Behavioral Segmentation for e-Tail Personalization

byDouglas L. MacLachlan
Professor of Marketing
University of Washington Business SchoolBox 353200, Seattle, WA 98195-3200(206) 543-4562
macl@u.washington.edu

June, 2003.

Behavioral Segmentation for e-Tail Personalization
Abstract
A multichannel retailer desires to develop a personalization strategy for customers who agree
to receive e-mail communications containing imbedded Internet purchase appeals. Usingcustomers’ transactions history with the firm, four behavioral segments emerged from factor
and cluster analyses. The segments were also distinguishable on the basis of attitudes toward
shopping, determined from an attitude survey. A CART analysis provided an algorithm forclassifying customers into the behavioral segments, based simply on their purchase history
information. The segments were validated in a replication, which involved a survey with a
new sample. Finally, different appeals were used in personalized messages tailored to two of
the segments in an I-media experiment. The appeals resulted in higher sales response for oneof the segments.

Key words: e-commerce, multichannel retailing, behavioral segmentation, personalization,
relationship marketing2

Although hyped as the eCommerce “Holy Grail,” true personalization at the individual
customer level remains far in the future for most retailers. Certainly a degree of 1-to-1
communications between retailers and customers exists today, but customers rather thanretailers typically initiate the exchange, and the actual personalization involved is fairly
minimal (Peppers, Rogers, and Dorf, 1999). So-called “personalized” retailer
communications are by and large reactive, rather than proactive or promotional. Reachingeach customer with individualized promotional messages is largely infeasible for most
retailers, despite the new information economics driven by the digital revolution (Peppard,
2000). Indeed, some have questioned whether personalization is even appropriate (Nunes andKambil, 2001). Those customers who agree to receive persuasive communications through Imedia, however, represent a potential source of new revenues for retailers having the desire
and technology to address them.

What can a retailer do to achieve a degree of personalization of promotional messages,
without communicating individually with all customers? The answer would seem to lie inbehavioral segmentation; that is, grouping customers with similar purchase behavior into
segments for the purpose of targeting them with persuasive messages that are personalized at
the segment level.

Retailers potentially have in their databases vast amounts of cumulative information on thetransactions of many of their customers. Not only can those databases contain transaction
dates and amounts (leading to information on RFM variables, i.e., recency, frequency, andmonetary value of customer transactions), but they may also record what was purchased oneach occasion, including such data as styles, colors, and other item-specific information,3

whether the item was purchased on promotion, method by which the purchase was made(credit card, check, cash), channel used (store, catalog, internet), and so forth. These are the“behaviors” on which behavioral segmentation can be based.

A major question to be answered before undertaking behavioral segmentation in this arena iswhether it is possible to define behavioral segments to which targeted (i.e., personalized)
persuasive appeals can be made that will actually result in increased sales. The answer
involves demonstrating the validity of several linked propositions: (1) behavior-based
segments, that are comprised of customers or potential customers who would responddifferentially to targeted appeals, exist and can be discovered; (2) persuasive appeals can be
designed that will be differentially attractive across the behavioral segments; (3) membershipin a priori defined behavioral segments can be identified; and (4) personalized appeals will be
successful in increasing purchase volume and/or frequency of purchase within targeted
segments.

A multichannel (store, catalog, internet) retailer set about to provide a “proof of concept” of
one type of behavioral segmentation in a realistic context.1 It involved a multistage research
program and a variety of multivariate statistical methods, as well as conceptual and creative
input from advertising specialists. This paper describes that effort.

It must be recognized that the behavioral segmentation described in this paper only involves
existing or past customers, and indeed, for purposes of developing marketing campaigns, only
those existing customers who agree to be contacted by e-mail. To that extent, what is
involved is a form of “permission marketing,” (see Godin (1999)). Prospective customers
1

The company has declined to be identified by name. An original co-author of this paper was formerly Directorof Customer Relationship Management for the company, but may not be identified because of company
confidentiality.

4

will require other variables than past transactional behaviors in order to segment them; e.g.,demographics, geocoded psychographics, and so forth.

1. The Company
Evolved from a single-store retailer specializing in outdoor gear, the company now has over
600 stores, selling mostly casual sportswear (although it has stores selling other items aswell), a large catalog operation, and a burgeoning Internet presence. Although its stores aremostly in the US, it does an increasing amount of business outside the US through its catalogs
and website. Its sales are in excess of $2 billion, of which roughly one-fourth comes from
catalog and Internet business. Thus, it has long had a multichannel business strategy anddesires to capitalize on that strength by increasing synergies across its channels.

