Market segmentation is becoming increasingly important as companies target different customer groups while seeking to extract maximum value. A simple example of this is where priceinsensitive customers have inelastic demand and will pay a higher price for a product, whereas a price-sensitive customer will seek to pay the lowest price possible. This may be for the same or different products or services. (See the sidebar “Product-Based Segmentation: Good-Better-Best Pricing” at the end of this article.)

A single price for one, all, or some products and services leaves money on the table by giving price-insensitive customers a bargain (because they would be willing to pay more) while simultaneously losing the price-sensitive customers unprepared to pay the single price.

Business-to-business negotiations

The principles of segmentation are important in B2B markets. A cardinal rule of negotiation is to avoid giving something for nothing. If a customer insists on the lowest price, the customer must make concessions. The key is to provide sales representatives with a “menu” of options as a basis for negotiation. For example, for physical products, these can include a warranty, delivery, rush orders, contract changes, and a customer helpline. Options for digital services include service availability, data storage capacity, service speed, time-sensitive information time lag, and access to cloud storage.

There are several types of B2B customers and not all are price driven. They may be value driven, wanting a product that meets their needs at a fair price, or they may be price-insensitive, prepared, for example, to pay a premium for reliability or immediate service or support. The emphasis, during negotiation, is on understanding what the customer values.

• Price-driven clients should be offered a minimal service. More functions and better service can be negotiated — at a price.
• Value-driven customers should be offered a range of options. This helps to pin down exactly what the customer values.
• Relationship customers who trust the supplier must be fostered. They probably value service and support, and the menu should offer services that they are prepared to pay for. If they have problems, they must be taken seriously.

Finance’s role

Management accountants have the key skills and techniques to make a vital contribution in supporting marketers and sales representatives in B2B negotiations on pricing. They can:

• Analyse customer sales data to determine whether the price paid, after considering all discounts and services provided, is satisfactory — taking account of the level of sales for each customer and the customer’s strategic importance.
• Analyse customer prices and sales volumes to gain insight into the type of customer: price-driven, value-driven or relationship.
• Act as a facilitator, coordinating marketing, product development, and finance, in preparing product variants.
• Work with marketers and product development to identify the minimum service that can be offered to price-sensitive customers, and its cost and price.
• Work with colleagues to identify a range of value-adding options that enhance the minimum service, and their costs and prices. This “menu” provides the basis for identifying what customers value, a vital step in negotiations.
• Support salespeople in determining costs and prices for special requests from value-driven and relationship customers.

The total cost of supply is not just the physical cost of the product: There are costs of inventory, credit, delivery, customer support, and warranties. The finance team, understanding the principles of activity-based analysis, can create the menu of costs and prices to be pre-approved by marketing management. (See the sidebar “Management Accountants’ Contribution to a Segmentation Exercise”at the end of this article.)

This approach means the sales representative can be empowered to negotiate with the customer without recourse to higher levels of management.

Higher managers may agree a deal without full understanding of context or implications and such access leads the customer to believe that a better price is possible by negotiating hard.

Product-based segmentation: Product use

Some products have many uses, and this can be important in segmenting the market. The chemical industry provides many examples, as chemicals can have many different uses, such as in producing fertilisers and in beauty products.

For example, Oriental Carbon & Chemicals (OCC), an India-based company, specialises in the production and sale of sulphuric acid and insoluble sulphur. Sulphuric acid is used in vehicle batteries and in industrial applications such as the manufacture of phosphatebased fertilisers, explosives, and detergents. Insoluble sulphur is important in vulcanising rubber during manufacture of many products including shoes, cables and, especially, tyres.

OCC has invested heavily to improve product performance and to comply with increasingly strict environmental regulations. To differentiate its product range, OCC has patented several grades of insoluble sulphur under the brand name Diamond Sulf, targeting different market segments.

Other types of segmentation

In addition, segmentation can be based on location, demography, time, and quantity.

Location. In territories across the world, local conditions are paramount in determining what price is acceptable. Finance needs to assess overseas sales, including consideration of transport costs, taxes, exchange rate risk, and the possibility of a grey market. This is where a product purchased in a cheaper market is re-exported into a more expensive market. To combat this, companies may limit the price differences between markets. However, this solution may be insufficient and, instead, it may be worthwhile to differentiate the product destined for a low-price area, for example by its packaging, warranty conditions, or even limiting its function, so that it cannot easily be re-exported. However, branding and marketing can be expensive and management accountants should be involved in assessing the relevant costs and projected revenues.

