Segmentation is the Key to Customer Psychology

Truly Make the Customer the CRM Design Point

Ms. Liz Roche
Managing Partner, Customers Incorporated (US)

This article is exclusively written for GCCRM.


Product placement! Lifestyle marketing! Integrated promotions! It seems that everywhere you look these days some marketer is trying to get you to buy a product by appealing to your psyche rather than explicitly advertising it. As technology continues to pervade our daily lives, the lines between sales, marketing, advertising and entertainment are rapidly blurring. The big payback for marketers is to get into your head and influence your behavior by augmenting traditional marketing and advertising with an appeal to your psyche.

But here's the rub: all customers are not created equal and as such it's not so easy to understand what actually drives purchasing behavior. Indeed Business Week recently ran a cover story on the psychology of the male consumer (Business Week, 09/04/06, Revealed! Secrets of the Male Shopper). But certainly not all consumers are men. And not all consumers purchase all products. And even if you have a handle on who purchases your product, not all customers are equally valuable (profitable + strategically important). As such, the key to effecting behavior via customer psychology is rock solid customer segmentation.

Customer segmentation is the key to making the customer the CRM design point, leveraging CRM effectiveness (doing better things), as opposed to simply implementing operational technology (e.g., sales automation) that largely addresses efficiency (doing things better). At its most basic level, segmentation involves classifying customers with similar characteristics into groups (called "segments") and then dealing with the segments instead of individual customers (especially important in organizations with large customer bases, where individual customer scrutiny would be virtually impossible). The key reason for segmentation is the development of informed, segment-specific customer lifecycle treatments as well as a better understanding of which industries and markets should be served and which should be lowest priority going forward. Most important, segmentation guides future interaction with customers, based on the organization's deeper understanding of each segment's (and, by inference, each customer's) profitability, behavior, industry context, and lifetime value. Companies also use segmentation to prioritize new product development efforts, develop customized marketing programs, choose specific product features, establish appropriate service options, design an optimal distribution strategy, and determine appropriate product pricing.

Customer segmentation begins with the identification and collection of pertinent data elements (classification variables) and assumes that IT and marketing professionals will work closely together in data gathering strategies:

. Financial: Revenue generated from the customer (transactions), cost to acquire and retain the customer, customer's credit worthiness, resulting profit from the customer, and interactions (cost to serve).

. Demographic: Describing customers in terms of their personal characteristics, such as age, sex, income, ethnicity, marital status, education, and occupation.

. Geographic: Describing customers in terms of their physical location, such as city, state, ZIP code, Census tract, county, region, and metropolitan/suburban/rural location.

. Psychographic: Describing customers in terms of personality traits, such as attitudes, lifestyle, aversion to risk, and TV programs watched.

. Behavioral: Emphasizes what customers have purchased and can suggest what other products they may be interested in; this includes brand loyalty, usage level, benefits sought, and distribution channels used.

This data is then used to generate customer segments, with additional qualification based on the current and future financial contribution each customer represents to the company. Further refinement of these initial customer segments must be planned for.

When customer segments have been developed, a CRM treatment (customer pattern) can then be developed to ultimately create exit barriers and gain channel efficiencies along the way. However, there is a "chicken or the egg" information conundrum: most organizations do not have enough information to profile their customers, though designing around the customer requires information to create customer patterns. This can be a vicious circle - and avoiding this conundrum means that even without perfect information, organizations must start somewhere and use that as an opportunity to collect information along the way, updating the segment/ treatments iteratively.

What Is the Right Number of Segments to Have?

There is no definitive answer. Experience, intuition, statistical results, and common sense all must be applied to decide on the number of segments to retain. If there are numerous very small segments, the segmentation criteria may need adjustment. Too many segments can lead to the development of too many different (i.e., expensive) marketing programs for small, very similar markets. However, several rules of thumb can be used to determine the appropriate number of segments. Segments must be:

. Large enough: The majority of segments must be large enough to be economically feasible to support marketing and product design efforts.

. Relevant: The segments must be relevant to the company's products/services.

. Reachable: Segments must be reachable through one or more marketing mix variables (price, promotion, features, and distribution).

. Differentiable: Clearly defined differences among customer segments must exist to make some segments more desirable than others.

Although determining a segmentation strategy is very much a business issue, technologies can be brought to bear to make this task somewhat easier:

. Data mining/behavior modeling: Predictive analysis technologies built into campaign management tools can help marketers move from declarative segmentation (segmenting based on database fields) to predictive segmentation (segmenting based on mathematical algorithms), enabling more "creative" segmentation.

. Optimization: Technologies providing nonlinear, constraint-based optimization enable mathematical calculation of best customer/segment, best offer, and best campaign.

As we have seen, organizations must understand customer psychology to truly make the customer the CRM design point. This notion is enabled by creating value-based customer segments and applying appropriately "sized" CRM life-cycle treatments.


source: http://www.greaterchinacrm.org:8080

The Role of Segmentation in Creating Marketing Advantage

Linda More is now a business and technology journalist

In the real world there is no such thing as an average customer - each customer is an individual capable of adding their own value to a business relationship. Customer segmentation is the powerful marketing technique that divides a group of all customers into smaller subgroups that share a number of common properties in their relationship with the business.

Understand Customers to Keep Them

Segmentation is the first step towards customer understanding, which allows organisations to build healthy relationships with their customers. "Money is made by keeping customers, and the whole idea of segmenting customers in order to build customer relationships is to turn it into a mutually satisfying relationship," says Ovum analyst David Bradshaw.

There is no such thing as the average customer Customer segmentation is the first step to building a healthy customer relationship Correct segmentation can increase revenue, decrease costs and increase customer satisfaction Difficulties occur when companies segment according to their own desired outcomes ('the wish-list') rather than the customers' Both tactical and strategic segmentation strategies need to be employed for best results Medium-sized organisations with fewer resources should use CRM tools to enable customer segmentation

To build these relationships profitably depends on treating different customers appropriately in order to align their individual needs with the most appealing product or service offering a business has. The challenge for the mid-market sector is to stop viewing their customers as one entity and to start communicating with them as individuals and according to their distinct preferences. "There is only one place that businesses make money - from active customers. Today, despite the tools at hand, mass marketing is still the primary method of customer communication," states Clive Humby, chairman of customer management consultants, Dunnhumby. If you do it right, the benefits of segmentation are threefold – increased revenue, decreased costs and increased customer satisfaction, according to Ian Charlesworth, senior analyst at Ovum.

Painting the Customer Picture

The shopping and buying habits of highly profitable, high-revenue customers are different, as are the products they choose to purchase. A significant part of the value of performing customer segmentation is in providing a common language that the entire business can use to talk about its customers. However, there is a downside if you get it wrong, as Charlesworth explains, saying: “If you target or segment customers in a way that is inappropriate, you can alienate them. What you are really doing is putting your customers into labelled buckets based on your judgement of where they should fit. What happens if they don’t see themselves as belonging in that particular bucket?”

