Benefits of RFM Analysis: Pareto Principle

The “RFM” in RFM analysis stands for recency, frequency and monetary
value. RFM analysis is a way to use data based on existing customer behavior
to predict how a new customer is likely to act in the future. An RFM model is
built using three key factors:
•how recently a customer has transacted with a brand

•how frequently they’ve engaged with a brand
•how much money they’ve spent on a brand’s products and services
RFM analysis was born out of direct mail marketing, in particular a 1995 article
by Tom Wansbeek and Jan Roelf Bult titled “Optimal Selection for Direct Mail,”
which was published in the journal Marketing Science. Their work helped
confirm the Pareto Principle — the idea widely held among marketers that
80% of sales come from 20% of a brand’s customers.
Benefits of RFM Analysis

RFM analysis enables marketers to increase revenue by targeting specific
groups of existing customers (i.e., customer segmentation) with messages
and offers that are more likely to be relevant based on data about a particular
set of behaviors. This leads to increased response rates, customer retention,
customer satisfaction, and customer lifetime value (CLTV).
Each of these RFM metrics has been shown to be effective in predicting future
customer behavior and increasing revenue. Customers who have made a
purchase in the recent past are more likely to do so in the near future. Those
who interact with your brand more frequently are more likely to do so again
soon. And those who have spent the most are more likely to be big spenders
going forward.
RFM analysis enables you to target customers with messages that best match
their relationship with your brand. For example, you are likely to have more
success suggesting big-ticket items to customers who spend frequently and in
large amounts. On the other hand, you are more likely to grow the customer
value of your relationships with consumers who make purchases frequently,
but only in small amounts, by rewarding them for their loyalty or offering
referral promotions.
How Does RFM Analysis Work?

Market research has traditionally concentrated on demographic and
psychographic data, which marketers use to conduct customer segmentation.
Those data points are then used to predict customer behavior across much
larger populations that share the same set of traits.
However, these methods depend on data from a small sample of consumers.
With the advent of systems like customer data platforms (CDPs) that help
gather, unify and synthesize customer behaviors, marketers have much more
granular data about the habits of individual customers to inform segmentation.
Rather than segmenting customers only using demographic and psychographic
data, marketers can create segments based on the real-world behavior of
individuals, including purchase history across any channel (online or offline),
browsing history, prior campaign responses and more. Unsurprisingly, this type
of segmentation is called behavioral segmentation.
And even a basic CRM system can perform rudimentary tracking of the three
easily quantifiable characteristics that contribute to RFM analysis:
Recency value: This refers to the amount of time since a customer’s last
interaction with a brand, which can include their last purchase, a visit to a
website, use of a mobile app, a “like” on social media and more. Recency is a
key metric because customers who have interacted with your brand more
recently are more likely to respond to new marketing efforts.
Frequency value: This refers to the number of times a customer has made a
purchase or otherwise interacted with your brand during a particular period of
time. Frequency is a key metric because it shows how deeply a customer is
engaged with your brand. Greater frequency indicates a higher degree of
customer loyalty.
Monetary value: This refers to the total amount a customer has
spent purchasing products and services from your brand over a particular
period of time. Monetary value is a key metric because the customers who
have spent the most in the past are more likely to spend more in the future.
RFM Analysis for Customer Segmentation

Rather than analyzing the entire customer database, it’s better to segment
customers by characteristics like age or geography and separate them into a
customer group. By engaging them in a well-segmented marketing campaign,
you are able to create a relevant, personalized offer for a high- value customer.
Computing RFM for real-world application typically requires special analytical

expertise or advanced math skills. And, like any model, RFM models can vary
in complexity from simple to sophisticated. RFM segmentation begins by
ranking customers in each of the three categories: recency score, frequency
score and monetary score. Typically, this is done
on a scale of 1 to 10. A 10 indicates the top 10% in each category (i.e., the
most recent to transact, the most frequent to transact and those who purchased
the most), a 9 the next 10% and so forth. By using a RFM scoring system such
as this you can construct an effective marketing strategy by creating customer
RFM segments, including:
Your best customers: These are the customers who earn top scores in every
category. They’re loyal, willing to spend generously and likely to make another
purchase soon. Such customers are primed to respond well to loyalty
programs. They’re more likely to be interested in new products you launch. And
because they’re committed to your brand and its products, it probably makes
less business sense to offer them discount pricing. Instead, increase CLTV by
suggesting big-ticket items and recommending products based on past
purchases.
Your big spenders: This customer segment is based on only one of the three
metrics: customers with top scores for monetary value. Typically, marketers
target this segment with luxury offers, higher subscription tiers and value-add
cross-/upsells that increase average order value. Again, it probably makes
sense not to shrink margins by offering discounts.
Your loyal customers: This is another customer segment that takes into
consideration only one of the three metrics: customers with top
scores for frequency. Despite making purchases often, they aren’t necessarily
your biggest spenders, so consider rewarding them with free shipping or similar
offers. Advocacy programs and reviews can
also be effective ways to engage these customers.
Your faithful customers: Customers who score high for frequency but low in
monetary value tend to respond best to product recommendations based on
past purchases, as well as incentives tied to spending thresholds (e.g., a free
gift for transactions above the brand’s average order value).
Your at-risk customers: Customers who have been in your top tier in the past
(best, big spenders and/or loyal) but who now score low
for recency and frequency present a special opportunity. Marketers
should consider targeting them with messages aimed at retention, such as
discount pricing, exclusive offers and new product launches. With the help of
your CDP, you can even create specific customer journeys aimed at re-
engaging and retaining at-risk customers.
Steps of RFM Analysis