The company maintains a database of customer transactions across the three channels and has
a number of customers who have agreed to be sent e-mail messages with imbedded I-media
content. It is this last group of customers with whom the company would like tocommunicate using personalized promotional messages.

The company is prototypical of the retail organization most likely to survive and prosper inthe future (Spector 2002). Rather than being a “pure-play” e-commerce company likeAmazon.com, it evolved over time from a successful retail store chain and catalog retailer,
into a completely integrated “bricks and clicks” firm, with significant synergies among theparts. Customers who have gotten to know and grown loyal to the company over the years,
either from visiting its stores or using its catalogs, are naturally drawn to its website as they
become more comfortable shopping for goods online. Most people who have purchased
goods online were already aware of the physical stores and typically began their relationship5with the company by purchasing at those outlets. Many customers have developed sufficient
good will and loyalty to the company to be willing to receive e-mail messages (on an
acceptance basis) that are linked to its online store.

Being a physical retailer has allowed the company to help its online customers obtain rapid
order fulfillment because of its existing network of warehouse and retail facilities. Returns
can also be taken directly to the stores, creating a level of product assurance unmatchable bypure-play e-tailers. Product assortments, while overlapping, can be different across the threechannels, making it easier to satisfy the variety of needs of its many customers with greater
breadth and depth of product lines.

Fundamentally, the multichannel marketing approach fosters a high level of trust among thecompany’s loyal customers and confidence that it will deliver on its promises. The ability
rapidly to obtain extensive data on purchase behavior through all channels allows thecompany to tailor its offerings more closely to its customers’ needs, thereby creating greater
customer satisfaction, loyalty, and repurchase behavior.

The data allow the company the ability to employ behavior-based customer segmentation.
The idea is to personalize, at the segment level, the offerings made through e-mail and overthe Internet. The general communication approach they have called “personalized content.”
While not strictly personalized at the individual customer or household level, personalized
messages are to be directed to segments of current and potential customers deemed to havedifferent needs based on their patterns of buying behavior. The company’s Customer
Relationship Management group experimented with and validated such a customer
segmentation and communication approach during the spring and summer of 2000.

6

As an aside, other cluster-oriented empirical segmentation approaches might have been
employed (Wind, 1978). For example, attitude-based segmentation schemes might appear tobe an acceptable alternative to behavior-based segmentation. However, past behavior has
been demonstrated often to be a better predictor of behavior than attitudes (or behavioral
intentions). Furthermore, measuring attitudes requires survey research, which would be an
expensive undertaking relative to the inexpensive information available on customers’ priorpurchases. This is especially the case if identifying segment membership required surveying
the attitudes of all of a company’s e-mail customers. Closely examining behavioral patterns
allow inferring the benefits that customers seek from their purchases and shopping activities.
So in fact, behavioral segmentation is a kind of benefit segmentation, perhaps the mostintuitively desirable form of customer segmentation available to marketers (Haley, 1968).

Unlike some companies’ approaches to behavioral segmentation (e.g., based on RFM or
similar variables), this company decided to incorporate attitudinal information at the earlystages of its investigation of this approach, to help understand behavioral patterns. Only after
behavioral segments were characterized in terms of their attitudes, were pure behavioral
segments selected for personalized communications. This might make the company’s
approach unique.

The purpose of this paper is to describe the company’s approach to researching whether thistype of segmentation and communication approach would be a viable means of targeting its
customers. Additionally, we provide some insights into a successful multichannel retailer’smarketing strategy.

7

2. Research Methods
The research was divided into three major phases: (1) preliminary development of behavioral
segments and means of classifying customers into those segments, (2) validation of the
behavioral segmentation with a new sample, and (3) testing to see whether targeted segments
would respond differentially to personalized messages.

To validate the propositions mentioned above, it was first necessary to match respondents
from an attitude survey with their transaction behavior data. That is, in order to target
persuasive messages, it was determined necessary to describe behavioral segments on thebasis of attitude variables as well. Thus the first step was to take respondents from a surveyof customer attitudes toward shopping in general and add to that database those customers’
shopping data from purchases made across all modes for previous years.

This combined database (of attitudinal and behavioral data) was then subjected to several
analyses. First, exploratory factor analyses were used to identify underlying dimensions of
behavior based on the item-specific variables obtained from purchase transaction records.
Factor scores from these results were used to cluster subjects into groups. Multiple clustering
routines were employed and the resulting clusters were cross validated to assure theirstability. (A combination of hierarchical and nonhierarchical clustering methods was
employed.) Next, the resulting clusters were described both on the basis of the behavioral
dimensions and the attitude dimensions coming from factor analyses of the attitude variables.
The last preliminary step before the experimental stage was developing a procedure forclassifying additional customers into the behavioral segments; i.e., for identifying segment
membership of any customers based on their prior purchase patterns across the channel
modes. Tree-structured classification models were used for this stage.