These difficulties in segmentation sometimes occur because companies often segment customers based on their own desired outcomes rather than those of their customers.

Painting the Customer Picture

The shopping and buying habits of highly profitable, high-revenue customers are different, as are the products they choose to purchase. A significant part of the value of performing customer segmentation is in providing a common language that the entire business can use to talk about its customers. However, there is a downside if you get it wrong, as Charlesworth explains, saying: “If you target or segment customers in a way that is inappropriate, you can alienate them. What you are really doing is putting your customers into labelled buckets based on your judgement of where they should fit. What happens if they don’t see themselves as belonging in that particular bucket?”

These difficulties in segmentation sometimes occur because companies often segment customers based on their own desired outcomes rather than those of their customers.

Tactical or Strategic Segmentation

Often segments are chosen on the basis of available data. For example, an organisation that has a lot of transactional data may opt for behavioural segmentation based on levels of spend, frequency of purchase or apparent loyalty. Another company with a wealth of customer preferences may choose to segment its customers based on the attitudes they display and the reasons why they choose to make their purchase

In order to segment customers in a way that serves the business the marketing needs of the organisation must be aligned to the most appropriate segmentation approach. “Organisations need to see value from segmentation and to do this they must understand the reasons why they are segmenting customers,” states Charlesworth. “To produce real value segmentation activity must be aligned with the business strategy and vision.”

According to Gartner analyst Gareth Herschel segmentation schemes tend to alternate between extremely granular tactical schemes, which can result in thousands of segments and very strategic segmentation with less than 15 segments. Tactical segmentation serves to address the immediate short-term issues of the business, such as deciding which customers get preferential customer service, additional mail shots or to drive business using a special offer. With the wealth of CRM (customer relationship management) tools available today, tactical segmentation is easily performed in-house using existing customer data.

Strategic segmentation is used to answer the big questions that the business has about market position and branding, competition and to identify new opportunities. It is used to pinpoint the type of customers a business wants to encourage, what image or brand is needed to attract them, how much they are willing to pay and what type of products they will need. Usually an outside specialist consultancy is called in to help with this process and the determination of the segments.

“Organisations require both tactical and strategic segmentation,” says Herschel. “They serve very different purposes and a big mistake that organisations make is to only operate in one dimension or the other.”

Conclusion

Segmentation is an effective part of a broader marketing strategy and should eventually include both tactical and strategic elements. The secret is to make a start using your existing data and tools and then keep refining your segmentation strategy focusing on the benefits that those segments really care about.

“Medium-sized organisation have the same needs as large ones – but with a lot fewer resources to address them with,” says Bradshaw, “so they need to use their CRM tools to maximum effect.”

Sources

Interview: Gareth Herschel, GartnerGartner Presentation – ‘Creating and Using Customer Segments to Balance Needs and Value’

Interview: Ian Charlesworth, Ovum

Interview: David Bradaw, Ovum

Interview: Clive Humby, Dunnhumby

Interview: Martin Hayward, Dunnhumby

Interview: Professor Adrian Payne, Cranfield University

source: http://www.microsoft.com/uk

CRM, As You Like It

Customer segmentation software helps companies build their business by identifying valuable customers so they can assign the appropriate resources.

Russ Banham, CFO.com

May 01, 2003

"Know thyself," wrote William Shakespeare half a millennium ago. Shakespeare recognized that we all have elusive wants, feelings, and frustrations that set each of us apart from everyone else. So when Dallas Teachers Credit Union wanted to grow its assets two years ago, it adapted a lesson from the Bard. Rather than manage its database with "neither rhyme nor reason," the DTCU invested in customer segmentation software to really know its customers — all 150,000 of them.

By creating 150,000 distinct customer profiles, the DTCU was able to determine customers' individual banking needs. Each customer was profiled, based on more than 100 different data points — things like age, level of schooling, annual income, type of home, and location. All customers also were "householded" to reveal who else in the nest might need one of the bank's services, such as a checking account, an IRA, a credit card, or a mortgage. Only then was targeted marketing material delivered to individual customers. The upshot: the DTCU increased its assets by more than $500 million in the last 18 months — to $1.45 billion — making it the fastest-growing credit union in the nation.

After rolling together its own internal customer data with an array of external demographic information provided by Acxiom, the DTCU ran it through sophisticated modeling algorithms created by IBM Global Services. This rigorous process enabled the credit union to "rank order" each of its myriad services by customer — that is, to identity which individuals had the greatest inclination to use each service. "The customer segmentation strategy took the guesswork out of cross-selling," says Patricia Korioth, senior vice president and CFO.

"Instead of sending marketing material to all our [150,000] members and getting a single-digit response rate, we'll now send out 15,000 pieces of mail and get a 10 percent response rate," adds Korioth. "The strategy gave us the confidence to re-charter as a community bank." Now called the Credit Union of Texas, the bank has expanded its potential customer base — it's no longer just for teachers only.

"We've even used the data to determine where our new branches should be located," says Jerry Thompson, the bank's chief information officer. "Internal surveys indicated our customers like to bank at a facility within a 10-minute drive. The internal data pinpointed where our most profitable customers resided, and the demographics indicated others of similar banking needs. Up went the branch."

Customer segmentation strategies using CRM software are almost a matter of course in the financial services industry, which retains an enormous amount of internal transactional and personal data on customers and customer behavior, enabling relatively easy segmentation for purposes of marketing and customer service. In recent years retailers have been discerning their customers' buying preferences by scanning their credit cards or frequent-shopper cards, and even by using radio frequency identification (RFID) technology to pick them out through their cell phones and other devices as they enter a store.

(Thereby hangs a tale: It's been reported that at least one retailer has explored the possibility of embedding RFID chips in its clothing, so salespeople could easily identify repeat visitors on arrival and give priority service to these more loyal — and hence more valuable — customers. Though it's not nearly as intrusive as the iris-scanning shopping-mall come-ons of Minority Report, privacy concerns seem to have put such initiatives on hold.)

Customer segmentation can offer both revenue-building and expense-lowering benefits. Top-line revenues can be increased through more-targeted cross-selling, as well as through superior service that builds customer loyalty. Bottom-line expenses can be pared by relegating lower-margin customers to less expensive self-service options — or perhaps even by steering those customers to another service provider altogether. Self-service is considered the most important CRM initiative by 62 percent of Global 3500 firms interviewed recently by research firm Forrester.

Yet while success stories like the Credit Union of Texas are legion, analysts warn that customer segmentation strategies are hardly risk-free. That same Forrester study noted that 41 percent of interviewees found no return on their investments in Web-based and interactive voice response (IVR) self-service. "It's a sticky thing," says Jill Griffin, president of The Griffin Group, an Austin, Texas-based consulting firm specializing in customer loyalty issues.

One sticking point, explains Griffin, is that a customer who is initially categorized as low-end — and then provided low-end service — will be less likely to stay with the provider when his or her material wealth increases. "The Internet has changed customer perceptions of corporate responsiveness," says Griffin. "People now expect instantaneous conclusions. If they're required to endure interactive voice response systems that lead nowhere or Web sites that are so labyrinthine that they get lost, their loyalty to your company breaks down."

