesn’t endear the customer to your business.

Read More:

The Concur Acquisition in Context: A SaaS MegaExit