Demography. Different prices for different customers are common — some retail businesses and entertainment venues offer deals to seniors, students, some employment groups, and loyal customers. Again, the finance team should be involved. These schemes are likely to increase sales volume but need careful attention because some customers previously paying full price will switch to take advantage of the deal.

Time. Time-based segmentation is prevalent for technology and fashion products: a high price initially, but decreasing over time. Apple iPhones, for example, are not withdrawn when a new model is released, and significant savings are possible by waiting one or two years. Unsold fashion goods are often offered at reduced prices in end-of-season sales.

Finance needs to assess the profitability of these policies, taking account of changing prices over the lifetime of the product. For fashion goods, significant first and second reductions often work well. Any remaining inventory might be sold in bulk to third parties to avoid further “giveaway” price reductions.

Quantity. Volume discounts are commonplace in both B2C and B2B markets and with good reason. Selling costs are likely to be little changed if more product is sold but the extra volume generates extra contribution. The market is segmented as high volume, price sensitive where customers are charged a lower price per unit; and low volume, relatively price insensitive where customers are charged a higher price per unit.

The safest discount gives a lower price only for incremental volume above a threshold. However, total volume discounts are also common, as in “£4 off when you spend £40” in supermarkets. Total quantity discounts need to be handled carefully.

Conceding, say, a 1% discount for extra volume seems trivial, but not if it applies to the whole volume. Another trap to be avoided is the customer claiming that the whole of a price increase should not apply because of an already negotiated discount. To concede would be disastrous — it would mean a reduced price increase while the customer retains the discount.

Conclusion

Segmentation techniques are many and varied but the underlying theme is always the same. It is to extract the value that the customer sees in the product or service, targeting price-sensitive and -insensitive customers separately with appropriately designed and promoted products or services. Finance should understand the techniques and the part that they can play in supporting their marketing, pricing, and product development colleagues.

Product-based segmentation: good-better-best pricing

There are many examples of good-better-best pricing: airlines’ first, business, and economy seats; Zoom’s basic, pro, and business packages; and so on.

Finance should have a key part to play in designing product ranges, pricing, and value propositions. An increased product range comes at a cost. The incremental costs need to be calculated and compared to estimated incremental revenue. And, while a wider range of products targets more customers, it risks confusing the customer and creating misalignment with both strategy and/or propositions for the products.

A range of products is needed to explore these three recommended pricing approaches:

• Extreme aversion. Customers tend to move to the central options and companies can profit from this, as “value” customers are tempted to move up the range.
• An anchor. Here the product range allows inclusion of a high-priced, prominently displayed, top-of-the-range item that can help anchor the customer’s price expectation; other products seem good value by comparison.
• A decoy. A product that is obviously inferior to another directs customers to the superior product — even though there may be better value elsewhere in the product range.

David Dugdale, ACMA, CGMA, is Emeritus Professor of Management Accounting at Bristol University in the UK. To comment on this article or to suggest an idea for another article, contact Oliver Rowe at Oliver.Rowe@aicpa-cima.com.

Management accountants’ contribution to a segmentation exercise

By Karl White

Finance can support a product or customer segmentation exercise by:

• Providing price and volume data for cluster analysis to identify products and customers that can be grouped into similar categories. For example, a distributor of building material might analyse data to see which customer segments in different geographical locations pay higher or lower average prices for a given product. Another example might be a fast-food restaurant analysing data to understand which products are typically purchased together and therefore may be good candidates for menu bundling.
• Sales transaction data can also be analysed to understand how different customer segments behave after a price change or a promotional discount. Regression analysis can show which customer segments are more or less price-sensitive. Analysis may also reveal cross-price elasticities where a price change in one product affects the volume of another product. Using the fast-food example again, if a burger meal is often purchased with a dessert, regression may show that a price rise on a burger meal reduces the propensity to purchase a dessert from the premium range.
• Scenario modelling is a crucial stage in pricing strategy development and finance should have a key role in assessing the financial impact of possible price changes and promotional activities. An example of this could be a software company developing a new technology to sell to its existing customer base. The sales and margin impact of likely demand across different price points needs to be modelled, taking account of likely migration of customers across the revised product range. Sensitivity analysis helps to inform management of the potential upside and risk of the new product pricing strategy.

Karl White is commercial director at AICPA & CIMA, together as the Association of International Certified Professional Accountants.

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AICPA & CIMA RESOURCES

“4 Ways CFOs Can Maximise the Benefits of Predictive Analytics”, FM magazine, 24 May 2023

“Valuing Customers: Part 1 – Profitability Based on Past Performance”, FM magazine, 19 October 2022