Others agree. "You need to be careful when you introduce new customer service options that you don't completely cut off traditional familiar communications channels," says Karen Smith, research director at Aberdeen Group, a Boston-based consultancy. "Think about the poor fellow standing on line at the bank for a half-hour who watches someone come in and get preferential, immediate service. If he hits the lottery next week, he may decide he wants service elsewhere."

A Little Something for Everyone
To segment customers fairly as well as profitably, Stockholm, Sweden-based Nordea Bank sought a customer-segmentation strategy that would allow it to reduce its call-center staff and associated expenses without lowering customer service. The key was a system that ensures each customer is assisted by a service representative with the appropriate skills.

For example, Nordea wanted its high-end customers to be transferred to representatives who had been trained to provide high-touch customer service — and to make a very persuasive cross-selling pitch at the conclusion of the interaction. Low-end customers would be routed to reps trained in the bank's online service system, to encourage those callers to use the Web for service issues in the future. That channel "is critical to our success," says Martin Karlsson, Nordea business IT manager, "since it is more cost-efficient, and also very convenient for customers."

Nordea Bank implemented customer segmentation software provided by Daly City, California-based Genesys two years ago. In Nordea's 14 contact centers across Sweden, Finland, and Denmark, the bank has increased the time spent talking to customers by 24 percent, yet it has increased its number of employees by only 15 percent. "We use the interactions to provide added value for the customers and for the bank, which means simultaneously advising on and selling products that would benefit the customer," says Karlsson. "It's very useful to match customer segments to specially trained and qualified agents. A call from a customer that is more profitable to the business deserves more high-level attention and service."

Brian Bingham, manager of customer care research at research firm IDC in Framingham, Massachusetts, puts it even more strongly. "Losing a high-end customer can have a profoundly negative effect on a company's profitability," says Bingham. "If they have urgent needs requiring satisfaction immediately, and they're forced to go through the same channels as low-end customers, they will become dissatisfied. There's an old expression, 'it's significantly more expensive to acquire a new customer than to retain an existing one.' "

Many CRM analysts recommend a value-based segmentation model similar to the one in place at the Credit Union of Texas. "You want to create a target list for a sales campaign based on the attributes of the customer," says Steven Bonadio, senior analyst at Meta Group in Stamford, Connecticut. "Knowing the customer is everything. You want to understand who they are and what is their relative value to the enterprise, not just here and now but into the future. Then you tailor the appropriate level of service or customer experience."

But Smith from Aberdeen warns that "appropriate customer experience" should not, in the case of low-end customers, translate into inferior service. "It goes back to the primary question — is the segmentation strategy predicated on serving the customer better, or just corporate interests and the bottom line?" she says. "When you say you're improving customer experience, are you really? Technology is not a panacea; it must be managed."

Even among high-end customers, continues Smith, "there are cases where a husband and wife each have checking accounts at a bank, and even though the wife is the actual breadwinner, she's kept on the phone punching digits because the husband is perceived as the decision maker in the gold bracket." Adds Smith: "That's why it's incumbent to household the entire family — you don't want to distance one member. I've seen five-member families each barraged with the same marketing material in the mail on the same day. Talk about a 'customer experience.' "

The Pared-Down Approach
Fireman's Fund Insurance in Novato, California, evaded many of these concerns in its customer segmentation strategy. The solution: Keep it focused on sales and marketing, and not on service. The insurer uses data warehousing software provided by IBM Global Services and data analytical tools from Cary, North Carolina-based SAS to identify the best customers in each of its markets. "Knowing who our best customers are on a niche basis, and then householding them, lets us know how best to service their insurance needs," says Michael DeVoe, Fireman's Fund senior director of customer research and strategies.

Adds DeVoe: "We discern the number of insurance policies in a particular household and then, using internal data and external demographic data, we create a 'life-stage segmentation.' As these customers age or move into larger homes, we know the products best-suited to cross-sell them, or the loss-control advice they may need."

Segmentation strategies give insurers an opportunity "to do something with all this customer information we have," continues DeVoe. "Historically, it's been very cumbersome to get our hands around this data because, like other large financial services companies, we tend to be structured along silos and have legacy systems that are not integrated. We've got three Ph.D.'s here now who are highly analytical people who do nothing but integrate all this data using the various tools. It's a minor investment for something that is generating millions in profit, simply by tailoring marketing to customers individually."

Or as the Bard wrote in another context, "Suit the word to the action, and the action to the word."Publish

Russ Banham is a contributing editor at CFO.com.

source: http://www.cfo.com/

Customer Segmentation: Think Beyond What You Can See

Article published in DM Direct Special Report
August 17, 2004 Issue

By Shailendra Kumar

The key to business success in today's competitive world is managing customer relationships. Customer segmentation is the first step toward this customer understanding, which allows organizations to build healthy relationship with their customers.

Know thy Customers

Due to the relentless competitive pressure currently being experienced in the financial services, retailing and telecommunications sectors today, a critical issue for business is to establish customer intimacy to maintain better customer relationship.

To build these relationships profitably certainly depends on treating different customers differently. Any organization must understand the customer history and its value to the business, both today, in the past and the future, so that all interactions with the customers are appropriate and lead to the relationship being profitably developed over the period of time. Customer segmentation is the key to this level of understanding.

Customer Segmentation

Customer segmentation is a powerful technique which divides a group of all customers into smaller subgroups that share a number of properties in their relationship with the business. It is obvious that these subgroups should be given very different treatment.

A simple customer segmentation can be produced easily with the analysts exploring the data and applying their understanding of the business. Typically the process begins with a business problem in mind and attempts to determine which measures of a customer are important to that specific business problem and how the chosen measures can be used to segment the data. This is a highly iterative and experimental process, with the analysts constantly increasing their insight into the behavior of the customers. For example, an analyst may want to segment the customer base, geo-demographically and then subsegment any one region by the amount of revenue generated by that region.

Segmentation is now an essential part of the marketing activities of most of the organizations, influencing key strategic decisions. Segments makes analysts think beyond what is there to see.

Practical Issues

There are a number of practical difficulties for analysts to implement the process of segmentation. By its very nature, this type of work needs to be carried out by a business, not a technology expert. A user-friendly, easy-to-use business tool may provide more specific support to help an analyst construct queries and experiment with different approaches to segmentation.

The complexity of the ever-increasing number of queries makes it difficult to track customers in a segment over time. As the customers' data changes, they may no longer fall inside the criteria of the original query for that segment - which makes any form of "then and now" analysis very difficult. For example, the analyst may want to track the response of a segment of customers who have been targeted with a direct marketing campaign or follow the changing composition of a particular segment over time.

