Smart pricing starts with the customer and works backwards. Our objective is to understand customer needs and their willingness to pay; and most importantly how needs and willingness to pay vary by customer or sector.
Working backwards is one of Amazon’s key leadership principles. It’s a philosophy which has been central to the company’s exceptional success. Its key tenet is to “start with the customer experience, then iteratively work backwards from that point until the team achieves clarity of thought around what to build”. Colin Bryar and Bill Carr, two Amazon executives, explore this philosophy in depth in their book ‘Working Backwards’.
One of the challenges with working backwards from the customer is that customers want different things. They may know what they want, but not what they need. And in the case of innovative new products, they may not even know that they want it. So how can we make sense of those differences to steer decision-making in the business?
The solution is to segment your customer base. This will model your customer base, capturing the key differences between them, and enabling you to act differently in targeting and engaging each segment. Differentiated actions will include:
Customer segmentation should be informed by a deep understanding of your customers. It’s not good enough to slice and dice your customer base according to your own instinctive perceptions (sector, size etc.), although those may be useful parameters.
Get real insight from the ground level: this should be achieved through direct customer research such as surveys and interviews with existing clients and industry experts.
The following framework is one we leverage often at Notion Capital; to help our founders empathise with customers and meaningfully identify their most critical needs. Understanding the customer requires empathy with their pains and then digging into what they are thinking, feeling and doing about those challenges.
The segmentation model for your business will be unique, as it depends both on your customer base and your proposition. But there is a general set of principles which will contribute to an effective segmentation model, as follows:
There are five key principles you need to take into account when designing a customer segmentation model:
That final principle is the ultimate litmus test for an effective segmentation model: if your segmentation does not give you new insight to act differently, then it is not an effective segmentation.
Determining how to approach each segment is relevant to all businesses, regardless of their level of maturity. In fact, in many ways it is hyper-critical to businesses whose products are early in their lifecycle and still exploring product-market fit. Focusing on the wrong segments, too many segments, or (worst of all) with no focus whatsoever, will create a significant drag on growth and can ultimately be fatal for VC-backed start-ups as they burn through funding with little to show for it.
In their excellent book “Customer Success”, Daniel Steinman, Nick Mehta and Lincoln Murphy, reference a discussion with Dave Kellogg, CEO of Host Analytics, who says that “90% of all churn happens at the point of sale”. Kellogg means that focusing on the wrong customers is enormously costly, and that to drive success for your customers - and hence ongoing revenue for your business - you must first of all be selling to the right customers.
Following on from defining your segments, a segmentation map is a useful tool with which to visualise which segments to focus on and then drive alignment across the business. Each segment is plotted against two dimensions:
The shorter the distance, the better the fit. The size of the bubble can also be used to represent the revenue potential to give a sense of materiality. In principle, you should focus on those segments with the smallest distance and determine the sequencing and workstreams required to address the remaining segments.Our thanks to Ed Cordin from the Team Room for sharing this powerful model with the Notion Capital team.
Colin Bryar and Bill Carr: Working Backwards
Nick Mehta, Dan Steinman and Lincoln Murphy: Customer Success
Ed Cordin, The Team Room