Scratching a Niche

Online interactions can tell companies which customers want innovations.

A major U.S. financial institution-call it HugeBank-was justly proud of the innovative online services it offered its millions of customers. It finally got around to analyzing its virtual customer base. The findings stunned management. Roughly 90 percent of the bank’s online customers logged on barely once a month. By contrast, an obsessive-compulsive 10 percent logged on at least once a day. HugeBank was both embarrassed and annoyed that its pathological dependence upon averages had led it to create a “typical customer,” concealing the extent of this disparity.

But here’s the steel-toed kicker: that laggard 90 percent accounted for barely 30 percent of the bank’s deposits; the hot-wired 10 percent accounted for almost 70 percent of the money. In other words, HugeBank’s most valuable customers by far were those who embraced the online service.

Those stark statistics obliterated what had once been a broad and aggressive innovation agenda filled with Internet-based strategies. The bank discovered that “Internet innovation” had completely different meanings-and profit potentials-for each of these customer segments. The bank’s belief that a single new-product development group could create cost-effective innovations for all the company’s customers provoked a huge internal debate that continues to this day.

With apologies to Harvard Business School’s Clayton Christensen, this revelation represents the innovator’s real dilemma: innovation for whom? It’s not obvious which of these customer segments merits what kinds of innovation. Should the bank focus its technology initiatives on better service for its nebbishy 90 percent or for its most opulent top tenth? A solid business case could be made that the bank would be better off investing the barest minimum to support the 90 percent. Then again, the bank had best be careful about how innovative it should be with the most active customers. They may want less online innovation, not more. Indeed, they may not want innovation per se: they may simply want better service.

But within that top 10 percent of active customers lurk even more provocative questions: Could there be a 10 percent subset that accounts for a similarly disproportionate amount of online usage and bank assets? And might this elite 1 percent become even more valuable if it were offered even newer online offerings?

Economically successful innovation requires economically successful segmentation. Segments that generate growth often require innovations that are fundamentally different from those offered to segments that generate profits. Pharmaceutical companies manage innovation one way for doctors who write prescriptions and another for the HMOs that manage the finances.

While there is no question that the future of segmentation and the future of innovation are increasingly intertwined, strategic innovation generates a portfolio of questions about innovators’ desire to service the segments that matter and ignore those that don’t. Most innovators could afford to invest far less creative effort on improving their innovations in favor of investing more ingenuity in finding customer segments that matter. That’s what HugeBank is now doing. The pleasant surprise? Improving the segmentation enhances the innovation. The needs of that 90 percent become clearer; the trends for that vital 10 percent stand out.

So a most intriguing aspect of a digital medium such as the Internet is that it turns the traditional practices of marketing inside out. Ordinarily, innovative companies spend lots of management time and effort identifying key customers and defining strategic market segments. But as the HugeBank anecdote demonstrates, the rise of Internet-based product and service innovations gives customers the opportunity to unconsciously  segment themselves.

This change should mean a marketing revolution for savvy innovators. Instead of shepherding their customers into predefined market segments, innovators can creatively leverage digital interactions to enable customers’ cost-effective self-segmentation. In other words, instead of spending money to sort out customers, spend money to let customers do it themselves. More often than not, the economics and insights that are derived from self-segmentation prove more favorable than traditional approaches. HugeBank has discovered that it’s cheaper to model services that are based on how customers actually bank online than it is to design new products and marketing campaigns that attempt to change customers’ behaviors.

The fact is, network economics allow innovators to outsource the vital market-segmentation function. That makes targeted innovation initiatives even more cost-effective. The business challenge is to pick the right segments. Should innovators follow the money? Can they afford to underinnovate or underinvest in what might be the segments of tomorrow?

To be sure, some business pundits believe that the ultimate destiny of segmentation is personalization and that technology will transform mass production into mass customization. Perhaps it will. But in the final analysis, customers have as many traits and preferences in common as they do differences. Market differentiation emerges from the differences, but economies of scale emerge from the commonalities. The economics of segmentation will drive tomorrow’s economics of innovation.

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