In fact, a marketing analyst may have neither the time nor inclination to write his/her own queries. The tasks involved in retrieving customer records from the database and building queries for segmentation are often left to IT specialists, based on the analyst's specification of whom should be in each segment. Not only does this increase the time needed to produce the segmentation model but effectively precludes the analyst from iteratively refining the model. Time constraints will not allow for many cycles and the analyst will lose his/her train of thought while waiting for models to be produced by IT support. Thus, it is suggested that it should be left to the analyst to access their own record set from the customer database and do the segmentation as per their requirement.

Another practical issue is the dirty data which does not allow the IT specialists to give data access to the marketing analysts. A tool which can segment customers and even handle dirty data is the effective need of the hour.

Business Benefits

A very significant part of the value of performing customer segmentation is in providing a common language that the entire business can use to talk about its customers. Indeed, segmentation is an excellent example of the way in which data can be turned into information and then into actionable knowledge. This information is relevant even to the most senior managers where a monthly board report, for example, could include the performance of the product by customer segment over a period of time. Customers can then be tracked as they move from one segment to another, as their relationship with the business matures or, perhaps, begins to go sour.

Customers in one segment with a similar geo-demographic profile to those in another higher value segment can be encouraged to migrate to the higher value segment. Market research can be carried out by segment to determine not just what the customers are doing, but also why they are doing it. New and prospective customers can be matched with known customers based on geo-demographic information in order to include them in an existing segment and understand their likely future behavior.

Today, the need is to provide marketing analysts with a business tool which is quick, can handle large amount of data and can help them do segmentation in simple English language on the customer base along with their transactions. This will make analysts more creative and innovative to follow their "train of thought" and allow them to take those decisions which they wanted to take today and not tomorrow.

source: http://www.dmreview.com/

Customer Segmentation

Customer segmentation is essential to successful database marketing. Segments are groups of customers with similar interests in your products or services which you have created based on their behavior, demographics and lifestyle. Your messages to customers in each segment should reflect these differing interests if you want to find a receptive audience.

The goal of customer segmentation is to develop database marketing action programs that lead to measurable increases in retention, cross sales, up sales and referrals.

An ideal segment is one which:

• Has definable characteristics in terms of behavior and demographics.
  
• Is large enough in terms of potential sales to justify a custom marketing strategy with appropriate rewards and budget.
  
• Has members who can be motivated by cost-effective rewards to modify their behavior in ways that are profitable for your company.
  
• Makes efficient use of available data to support segment definition and marketing efforts.
  
• Can be measured in performance, with control groups
  
• Justifies an organization devoted to it. There should be someone definite in your company who “owns” each segment.
  
  

One clothing retailer developed segments by asking the following questions:

• Who are my best customers?
• What percent of sales do they generate?
• How big is their clothing budget and the chain's share of their wallet?
• What are their demographic characteristics?
• When and what do they buy in our category?
• Who buys full price versus only items on sale?
• When and what do they buy from the competition?

They went through four steps to create the segments:

• Determine the behavior that drives each segment
• Identify naturally occurring clusters of customers with a unique buying pattern
• Enhance these clusters with lifestyle data and demographics
• Conduct an in-depth survey of each cluster for competitive information and fashion attitudes
  

The chain ended up with nine customer segments. The bottom three segments had 52% of the customers and 10% of the sales. The chain allocated only 5% of the marketing budget to these three segments. The top three had 14% of the customers but 55% of the sales. These received 60% of the marketing budget. Result: increased retention and increased sales from the top segments compared to controls.

Arthur Middleton Hughes is Vice President / Solutions Architect of KnowledgeBase Marketing. He is the author of Strategic Database Marketing 3^rd Edition. (McGraw-Hill 2006).

source: http://www2.kbm1.com/

Tips for Successful Customer Segmentation

Start with the basics.

By Alice Dragoon

October 01, 2005 — CIO —

1. Put each customer in only one segment. Otherwise, customers can get bombarded with multiple, uncoordinated offers.

2. Be channel-neutral. Customers should get the same offers no matter which channel they use. So custom product recommendations should be available to all customer-facing employees and delivered to customers who go online.

3. Give customer-facing employees specific, action-oriented intelligence. Don’t give them data that’s open to interpretation. Tell them exactly which offer is most appropriate for each customer.

4. At the outset of customer segmentation, give the sales force only the best leads to ensure a very high success rate. Once the sales force sees the value of segment-driven sales recommendations, you can expand the lead list to include more customers, giving a "propensity to buy" score for each so that reps understand what level of receptivity to expect.

5. Give a senior manager P&L responsibility for each segment.

6. Put senior management in charge of driving segmentation. As RBC Financial Group Vice Chairman and CIO Martin Lippert notes, companies may miss part of the customer perspective if only a single line of business is pushing segmentation. Also, segmentation is less prone to budgetary constraints if it’s funded by the enterprise instead of by a single group.

7. Start small, then evolve. First divide customers into a few coarse segments, then gradually break them into smaller, more precise subsegments. But don’t wait until you’ve got it all perfect. Just begin.

© 2007 CXO Media Inc.

source: http://www.cio.com/

Customer Segmentation Done Right

October 01, 2005 — CIO — If banks could choose their customers the way kids choose sides on the playground, customers in the 18-to-35 age bracket would be picked last. With their relatively small incomes, low account balances and large student loan debts, young customers aren’t exactly the sort over whom the average bank salivates.

At RBC Royal Bank, however, executives recognized that some of those impecunious young customers might eventually turn into wealthy, profitable customers. So RBC analysts pored through the bank’s data on its young customers looking for subsegments with a strong potential for rapid income growth. Their analysis identified medical school and dental school students and interns as a group with a high potential to turn into profitable customers. So in 2004 the bank put together a program to address the financial needs of credit-strapped young medical professionals, including help with student loans, loans for medical equipment for new practices and initial mortgages for their first offices. Within a year, RBC’s market share among customers in this subsegment has shot up from 2 percent to 18 percent, and the revenue per client is now 3.7 times that of the average customer. Martin Lippert, vice chairman and CIO at RBC Financial Group, says the bank’s willingness to help these young professionals get started will likely be rewarded with a lower attrition rate down the road.

"We may have customers we’re not making money on, but we look at that as more our problem than the customer’s," Lippert says. "Our opportunity lies in finding what the needs of the customer might be so we can offer them additional products and get them to a point where we’re making some return."

While lots of companies claim they’re customer-centric, RBC is one of just a handful of organizations that segment customers based on customer needs, not their own. And by focusing its operations on addressing those needs, RBC has grown its market capitalization from $18 billion almost six years ago to close to $50 billion today.

So far, few companies are as sophisticated at segmenting customers as RBC. Many don’t do any customer segmentation at all, and those that do typically don’t reap much value from the exercise because they segment on the wrong criteria. Precise, needs-based customer segmentation is time-consuming and difficult, and very much in its infancy. But it’s worth doing because it enables cost-effective targeting of customers with product and service offerings that match their needs. That kind of precise targeting obviates spending a bundle on largely ineffective mass mailings—and alienating customers with irrelevant offers. It’s the quintessential win-win: Customers get what they want and subsequently buy more; companies waste less money and increase sales and profits

"The more you’re able to do for the customer, the more likely she is to pay attention to the next offer," says Martha Rogers, coauthor of Return on Customer and cofounder of Peppers & Rogers Group. Yet "companies are not doing nearly so much as they can."