8

The behavioral segmentation validation of phase 2 involved using a new sample of current
customers with a similar behavior profile, to see if the attitude profiles would be replicated in
the behavior segments. This new sample of customers was surveyed to ascertain theirattitudes about shopping, fashion, clothing and lifestyle. The transaction behavior
information available on these surveyed customers allowed their classification into thepredefined segments. Attitude profiles were then developed for the segments and comparedwith similar profiles developed in phase 1.

The testing stage, phase 3, involved designing persuasive communications in the form ofinternet-embedded messages in emails that were sent to customers who agreed to be thus
contacted. The persuasive communications were designed to appeal differently to thesegments. Customers who were to be contacted by e-mail were classified into their respective
segments and the different appeals were sent. Sales across all channel modes were monitored
for all customers sent the messages and compared to customers who did not receive thepersonalized messages.

It was not necessary to use samples of customers in the third phase, because the experiment
could involve all customers.

3. Results of Phase 1
Customers in an attitudinal sample survey done in 1998 were matched to the in-housetransaction database for all transactions across all channels for the five years between 1995
and 1999. This resulted in data for 615 customers.

9

Transactions were transformed into variables that reflected the type of product (e.g., garmentspurchased were categorized by color, size, dressiness, and so forth), the channel, the payment
method, spending levels, and responsiveness to offers. Additionally, transactions weretransformed into variables for each channel or category of product that reflected the frequencyof purchase, share of total purchases, dollars spent, and average number of items. Factor
analyses of these behavior variables resulted in four dimensions of customer relationships
with the company: spending level, channel preferences, spending pattern, and productpreference.

Cluster analyses using factor scores resulted in stable clusters for four behavioral segments.
Comparing the results of different cluster and linking algorithms assessed stability of the fourcluster solution. (As an interesting side note, in a paper presented at the 2001 Marketing
Science Conference, Dolnicar and Leisch (July 2001), a content analysis of a large number ofpublished segmentation studies showed that four was the modal number of segments
identified in those studies.)

Profiling of the four segments resulted in naming them as follows: Too Busy, Stylish
Professionals, Conformists, and Shopping’s Fun (not the actual labels). Table 1 shows thepercent of the sample for each segment along with some of their descriptive characteristics.
The two smaller segments accounted for disproportionately larger spending.

Table 1 about here

10The designated segments were then characterized according to their attitudinal profiles.
Attitudinal dimensions uncovered with factor analysis were: Brand Orientation, Shopping
Experience, Style Consciousness, and Self-Confidence. The results are shown in Figure 1.

Figure 1 about here

As can be seen, the three dimensions Brand Orientation, Shopping Experience, and Style
Consciousness distinguish the segments Too Busy and Conformists on the one hand, from
Stylish Professionals and Shopping’s Fun on the other. The remaining dimension, SelfConfidence, distinguished Too Busy and Stylish Professionals from the Conformists andShopping’s Fun segments. Multivariate ANOVA demonstrated that the four dimensions
distinguished among the four groups at the .001 level of significance.

This is an important finding, in that it demonstrates, at least in this instance, that transactionbehavior actions are associated with attitudinal differences. Thus, the attitude descriptors of
the segments can be used to help develop creative appeals that are designed to be attractive
specifically to the different behavioral segments.

Next, in order to be able to identify membership in the different segments for other customers,
classification trees were developed using the CART procedure (Breiman, et al., 1984).
CART provides automatic development of a model that can incorporate interactions in abinary tree structure. It has a cross-validation procedure that selects stable trees. Among theset of original variables used to develop the segments, twenty-three variables were founduseful for predictive classification. Although the variables employed are disguised, the treethat was developed and validated is shown in Figure 2. Each final node represents

11classification into one of the four segments as indicated. What is not shown is that theclassification is essentially probabilistic, in that each node represents proportions of customers
in each of the four segments, with the assignment made on the basis of highest proportion(plurality) at that node.

Figure 2 about here

The tree in Figure 2 allows unambiguous classification of most of the company’s customers
into one of the four segments (except those customers for whom little transaction data isavailable). Although misclassifications will certainly occur, the model provides correctclassification for a large majority of customers.

