Identifying Valuable Customers
Every good business tries to make the most of its top customers; and many work just as hard to avoid wasting resources on poor prospects.
The Pareto Principle, which was first developed by Vilfredo Pareto in his book, "Cours d'économie politique," tells us that 80 percent of sales come from only 20 percent of customers. Yet research shows that most marketers can't identify that segment of their database. Without this crucial information, they resort to a "one-size-fits-all" approach to communicating with their customers.
One way to avoid this, and to make more sense of a market, is to use RFM segmentation*. In this article, we'll discuss how this tool has evolved from the early days of direct mail to the modern world of e-marketing. We'll look at its advantages and disadvantages, and how you can use it to "zero in" on your most valuable customers.
What Is RFM Segmentation?
RFM segmentation is based on the belief that customers' past actions predict their future behavior. It examines their Recency, Frequency and Monetary value:
- How recent was the customer's last purchase? A person who has bought your goods or services in the last week, month or quarter is more likely to respond to you than someone who hasn't dealt with you in more than a year.
- How frequently does the customer purchase? If he is buying something from you several times a year, he's already a fan. He's likely to respond more actively and positively than the casual browser, who rarely buys anything.
- How much money does the customer spend? If she chooses your more expensive services, or orders lots of items at a time, she's going to respond more warmly to you than a customer who goes for the cheaper options.
Look at all three aspects of RFM segmentation together. This will give you a more reliable view of your database than only considering one or two of these factors. For example, although Carlos has spent many thousands of dollars with you, he might not be such a great prospect for a return sale if his purchases were only occasional, and date back several years.
How to Use RFM Segmentation
Look at the data you have on your customers' activities – this could refer to a set period, such as the last month or year, or the entire lifetime of your relationship with them. Then rank this information against each of R, F and M, using a scale of your choice.
For example, if you use a scale of one to five and divide your database equally, you'd rate the top 20 percent (one fifth) of customers a five, and the bottom 20 percent a one. Each measure is independent of the other two: so Carlos, in our earlier example, would have a low score for both recency and frequency, but a high score for monetary value. The poorest overall score in this model is, therefore, 1R-1F-1M or 1-1-1, while the best is 5R-5F-5M or 5-5-5, with 123 possible scores in between.
For more advanced analysis, try tuning your scoring to suit your particular business. You could apply a simpler scale, such as Low, Medium and High, or a finer scale, such as one to 10. You could divide your customers across the scale unevenly, or give a different weight to each of the three factors. A reverse scale might be more appropriate if you sell more expensive, durable goods such as cars or furniture. In this case, the longer a customer has gone without buying, the more likely she may be to return!
Acting on the Results
Once you have grouped your buyers' RFM scores into a manageable number of segments, you can tailor your marketing strategy to fit the likely response of each segment. Here are some approaches you might take.
You could offer exclusive benefits to the customers who score the highest, such as free shipping or membership of a VIP group that hears about new products first. Relevant rewards will strengthen this segment's enthusiasm for your brand, and its members' loyalty will deepen. They might also go on and "fire up" more fans through their social networks, in effect becoming ambassadors for your company.
Customers who used to have a high monetary value but who haven't been in contact with you for some time could be worth winning back. You could offer them discounts or deals on their next purchase, for example. Then monitor their responses and adjust your approach as you rebuild your relationship.
Be sure not to write off everyone who's engaged with your organization just once or twice. Those who have spent with you recently are new customers who you would be wise to encourage. Even if their activity was a long time ago, they could still be worth staying in touch with. However, you might choose to save resources by reaching out to them less often, or by using cheaper methods.
What's Next for RFM?
RFM is clearly useful with direct mail and telephone marketing, where each communication has a noticeable cost, and you want to minimize waste. So, if you've switched to email- and web-based marketing, you might be tempted not to segment. After all, you can now afford to address your entire market at once. This could, however, be a serious mistake, because consumers are increasingly "savvy" and expect marketing to serve their needs.
They'll become frustrated if they face a daily deluge of unwanted emails or adverts. They may unsubscribe from your list, report you to their internet service provider for spam, or even complain publicly. You'll have lost the opportunity to influence them positively and, worse still, their negative reaction could damage your reputation. So, applying a segmentation strategy can be just as essential for building consumer engagement as it is for targeting your resources. (Here, you might divide your market into conventional segments and then apply RFM to those segments.)
Also, e-marketing has brought further new opportunities: you can measure and target more types of action taken by the members of your database than just making a purchase. These might include clicking a link in your newsletter, viewing pages on your website, registering their details, nearly buying (abandoning their virtual shopping cart before paying), or liking and sharing one of your blog posts.
Some marketers call this adaptation of RFM "RFE" (Recency, Frequency, Engagement) or "ERFM" (Engagement RFM). And you might find that it supports a decision to communicate several times a week, or even a day, with your most engaged customers, without too much fear of a backlash.
The Upsides and the Downsides
So, what are the advantages and disadvantages of RFM segmentation?
This tool is simple to use, easily adaptable, and yields straightforward results. It enables targeted marketing, which costs less than blanketing an entire database with the same campaigns. We've seen that it is more likely to help you build customer engagement, which in turn can boost your conversion rates and revenue.
It is also less expensive to run RFM segmentation than it is to build a complex predictive model based on hundreds or thousands of personal attributes. Using RFM, and its more subtle variant ERFM, will ensure that you keep your focus on your most valuable customers, which will allow you to build stronger brand loyalty among them and minimize their negative responses.
However, RFM segmentation can sometimes be too simple. It offers a mere snapshot of a single point in time and doesn't allow for people's changing circumstances – their actual behavior could be quite a surprise! And RFM can encourage companies to solicit high-ranking consumers so aggressively that they lose them, undermining the very purpose of segmentation.
RFM segmentation is a marketing tool that measures customer behavior according to its recency, frequency and monetary value. Recency refers to how recently customers have purchased, frequency describes how often they buy, and monetary value represents how much they have spent.
You can segment your customers into groups based on their RFM scores, and ensure that you target your promotional efforts to those most likely to make a purchase or to become ambassadors for your brand.
If you "flesh out" this simple analysis with data from non-sales engagement activity, too, you can be even more confident that your marketing is neither wasting your resources nor damaging your reputation. Instead you'll have increased your chance of developing commercial relationships that are worthwhile and effective for both you and your customer – a true win-win situation.
* Originator unknown. Please let us know if you know who the originator is.