The Wrong Way to Segment Customers

Many segmentation efforts today are an exercise in futility because companies are basing their segments on inappropriate criteria, says Larry Selden, coauthor of Angel Customers & Demon Customers and professor emeritus of finance and economics at Columbia Business School. As a result, organizations often wind up with segments that drain resources, instead of with segments that lead to more effective ways of running the business or meeting customers’ needs. For convenience, companies that are organized along product lines often segment customers by the products they buy. This approach, however, risks alienating customers in two ways: Customers who happen to be in more than one segment get bombarded with multiple uncoordinated offers. And big spenders in one product category who start buying in a second category are justifiably miffed when they’re treated as strangers.

Segmenting by demographics is also quite common, but it’s generally not useful unless customer needs happen to align neatly with demographic characteristics. Lego customers’ needs, for example, do tend to shift with age. Preschoolers, after all, play very differently from kids who are between 5 and 14 years old (what Lego calls the in-school segment). And the 30,000-plus adult fans of Legos tend to be hobbyists with a completely different mind-set altogether. Yet considering age alone isn’t sufficient; Lego also looks at what users do with their bricks. In-school kids who focus on building when they play will likely want plain bricks, but those who focus on role-playing usually gravitate toward themed sets. Cases in which demographics alone are an indicator of a common need are generally rare.

A lot of companies segment customers by revenue, intuitively assuming that revenue is a good indicator of profit. But, Selden argues, that’s hardly ever the case. He maintains that an effective segmentation strategy should begin with a profitability analysis, divvying customers into 10 deciles ranging from most to least profitable. When he segmented one major retailer’s customers by revenue, some that had the largest revenue generated among the lowest gross profits. And to get a true picture of profitability, banks need to think about the amount of capital they must allocate to high-risk customers.

t’s not a given that all or even most customers within a certain profitability decile are necessarily alike. Even so, understanding which customers are profitable and which aren’t is a good starting point. The trick is to delve into each profitability segment to look for hints of possible subsegments, that is, customers whose behavior patterns or other shared characteristics suggest they might have common unmet needs. Once RBC identified the shared unmet needs of young medical professionals, it was able to put together targeted offers to meet those needs and increase the profitability of that subsegment. "The goal for segmentation is to put customers in homogeneous groups based on common needs and wants that you can act on with a common solution," says Selden. "So who are all the people you can go at with a common offer that will make you a boatload of money?"

The Royal Bank Way

Determining your customers’ needs is not a onetime exercise. Although this means you can never be done with the process of needs identification, the good news is that you don’t have to be perfect on the first go-round. Effective segmentation is an exercise in fine-tuning. For instance, RBC started back in 1992 with just three customer segments: high, medium or lower profitability. Over time, RBC’s segmentation process has become much more sophisticated. Today the bank has more than 80 customer models in its data warehouse, and each month it scores all of its eligible customers on all relevant strategic and tactical models. (Someone who already has a line of credit at RBC, for example, would not be scored against a model that predicts the likelihood of acquiring a line of credit. And customers who have opted out of having RBC use their information for promotional purposes aren’t scored at all.) Strategic models—including profitability, life stage, potential, defection risk, client commitment or loyalty and overall risk—help the bank home in on customers’ needs and priorities. Tactical models—such as propensity to buy, the likelihood of a customer canceling a product or service, and the degree to which a customer uses the products he’s acquired—are used to identify revenue opportunities and generate lead lists for employees who deal directly with customers. Scoring customers monthly on the 80-plus models is helping RBC generate more than 13 million targeted leads each month. Roughly 6 million leads are used by salespeople to reach out to customers. The other 7 million are called "sales opportunities" to be used when the customer initiates contact with RBC. That means customer service reps and branch employees have targeted product pitches to offer customers after they’ve handled the customer request.

The three most critical models that drive RBC’s business are profit potential, current profitability and life stage, says Ga¿ne Lefebvre, vice president of client knowledge and insights at RBC Financial Group. "If you have these three things, you can fundamentally manage your business very well," she says. "Those are the ones we’ve been using as a proof of concept since as early as 1996." RBC’s method of projecting potential for each customer is so proprietary that Lefebvre won’t even discuss it, aside from saying that it is not simply a lifetime value calculation. (See "The Lifetime Value Equation," Page 79.) "Profitability is extraordinarily important and it’s where you want to start," says Lefebvre. "But it’s not very informative for understanding client needs." For that, RBC relies heavily on its life-stage model. Using this model (supplemented by focus groups, surveys and third-party research) divides individual clients into five strategic life-stage segments:

1. Youth: These clients are younger than 18.

2. Getting Started: These clients, generally between 18 and 35, are going through first experiences: graduation, first credit card, first car, first loan, marriage, first child.

3. Builders: These clients, usually between 35 and 50, are in their peak earning years. Typically they borrow more than they invest, as they build families and careers. With many expenses, their primary goal is to manage their debt load effectively.

4. Accumulators: Typically between 50 and 60, these clients are worried about saving for retirement and investing wisely. They want to know if they’ve saved enough to retire, if they’ll have to change their lifestyle when they retire and if they’ll need to work to supplement their retirement income.

5. Preservers: The primary needs of these clients, who are usually older than 60, are to maximize retirement income and maintain the lifestyle they desire. They typically manage multiple income sources and are starting to do estate planning.

Lefebvre and her team overlay these life-stage segments with other strategic models such as profitability, potential, client credit risk and client vulnerability (risk of leaving the organization) onto the bank’s objectives: retaining profitable customers, growing customers with potential, managing and controlling customers with higher credit risk profiles and optimizing the costs of less profitable customers. By doing so, they can identify opportunities to make a difference in the market, she says. Once the bank has identified a high-potential opportunity, it models the opportunity to see how much it might grow the business. Then RBC fine-tunes and validates the offer with 100 to 200 customers in focus groups or client interviews. If the offering is complex or demands significant investments of bank resources, RBC will often verify the results through further qualitative research or a pilot, testing different offers and creative among thousands of customers before rolling out the optimal version on a larger scale.

Targeting the Snowbirds

Once you’ve identified a group of customers who appear to have common needs, you have to determine if you can profitably offer a value proposition to meet those needs. It’s all about finding the ideal middle ground between segments of one (it would be too expensive to address customers’ needs individually) and segments that are so large and heterogeneous that you can’t tailor offerings to customers’ needs. Sometimes it’s not worth subsegmenting your customers. (Selden observes that Wal-Mart essentially has one segment of 200 million, based on the assumption that everyone just wants low prices, period.)

"Normally, companies start with a relatively small number of segments, which are fairly coarse," says Selden. "But if you have 40 million customers and five segments with 8 million customers per segment, the chances of those being highly homogeneous are very limited." The goal, then, should be to evolve those segments into more precise subsegments that allow you to deliver more targeted value propositions.

