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Every business owner must be able to answer one very basic question, “Why should a prospective customer buy my product or service rather than a competitor’s?” If the owner cannot answer this question, he or she should probably cut his or her losses and seek alternative employment. Fortunately, this isn’t a complex question. At its core, there are only two possible answers; either the product or service is being offered at a lower price or the offering must be differentiated from the competition’s.
Companies such as Walmart have been extremely successful pursuing a low cost strategy. Walmart uses its massive volume to negotiate purchase prices that are well below what smaller competitors pay. Consequently, the retail giant can make very good margins selling brand name products at lower prices than competitors can offer. As a practical matter, small businesses will generally not have the volumes to pursue this type of strategy.
Very small businesses can sometimes offer lower prices than their larger competitors because they have much lower overhead. For example, consider a residential cleaning service run by two friends out of their homes. The two friends are the only employees. There is little to no overhead. Such an operation can offer its services at prices below those that a company such as Merry Maids would have to charge, because Merry Maids does have significant overhead. However, this strategy is inherently limiting. If the two friends were to attempt to significantly grow their enterprise, they would discover that they would need to add overhead similar to their larger competitors.
Most small businesses that want to grow beyond a few employees will find that a low cost strategy is difficult to pursue successfully. Therefore, such enterprises are left with the need to differentiate their products or services—give their customers a reason to buy that isn’t based on price.
It’s great to create a differentiated product/service package. Unfortunately, that, by itself, is not enough. In addition, the differentiated product/service package must be more desirable to a specific segment of the market than any alternative. Also, the size of this segment must be large enough to be attractive. For example, you could market a skunk-flavored Popsicle. This would be a differentiated product; nothing remotely resembling such an offering is available in your local supermarket. However, it is highly unlikely that this product would be attractive to a large enough segment of the market to make it an economically viable offering. This is a silly example, but it makes the point that differentiation alone isn’t sufficient. You must target the differentiated product/service package to a sufficiently large segment of the market, which values the unique characteristics of the offering.
So, what makes a market segmentation that will allow companies to target their products and services profitably to customers who will pay a premium for them? There are two criteria for a segmentation to deliver significant value. First, members of the segment must make the buying decision like each other and differently from those not in the segment. Second, members of the segment must be externally identifiable or they must be willing to self-identify.
The key to effectively segmenting a market is to understand how customers make the buying decision. What characteristics of the product/service package are most important to each group of customers? For example, automobile manufacturers must target specific segments. Some people are looking for basic transportation with a low cost of operation (i.e., good gas mileage and low maintenance costs). Other car buyers are interested in a sporty looking, high performance automobile. Still others are interested in luxury and prestige. More recently, a segment has emerged that is primarily interested in a car that is environmentally friendly. One product cannot possibly satisfy all segments. Product design and advertising are specifically intended to position the manufacturer’s offerings closer to the wants and needs of a given segment than those of the competition.
Assuming that the product/service package can be targeted to uniquely meet the needs of a sufficiently sized group, the customers in each segment must be externally identifiable. Marketers need to know how to reach the specific segments. Should the company advertise in Sports Illustrated or Cosmopolitan? Alternatively, the members of a particular segment may be self-identifying. For example, if a man intends to buy a suit, those who walk into Sears, The Men’s Warehouse, Joseph Bank’s, or Brooks Brothers are fairly clearly members of different market segments.
To be successful, every business owner must be able to explain why a prospective customer would buy his or her product or service rather than a competitor’s. The answer will be based either on lower price or a differentiated product or service. If the answer is based on differentiation, the product or service will have to be the most attractive alternative for a segment of the market that is large enough to sustain the business. Although this may sound straight forward, our experience is that sorting this out can be complex and the business owner may need to reach out for expert advice. But, the rewards are worth the effort.
Doug and Polly White are Principals at Whitestone Partners; a management-consulting firm that helps small businesses build the infrastructure they need to grow profitably.