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Segmenting Relationships

November 11, 2009

As The Economist points out, market segmentation is a topic of growing interest and sophistication (see Segmentation). Traditionally, it is the process by which we slice ‘markets’ into different types, in order to improve services and increase revenues. However, the technique is increasingly used more broadly by any organization or group providing products or services, in order to ensure the efficiency and relevance of their offering to customers or users.

I find the topic of segmentation fascinating because of course it has direct relevance and application in the world of contracts and relationship management. As The Economist points out, the technique was a direct reaction to the ‘one size fits all’ mentality of Henry Ford. While the Ford approach was undoubtedly efffective in delivering high volume, low cost products, it was not effective at meeting the needs of specific groups – for example, those with large families, or greater wealth.

Large corporations have tried to simplify the complexity and risks of contracting with similar ‘one size fits all’ models. Under pressure, they would agree to custom negotiations and some have developed a limited portfolio of contract types, or allow customization through pre-configured fall-back terms.

However, these methods continue to lack real sophistication. Contracts contain commitments and also set the framework for how the relationship will be managed. They contain provisions related to responsibilities, change procedures, rights and obligations. Often they ignore the value that the other party may place on these provisions – so sometimes the terms are over-engineered and sometimes under-engineered. Identical products or services may be put to very different applications within a customer organization – and therefore demand very different commitments from the supplier.

This concept of needs-based segmentation is still relatively immature and unfortunately many contracts groups – buy and sell – are relatively remote from their product and service development teams. Those products and services are therefore brought to market with ‘one size fits all’ terms and conditions, which can then be changed only through individual negotiation. Not only is this inefficient, but it creates risk. This risk is because we find ourselves making non-standard commitments that the business has not enabled – hence the cost of performance is greater and the risk of non-performance higher.

I observe some companies  aligning contracts and commercial staff with the product or service lifecycle management teams and ensuring one basis of market segmentation is the understanding of different commitment requirements. Of course, this analysis may lead to certain segments being viewed as unattractive because of the implied terms and conditions. For example, risk averse customers (or suppliers) may not be selected because of the low margins they represent. Indeed, I was talking just today with the head of supply management at a major financial services company and he was observing how some of those he views as top suppliers are becoming more and more selective about when they decide to bid. And he realizes that he should view their no-bids as a warning sign that maybe his requirements are wrong.

All of us in the world of contracts – whether buyers or sellers – are dealing with markets. I believe that we ignore the principles of segmentation at our peril. It is something we should all understand and use to the fullest possible effect.

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