"Subsegmenting," Selden says, "is where the gold is."

Defining a useful subsegment generally involves doing a deep dive into the most profitable end of the segment to tease out distinct behavior patterns. On delving deeper into RBC’s preservers segment, Lippert says, RBC noticed a subsegment of people who spent a lot of time out of the country in certain months. Many of these were snowbirds escaping to Florida to avoid the harsh Canadian winters. Because RBC has branches in the United States, the bank quickly realized that snowbirds represented a sweet spot of untapped potential for the bank.

To address these customers’ unmet needs, RBC put together a "snowbird package" that included travel health insurance, easy access to Canadian funds, online consolidated account review, real-time transfers, the ability to leverage a Canadian credit history to secure mortgages in the United States and a toll-free number for cross-border banking questions. RBC also began introducing customers in the snowbird subsegment to personal bankers in the United States, making it clear that the institution knows its customers and understands the importance of their business.

Catering to snowbirds has resulted in a higher than average number of products per client in that subsegment. And for RBC, that translated to a 250 percent increase in net income per client before taxes. Equally stunning is the 45 percent decrease in the defection rate among the snowbirds. Because acquiring a new customer costs RBC a projected five to 10 times more than holding on to an existing customer, Lippert says that a reduction in the defection rate adds significantly to bank’s overall P&L. The package has been so successful that the bank now offers a similar RBC Access USA package to other groups of customers, such as students and executives, who spend a lot of time in the United States.

Although the snowbird subsegment turned out to be highly profitable, unearthing other subsegments may reveal that they are financial drains on the institution. When RBC uncovers unprofitable behavior patterns, it looks for ways to more efficiently address those customers’ needs. For example, the least profitable group within the preservers segment turned out to contain a number of Canadian retirees whose fixed incomes plummeted in value when interest rates fell and stock returns diminished. Because of the poor return on their investments, they were highly dissatisfied—as well as frustrated with the limited advice offered by financial institutions. Although unprofitable, they were valuable customers who carried twice as many products and services as the average preserver. It turned out they were keeping large balances in short-term guaranteed investment certificates (GICs, the Canadian equivalent of a certificate of deposit) that they were rolling over instead of cashing in. And because they were good at negotiating higher rates when they rolled over their GICs, they were that much more unprofitable for RBC. So the bank developed a group of cash-flow model portfolios to offer these customers. The portfolios, which typically include mutual funds as well as GICs and vary by level of risk and expected return on investment, deliver a better return as well as tax breaks. The customers are happy because they make more money and get to keep more of what they’ve invested. And within two years, RBC has generated 21,000 new retirement-income plans and achieved a net growth of $1 billion in account balances.

The Value of All That Slicing and Dicing

Companies that get the most from their segmentation strategies don’t just pay lip service to the importance of segmentation, they organize their operations around addressing customer needs. At RBC, a senior manager with P&L responsibility manages each segment. In addition, RBC offers very specific, actionable data to customer-facing employees.

"Different people can interpret data in a different manner," says Lefebvre. "We didn’t want to provide data that anyone would have to interpret. So we give them something very specific, such as ’For this client, offer a preapproved line of credit,’ or ’Call this client about a registered investment [Canadian 401(k) equivalent].’" So whether a customer dials in to the call center, visits a branch or talks to a manager, she will be given the same offer because the employee who interacts with her will be prompted by the CRM system to do so. "Delivering data on a real-time basis to reps when they are engaging the client has a tremendous lift," says Lippert. "Some organizations are pushing home equity lines this month, credit cards next month. Our folks are asking clients about particular products that we have intelligence are the ones that those clients are likely to purchase."

By segmenting its customers to offer them targeted, relevant offers, RBC’s personal and commercial division reached its goal of increasing revenue by $1 billion. Since October 2003, client defection has also decreased from 8.4 percent to 6.2 percent, while the number of high-value clients has increased from 17.1 percent to 19.1 percent of the client base today. RBC also boasts a return on equity of nearly 25 percent.

"We have a culture that recognizes that what’s in the information vault is as critical to us as what’s in the money vault," says Lippert. "It’s important to understand that [segmentation is] not typically a year-one, year-two payback kind of investment. It’s something that gets better with time and gets better with the organization’s ability to understand the data."

Lefebvre says that companies just starting down the customer segmentation path should view it as an evolutionary process and just jump in and begin. "Don’t wait for everything to be perfect," she says, "and don’t wait for the next piece of data before you do things. Often you can improve the business successfully in a rudimentary way. Ten years ago we were not as granular.

"Segmentation," she says, "is a journey."

© 2007 CXO Media Inc.


source: http://www.cio.com/

Practice Customer Segmentation for More Targeted Marketing Campaigns

Customer segmentation, also referred to as market segmentation, is the practice of segmenting customers into groups of individuals with common characteristics. By gaining a better overall understanding of customers, then grouping them into categories, companies are able to better optimize marketing programs and allocate marketing dollars more effectively. For example, you wouldn’t want to advertise beach balls to customers living in the North Pole, but you might offer a specialized promotion to your “best” customers (e.g., those who spend over a certain amount per year).

For online store owners, a baseline segmentation analysis can be accomplished using data points that have already been collected from existing customer registrations, order checkout information, and other sources.

Their can be two approaches to segmentation. The first approach, traditional segmentation, organizes customers by key variables such as demographics. The second approach, value-based segmentation, looks at customer needs as well as the costs of establishing and maintaining customer relationships. A brief introduction to each approach is provided below.

Traditional segmentation

Traditional approaches to customer segmentation group customers based on a number of variables that include:

· geographic variables, such as region of the world or country, country size, or climate

· demographic variables, such as age, gender, sexual orientation, family size, income, occupation, education, socioeconomic status, religion, nationality/race, and others

· psychographic variables, such as personality life-style, values, and attitudes

· behavioral variables, such as benefit sought, product usage rates, brand loyalty, product end use, readiness-to-buy stage, decision making unit, and others

Value-based segmentation

Today, the most successful companies practicing segmentation carefully consider overall customer needs and segment customers based on those needs and overall business value. While this strategy is less scientific than the traditional approach, companies that have been successful at assessing groups of consumers both in terms of the revenue they generate and the costs of establishing and maintaining relationships have been reaping great rewards.
Software and solutions

Tools used to assist with segmentation analysis can range from multi-million dollar customer relationship management (CRM) software implementations to smaller software packages that can be used to important and analyze data from spreadsheets.

For the online store owner, the practice of web analytics can be a useful resource for profiling and segmenting your customer base.

source: http://www.goecart.com/

SOA and the Core Competency Model: A Business Perspective for Realizing Competitive Advantages

by William Murray

Published: March 1, 2007 (SOA Magazine Issue V: March 2007, Copyright © 2007)


Abstract: How does the application of SOA translate into a competitive advantage for organizations? The ability to clearly and concisely respond to this question is a prerequisite to any investment in SOA. The core competency model provides a strategic framework from which a corporation can develop an SOA business strategy based on improved business focus and enhanced ability to leverage market-based economies of scale. Four key business concepts that underpin the strategic framework are presented in this article, along with a discussion of how SOA, coupled with business process outsourcing (BPO), provide a strategic opportunity for corporations to drive and leverage the emergence of the service-oriented market.