4. Results of Phase 2
Six hundred customers participated in a telephone survey in spring of 2000, which was not
identified as being sponsored by the company. The sample was extracted from a customer
database that had been scored for membership in the four segments by the classification tree
developed in phase 1. The four segments were approximately equally represented in thesample, which was a slightly different proportion than occurred in phase 1. The questionnaire
included a subset of the attitudinal battery from the original survey, some demographics, andquestions about channel usage (to update internet-related behavior which was assumed to bequite different after two years), spending, and competitive purchases. The respondents also
evaluated the extent to which descriptions of the four segments’ profiles fit their attitudes
toward shopping.

12

The attitude profiles of three of the four segments were validated. The Stylish Professionals
had nearly identical patterns in all aspects of the profiles. The Too Busy segment’s customers
were still convenience-oriented and bulk-purchase-oriented in both attitudes and behaviors.
The Conformists were somewhat more fashion conscious than in the earlier study. Although
the Shopping’s Fun segment’s customers were consistent with its original profile for the mostpart, some of their attitudes were different from before, making that segment no longer fully
warrant the name. Although this last segment still expressed some enjoyment in shopping,much of the challenge and fun was missing for them.

The results indicate that the classification-tree scoring algorithm was successful; i.e., thesegments were behaviorally differentiated as before. Any differences in spending patterns
from those found before were consistent across all segments and represent general trends.

The data support the development and use of positioning themes created after the initialproject. Links between behavioral indicators and attitudes provide a rich resource fordevelopment of communications to attract key customers.

5. Results of Phase 3
As indicated above, attitude and behavioral profiles of the four segments were presented tocreative personnel, along with instructions to design two different persuasive communications
that could be transmitted to customers willing to be contacted by e-mail. Thus, different
messages were to be targeted to the most valuable segments (in terms of their higher per
capita revenues), Too Busy and Stylish Professionals. Given the attitudinal profiles, it was
felt that the Conformists and Shopping’s Fun segments would probably be influenced at least
somewhat by appeals directed to the other two segments, respectively. That is, the idea was13

to direct two different appeals to the left and right side segments shown in Figure 1. For thistest, three versions of e-mail were sent to different cells of the two target segments – one
designed for each target segment and a third neutral control version. Subgroups within eachtarget segment were sent the neutral control e-mail.

The creative staff came up with two positioning themes to address the segments. “EasyChoices” aimed primarily at the Too Busy segment and “Add Spice to Your Wardrobe” to betargeted mainly at the Stylish Professionals.

As an example of one appeal developed to be sent to the Stylish Professionals (andShopping’s Fun), an ad used the lead line: “Find accessories to put your own mark on classic
business clothes …”. The ad stressed spontaneity and versatility in the clothing and used
edgy, dramatic flair in the photography. The appeal to be sent to the Too Busy (andConformist) customers emphasized simple purchases of classic ensembles. The same
products were to be displayed in each ad, but with different executions. Obviously every
communication must be different over time as merchandise and fashions change, but clear
understanding of a positioning theme allows creative personnel to work within guidelines in
the hope that personalized appeals will differentially influence the intended target segments.

After classifying all e-mail customers into the four segments, the two appeals were directed tothe segments in the left and right halves of Figure 1. Neutral appeals sent to subsets of eachsegment contained only general information, not product-specific appeals. Results weremonitored in terms of actual sales to these customers across all channels over the ensuing
period (one week). Although the results are proprietary, it can be disclosed that significantly
higher per capita sales occurred for customers in the Stylish Professionals segment who

14

received the personalized e-mail message over those receiving the neutral e-mail. None of theother segments outperformed customers receiving the neutral control e-mail, in terms of percapita sales.

Therefore, it was determined that the experiment was only a partial success. One of thesegments performed better than would be expected by chance. The personalized appeal
apparently was sufficiently persuasive with members of the segment who received it, toincrease their purchase propensity. The Too Busy target segment (and other segments) might
not have been provided with sufficiently creative personalized appeals to generate more thannormal purchases.

6. Conclusions
By and large, this series of studies has successfully demonstrated the proof of concept thatwas their objective. It was found possible to uncover behavioral segments with variables
derived completely from transactional information on customers. These segments were not
only different behaviorally, but also different in their shopping attitudes. A scoring algorithm
was found to be successful for predictively classifying customers into the behavioral
segments. For the most part, the segments were determined to be stable and consistent over a
two-year period. Personalized I-media communications were found to be differentiallyinfluential in stimulating purchases in the case of one of the targeted segments.

