Improving Personalization Solutions through Optimal Segmentation of Customer Bases

On the Web, where the search costs are low and the competition is just a mouse click away, it is crucial to segment the customers intelligently in order to offer more targeted and personalized products and services to them. Traditionally, customer segmentation is achieved using statistics-based methods that compute a set of statistics from the customer data and group customers into segments by applying distance-based clustering algorithms in the space of these statistics. In this paper, we present a direct grouping based approach to computing customer segments that groups customers not based on computed statistics, but in terms of optimally combining transactional data of several customers to build a data mining model of customer behavior for each group. Then building customer segments becomes a combinatorial optimization problem of finding the best partitioning of the customer base into disjoint groups. The paper shows that finding an optimal customer partition is NP-hard, proposes a suboptimal direct grouping segmentation method and empirically compares it against traditional statistics-based segmentation and 1-to-1 methods across multiple experimental conditions. We show that the direct grouping method significantly dominates the statistics-based and 1-to-1 approaches across all the experimental conditions, while still being computationally tractable. We also show that there are very few size-one customer segments generated by the best direct grouping method and that micro-segmentation provides the best approach to personalization.