Introduction: A Business View of IT

While many IT professionals are quick to extol the strategic value of IT, the business world views things quite differently. Two notable publications (“IT Doesn’t Matter” [REF-1] and “The End of Corporate Computing” [REF-2]) revealed that most data centers operate at less than 35% capacity, and the average desktop capacity utilization is less than 5%. Further, many of the same IT-related functions and associated costs are replicated across IT-dependent organizations.

What this all boils down to is an acknowledgement of the fact that, on their own, the boxes, wires, operating systems, application software, and the facilities and people required to care and feed them, do not generally provide a strategic advantage. This is a prevailing business perspective, and one that is actually correct.

Traditional hardware and software alone are not enough to make an organization competitive. That is not to say they are unimportant. On the contrary, as any IT-dependent organization will tell you, they are critical. But critical is not strategic.

As a result, if you want a business audience to understand the strategic value of SOA, it is advisable to leave these issues out of the discussion. And while only the most myopic view of IT would limit its potential contribution to hardware and software components, it is nonetheless incumbent upon IT professionals to fill the void between “IT doesn’t matter” and “IT is of strategic value” with something meaningful. This is why the business of IT (and the business of SOA in particular) is so crucial. In this article, I hope to help fill this void by discussing SOA from a corporate strategy perspective.



SOA-Related Business Concepts

Understanding fundamental business concepts is a prerequisite to any meaningful discussion of the potential impact of service-oriented architectures on business strategy and organizational design. Let’s therefore summarize some key concepts associated with SOA:

1.	Corporations typically internalize core activities and externalize non-core activities. There are two reasons for this. First, quality and efficiency tend to increase as an organization optimizes around a set of core competencies (business focus). Secondly, variable cost structures tend to be less expensive than fixed cost structures (economies of scale).
2.	Market exchanges incur transaction costs. The costs associated with common exchanges (such as sourcing, negotiating, monitoring, dispute arbitration, and exit) offset partially or wholly the potential benefits of improved business focus and economies of scale.
3.	Market and product efficiencies reduce transaction costs. These efficiencies enhance the ability of corporations to externalize non-core activities, thereby improving business focus and cost advantages through economies of scale.
4.	The digital market has improved market efficiencies largely through the application of information technology. Product commoditization (the standardization of products and product interfaces) and efforts to enhance interoperability improve product efficiencies.

With these concepts, we can now probe deeper into the impact of service-orientation on business strategy and organizational design in terms of enhancing the ability of corporations to focus on core activities and the externalization of non-core activities.

We should be mindful that the core competency model is only one form of corporate strategy, albeit widely in use, and certainly not the only way service-orientation can deliver significant competitive advantage. Nevertheless, the ability to discuss service-oriented architecture in these terms is a significant leap forward in pursuit of bridging the gap between IT and business.



Organizational Processes

The corporation, at some level of abstraction, is a collection of inputs, processes and outputs, as illustrated in Figure 1. The core competency model has primarily focused on inputs and outputs. Consider the increasing prevalence of extended value chains in the manufacturing sector, for example.

Figure 1: A simplified view of the corporation responding to inputs by providing outputs.

These value chains link the inputs and outputs of numerous corporations, each of which performs a highly specialized function. Collectively, these functions transform raw materials to consumer products. This shift from vertical integration (where a corporation internalizes the majority of functions required to develop, produce, and deliver a product to consumer markets) to horizontal integration (where a collection of corporations specialize within an extended value-chain) has been enabled by, and reflects improvements in, market and product efficiencies.

Without these improvements, the transaction costs associated with market exchanges would outweigh the benefits of increased business focus and economies of scale. As such, the degree of horizontal integration evident in a given market is a measure of market and product efficiencies. What is being exchanged between corporations at least in the case of the manufacturing sector are inputs and outputs. The majority of internal processes remain deeply embedded within each corporation and are replicated across the value chain.

Apart from production processes directly associated with inputs and outputs, a corporation is also composed of numerous information intensive processes. These would include (but are not limited to) front-office activities (sales, marketing, customer relationship management), as well as back office activities (material, finance, human resource, procurement, and logistics management). The management attention and cost associated with caring, feeding, and coordinating these considerations is significant.

As a result, there is an opportunity to improve business focus and benefit from economies of scale by externalizing many of these “non value-adding processes.” Why then do the majority of these processes remain embedded within the corporation? One possible explanation is that the service sector in general is relatively young in comparison with the manufacturing sector.

More to the point however is the fact that the manufacturing sector has been heavily influenced by the application of engineering principles whereas the services sector has not. These principles are embedded in product design and production processes in the form of product and interface standards and modularization conventions. This has resulted in a significant degree of commoditization of inputs and outputs that, coupled with improved market efficiencies, has driven the shift to horizontally integrated manufacturing markets.

Service process and service product designs are, for the most part, developed by functional experts within the administrative services domain. Not surprisingly, the concepts of interoperability, interchangeability, modularity, decomposition, i.e. an engineered approach to service process and product design are not the primary interest of these functional-oriented communities. The resulting variation (and fragmentation of) service delivery processes makes it difficult for service products to be combined or decomposed (Figure 2).

Figure 2: Non-core internal business processes.

For example:

•	They often implement numerous functions across the organization in a web of activity that is not easily discerned or decoupled.
•	They tend to produce numerous “process tentacles” in order to accommodate unique process exceptions.

In short, as standardization and interoperability are rarely among the process-level design objectives there is a lack of commoditization across administrative services and, as a result, transaction costs related to market exchanges remain high.

The point is, if we apply the logic behind the statement “IT doesn’t matter” broadly across the full spectrum of internal services, it becomes abundantly clear that there are many services, (in addition to the subset of IT-related services discussed earlier) which while critical, are not a source of competitive advantage.

IT-related services however, often tend to attract more attention because they seem to be less embedded or tightly coupled with the business of the organization (in large part due to the application of engineering principles and convergence towards best practices in the industry). This is often construed as being indicative of their declining importance to the business. But the degree of "embeddedness," or “tightness of coupling” may have more to do with the way the underlying business processes are designed than the relative strategic value of the service.



Value Streams

Business process reengineering attempted to address process efficiency by leveraging accumulated technological capability within the emerging digital corporation. The objective was to produce cost/quality advantages through horizontal integration and streamlining of internal business functions to create efficient, client-focused value streams within the organization. The scope of the exercise however was intra-organizational and the boundaries of the organization were largely unaffected.