Although this project provides only a partial validation of the proposed strategy foraddressing behavioral segments with targeted communications, the results are encouraging.
Companies with similar databases as this company can perhaps identify segments for
personalization of their I-media communications. In the case of this company, more work

15

will need to be done to refine its segmentation, to develop positioning themes, and to makethe communications increasingly attractive differentially to its customers. As a practicalmatter, the company management has decided not to pursue this avenue for e-personalization
at this time. However, the series of studies is valuable in that it demonstrates that the chain ofreasoning from behavioral data to segments that can respond differentially to communications
can be validated in certain circumstances.

We have been able to provide only sketchy descriptions of the methods employed in thisresearch project, but we hope that they stimulate future work in this arena. Human behavior
is complicated, necessitating complex methods for understanding and predicting behavior that
results from attempts to persuade. It is a big leap from classification of customers into
behavioral types to designing and communicating persuasive messages with hope of
encouraging additional sales. Yet the advent of e-mail and Internet, along with technologies
for database marketing, has opened the door to the possibility of successful e-personalization
through behavioral segmentation.

References

Breiman, L. J. H. Friedman, R. A. Olshen, and C. J. Stone. (1984). Classification andRegression Trees. Belmont, Calif.: Wadsworth.

Claycamp, Henry J. and William F. Massy. (1968). “A Theory of Market Segmentation,”
Journal of Marketing Research 5 (November), 388-394.

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Dolnicar, Sara and Friedrich Leisch. (2001). “Knowing What You Get – A Conceptual
Clustering Framework for Increased Transparency of Market Segmentation Studies,”
Marketing Science Conference, Wiesbaden, Germany, (July 6).

Godin, Seth. (1999). Permission Marketing. New York: Simon & Schuster.

Haley, Russell. (1968). “Benefit Segmentation: A Decision-Oriented Research Tool,” Journalof Marketing 32 (July), 303-315.

Nunes, Paul F. and Ajit Kambil. (2001). “Personalization? No Thanks,” Harvard Business
Review (April), 2-3.

Peppard, Joe. (2000). “Customer Relationship Management (CRM) in Financial Services,”
European Management Journal 18:3, 312-327.

Peppers, Don, Martha Rogers, and Bob Dorf. (1999). “Is Your Company Ready for One-toOne Marketing?” Harvard Business Review (January-February), 151-160.

Spector, Robert. (2002). Anytime, Anywhere: How the Best Bricks-and-Clicks Businesses
Are Delivering Seamless Service to Their Customers. Cambridge, MA: Perseus Publishing.

Wind, Yoram. (1978). “Issues and Advances in Segmentation Research,” Journal ofMarketing Research 15 (August), 317-337.

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Table 1: Behavioral Segmentsa
Segment

Percent ofSamplePartial Description•

Too Busy

22••

Stylish Professionals

16

•
•

Conformists

30

•
•

Shopping’s Fun

32•

High spending levels, especiallyfrom catalogs and I-media
Frequent bulk and big-ticket
purchases
Buy dresses, but infrequently
buy other clothing
Frequent trips to store with smallpurchases
Bulk purchases often, mainly
storesHighest men’s purchases

Higher than average retail trips,
but not spending
Purchase at discount oftenaNames and partial descriptions disguised.

18

Consciousof Other
TastesSelf-Confidence

Strong Senseof Own Style

Brand Indifferent

StylishProfessionals

Too Busy

Boring,Time-Consuming

Fun

Shopping Experience

Shopping’s
Fun

Conformists

What’s Right

Brand Conscious

Brand Orientation

Style Consciousness

Figure 1: Segment Attitude Profiles

What’s New

0, missing
>8

<=8
X2

3

>0

X1

<=4

<=90

>90

X3

>4

X4

<=25

4

X5

>25

2

<=1

<=8

4

<=750

X7

missing, 0
<=.25

>1

X8

1

>8

X11

>.25

X10

<7

>0

2
1

1

<=.15

<3

missing, 0

X14

>0

4

missing,0

missing, 0

X17

>.25

<=750

4
1 – Too Busy
2 – Stylish Professionals
3 – Conformists
4 – Shopping’s Fun

0, missing

X22

4

>750

X6

X19

>=1

>0

1
missing,0

X210, missing

>=1

2
4

3

>0

X20

<=.3

X23

>.3

2
4

3

2

>0

X18

2 missing, 0>0 <=1.6

X8

>1.6

2
3

<=.25

1

X15

>=7

X12

>.75

1

>=3

X13

X16
<7

>.15

X9

>=7

X12

<=.75

>750

X6

2

4

Figure 2: Classification Tree
21