Understanding Market Segmentation
I believe to make effective use of the resources that society makes available to us in the form of goods and services its essential for the individual to understand the mechanisms and incentives at play.
The most fundamental economic mechanism is the law of supply and demand. “Law”, in the economic context, is a description of a naturally-occurring phenomena, much like the laws of physics, the law of gravity and so on, meaning it is not enacted by anyone in particular, just emerges as a behavior of the system.
In a free market, sellers offer goods and services, providing the “supply” side of the equation. Buyers offer the money and purchasing power, providing the “demand” side of the equation. Buyers and sellers “agree” at a common price P and perform the trade.
Remember, this is a model, meaning that it is a simplification of reality that attempts to capture some underlying essence with the goal of providing the means to explain and predict observations.
I choose the word agree because there's a two-way leverage in an ideal free market: If the price is too high for the buyer, they won't buy. If the price is too low for the seller, they won't sell.
I put the word “agree” in quotes because this is often an adversarial interaction, not a cooperative one: the seller wants to sell as high as possible to make the most money out of their goods; while at the same time the buyer wants to buy as low as possible, to make the most value out of their money.
Also note that one may switch roles depending on the transaction. If one is an employee, they are the seller of their own expertise and time to the job market and, in an analogous manner, the companies act as the buyers in the job market, acquiring from the pool of the available talent.
With the econ basics out of the way, lets dive back into market segmentation.
The reason that most companies exist is to capture as much of the value they generate to society in the form of profit for their stakeholders.
The argument that companies generate value to society is pretty straightforward (even without considering the “creating jobs” argument): think of how cheap a household appliance is compared to if you were to acquire the skills and raw materials to develop a similar piece of equipment yourself. There's benefit in scale and reuse, and companies are, often by design, “organisms” that thrive on scale and growth.
As outlined above, companies generate value to society. That free value can then be captured by either the seller or the buyer, but usually settles in some place in the middle -- at least for true markets. For example, with non-essential luxury goods, the seller has the role of persuading the buyer that the good or service provided is more valuable than the money it costs, while the buyer has the role of exercising their ability to not buy.
Market segmentation succeeds at aiding the company to capture more of that free value it generates by addressing different buyer demands at different transaction volumes.
For example, there's the entry-level model: the cheapest product that the company sells in retail. This product has one role and one role only: sell a very high volume and turn a profit through cheaper manufacturing costs. This is often not the best “bang for the buck” or the best benefit for the buyer, but has a role in the product line up: filling the lower end of the price range.
The next step up is the intermediate model, which captures a market segment of buyers able or willing to pay more “buck” for more “bang”. This is usually lower volume than the entry-level model, but makes up for it with a slightly higher “premium” built-in into the price.
Finally, there's the luxury model, designed to capture the “money being no object, what's the best product that exists”. This is for the buyers willing to pay any amount as long as they can get the experience or product only available there. This is naturally the higher-end of the price range and low volume, but still turns a profit to the company due to the very high premium added to the price.
An exercise that is often fruitful is a counterfactual analysis, namely, asking oneself “what if this weren't the case?”.
Suppose that only the entry-level product were to be produced: the increase in volume due to removing the intermediate and the high-end product models would be small (since those markets are smaller than the entry-level market in absolute terms of buyers).
Suppose that only the intermediate or high-end product were to be produced: the vast majority of the buyers would be unable or unwilling to buy it, leaving a lot of untapped value “at the table” -- besides letting the company be vulnerable to disruption by a competitor willing to undercut in price.
Therefore, as natural as supply-and-demand is, segmentation is also a very natural strategy for sellers in general and companies in particular: offer a high-volume low-end product at the cheapest possible manufacturing cost, offer an intermediate product somewhere in between at a medium-volume, then offer a low-volume high-end expensive product at high margin.
The role of the buyer, in this context, is realize their own power and leverage that comes from not buying it. It's also useful to understand and distinguish the purpose that each model in a product line up fills for the company so that consumers can make a better informed decision for themselves.
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Appendix: Critique from ChatGPT 4o to the “Understanding Market Segmentation” post