Reengineering efforts tended to produce tightly coupled processes that became increasingly hard-wired with the implementation of custom enterprise resource planning and management systems. The development of commercial ERP systems did little to change this, as the degree of customization and the instance variations that resulted across organizations were considerable. While in many cases cost/quality advantages have been achieved through process reengineering efforts and the implementation of ERP systems, the net effect has been a set of hard-wired, deeply embedded, tightly coupled business processes. Arguably, these processes were rarely directly connected to any value-adding core competency of the organization.

Figure 3: A market-centric view of SOA and BPO.

More recently, similar efforts have been focused on front-office activities with the introduction of customer relationship management systems. This time around, the focus has been on client-facing business processes. The net effect again is a tendency toward tightly coupled internal business process logic. While many client-facing processes may be too important to externalize even if they are not directly related to the value-adding core competency of the corporation, the prevalence of for example third-party call centers suggests that “many” does not mean “all”.

It may appear as though this attempt to strategically position SOA in terms of improving business focus and leveraging market economies is beginning to sound like a lot of techno-garble for business process outsourcing (BPO). There is some truth to that in so much as the benefits delivered through BPO are much the same as those commonly ascribed to SOA. The overlap is in fact a good thing, as both BPO and SOA (keeping in mind that we are only discussing SOA from a core competency perspective this time around) are based on the same fundamental value proposition – competitive advantage through improved focus and economies of scale. The difference is that BPO is supply-side focused and SOA is demand-side focused; however, each represents a complementary part of the same equation, as illustrated in Figure 3.

Despite a compelling value proposition, BPO market growth has been roughly 10% per year for the last 3 years. Adjusting for general growth in the economy, real growth in the BPO market has been in the high single digit range. Given that BPO and SOA are considered complementary, this rate of growth, while reasonable, is hardly representative of the disruptive shift in thinking often attributed to SOA.

The problem is that BPO is a case of market supply anticipating demand. While the benefits of BPO are very compelling, for the reasons we have discussed, they are quickly offset by the transaction costs associated with the market exchange. SOA promises to address this by commoditizing the demand side, thereby driving down the transaction costs.


The Unavoidable Shift to Service-Orientation

In the first article [REF-3] of this series, I stated that the emergence of the digital market is precipitating a shift in mindset from business processes to business services as the fundamental building block of the corporation. The shift towards service orientation in IT is evident in the many case studies on the implementation of service-oriented technology and applications within IT enterprises.

These studies often result in the extension of select object-oriented principles beyond traditional application boundaries. The scope of the exercise has largely remained intra-organizational, albeit with the potential for eventually leveraging the external application services. These efforts are certainly worthwhile, but it is only when the scope of the exercise is expanded beyond the boundaries of the enterprise that the implications of service-orientation from a business architecture perspective become clear.

While SOA initiatives are important in so much as they deliver benefits related to improved reuse of existing technology assets, they must be firmly rooted within an overarching market-centric business strategy. If they are not, we can expect significant variation between SOA implementations and a lack of attention directed toward the commoditization of internal business processes necessary to leverage the external service-oriented market.

Organizations that recognize the opportunity of the digital market and develop market-centric business strategies will both drive and leverage the emergence of the service-oriented market. Those that hurry toward service-oriented technology in the absence of such a strategy may be trading short-term gain for longer-term pain. A lack of alignment with market standards will constrain their ability to compete within and/or leverage the emerging service-oriented market.

Our discussion so far firmly positions SOA in the corporate strategy domain - a perspective that tends to resonate with a business audience. Below is a summary of the key points:

• The corporation is a set of inputs, processes, and outputs.

• In the manufacturing sector, many inputs and outputs have been commoditized (high product efficiency) through the application of engineering principles. This has resulted in a horizontally integrated market of specialized corporations performing value-added functions along a value-chain from raw materials to consumer product. The resulting market structure enhances the ability of corporations to focus on core business and leverage market economies.

• In the information services sector, inputs and outputs have not been commoditized to the same degree (low product efficiency), because service process and service product design do not typically ascribe to engineering principles. This translates into vertically integrated market structures with diffused business focus and limited economies of scale.

• Both the manufacturing and service sectors have information-intensive processes that remain locked within the corporation. Though arguably not part of the core business, these processes represent significant operational cost and management distraction.

• BPO and SOA are complementary disciplines that collectively enable the same fundamental value proposition: improved business focus and economies of scale. SOA promises to commoditize internal services that, coupled with BPO, drive the growth of the service-oriented market.

• Service-oriented architectures implemented in the absence of an overarching market-oriented business strategy and target business architecture run the risk of limiting the opportunities to leverage the emerging service-oriented market. This can inhibit the realization of competitive advantages through improved business focus and economies of scale.

Conclusion

The core competency model is but one form of business strategy and organizational design to which SOA can deliver strategic value. At the opposite end of the spectrum are differentiation-based strategies, which are in some sense the antithesis of the core-competency model. These strategies will be discussed in the next installment of this series.

Understanding the Core Competency Model For those of you new to the core competency model, here’s an example. Consider two fictional corporations: Acme Belt Company and ABC Belt Company. Both companies manufacture belts for sale in the consumer market. The Acme production processes include the construction of the belt, its buckle, and its final assembly as a market-ready product. ABC, on the other hand, purchases the belt and the buckle from Beaver Belt Supplies and Smith Buckle Manufacturing respectively, and then performs the final assembly for a market-ready product. The cost structures and the unit costs for ACME and ABC are as follows: In the example above the fixed cost structure of the ACME Belt Company results in a higher per unit cost than the variable cost structure of the ABC Belt Company. The difference in unit cost is a source of competitive advantage for ABC. Why is ABC able to purchase belts and buckles at a cost that is lower than ACME can produce them for? The answer lies within the cost structures of Beaver Belt Supplies and Smith Buckle Manufacturing: Because both Beaver and Smith corporations produce belts and buckles for multiple customers in belt and belt-related industries, they have much higher unit sales. Accordingly, the per unit cost of production is lower (economies of scale). As a result, they are able to sell the belts and buckles to ABC Belt Company for a price of $3.00 realizing a per unit profit of $1.00. ABC is able to leverage the market-based economies of scale by externalizing the belt and buckle manufacturing, and focusing instead strictly on assembly. They now enjoy a significant cost advantage over ACME belt supply. Equally important however, are the benefits that accrue from their ability to optimize internal processes around product assembly. For example, because ABC has implemented a just-in-time inventory system with Beaver and Smith, their turn-around time on customer orders is days instead of weeks. For ACME to achieve the same level of operational efficiency they would have to stockpile excess inventory of manufactured belts and buckles, incurring additional inventory carrying costs, thereby increasing per unit costs. The example of ACME and ABC demonstrate the relative competitive advantage of the core competency model related to improved business focus and leveraging of market-based economies of scale.

References

[REF-1] “IT Doesn’t Matter”, Nicholas G. Carr, Harvard Business Review, May 2003

[REF-2] “The End of Corporate Computing”, MIT Sloan Management Review, 2005

[REF-3] “Implications of SOA on Business Strategy and Organizational Design”, William Murray, The SOA Magazine, January 2007