The steps below provide a high-level overview of how an RFM Analysis and
segmentation is executed.
Build RFM Model
In order to build an RFM model, you need to assign a recency score, frequency
score and monetary score to each unique customer. The raw data, which can
be collected from a customer database from previous transactions, is then
compiled in a spreadsheet or database.
Divide the Customer Segment

Next, divide the RFM database into tiered groups for each of the three values
of the RFM score. Tier designation is based on the greatest to the least. For
example, tier one for monetary value is assigned to the high spenders and tier
five is assigned to the lowest spenders.
Select the Targeted Customer Group(s)

The third step involves the selection of the segmented customer group with
high customer value. Organizing the RFM segment, you can begin to assign
titles to segments of interest, such as your best customers, biggest spenders,
faithful customers and at-risk customers.
Craft a Personalized Marketing Strategy

Finally, craft a unique marketing strategy designed for each RFM segment
focused on their behavioral patterns. Utilizing the RFM Analysis, marketers are
able to effectively communicate their messaging to customers in a way aligned
with customer behavior.
Why RFM is Effective for Small and Medium-Sized

Businesses
For startups and smaller retailers with limited marketing resources, RFM
analysis can be a particularly effective tool because of its:
Simplicity: RFM analysis does not, on its own, require complex tools or
sophisticated analytical capabilities. The principles are easy to understand and
the results are easy to interpret and act on.
Affordability: In many cases, it’s possible for marketing professionals without
advanced statistical or analytical training to
perform RFM customer segmentation with only a standard
spreadsheet.
Effectiveness in direct marketing: RFM analysis, which grew out of
database marketing and direct mail marketing, has been shown to be effective
with relatively inexpensive digital direct marketing strategies that smaller
brands can afford, such as an email marketing campaign.
Scaling RFM to the Enterprise

That said, as a business scales, you will also need technology that scales with
the complexity and volume of interactions across all your channels, regions and
more. With advanced RFM, you can create more authentic experiences at
scale, using a range of customer traits as inputs to your model and going
beyond scores and segments to achieve one-to-one personalization.
The most advanced enterprise-class CDPs serve as an engine for creating

these types of RFM-driven experiences. They empower business users to
orchestrate campaigns and journeys quickly and seamlessly leverage the full
breadth and depth of all your customer data across any and all channels.
The Limits of RFM Analysis: What to Avoid

While RFM segmentation is powerful, it does have limits. When performed
manually, it’s prone to human error. RFM analysis is also based on just a few
behavioral traits, lacking the power of the advanced predictive analytics now
available.
Some businesses may use RFM analysis as an excuse to bombard high-

ranking customers with messages and thus reduce response rates on
campaigns that could otherwise be highly effective. On the other hand, it can
cause marketers to neglect customers with low rankings even though many of
them may be worth cultivating. For example, your RFM model may fail to
account for the impact of past promotions or seasonality on RFM analysis.
Likewise, a customer may have very little activity with your brand one month,
yet be ready to engage in purchasing behavior the following month due to a
birthday or anniversary.
How Relevant the RFM Model is Today

RFM analysis remains a perennial favorite of marketers. It’s simple and
intuitive, yet data-driven. It has the power to provide actionable insights down to
the individual customer level — all without any input from data scientists or
complex tools. That isn’t to say you can’t do sophisticated things with RFM
analysis. For example, you can use RFM techniques to identify your best
customers and turn them into a seed audience within an advertising platform
that uses lookalike modeling to automatically identify prospects who share
similar key traits.
Nevertheless, thanks to CDPs, marketers are now able to combine RFM data
with other behavioral and demographic traits — everything from geolocation to
recent products purchased — to create even more effective segmentation.
Better yet, they can quickly and easily apply lookalike models and other
sophisticated analytics to predict what messages are
most likely to resonate and how and when those messages are most likely to
prompt action.
With or without these more sophisticated approaches, marketers can use

RFM analysis to:
Increase the effectiveness of email marketing campaigns: Build an

automated drip campaign with messages tailored to each segment.
Increase loyalty and user engagement: Follow up with recent
customers or new customers with timely promotions and educational content
likely to increase their engagement with your brand.
Decrease churn: Send personalized messages, offer repeat
purchases at a discount or provide surveys that help you understand and
address potential concerns.
Reduce marketing costs and increase ROI: Reduce costs by
focusing quickly and easily on smaller segments that are more likely to
produce revenue and use insights from RFM analysis to optimize campaigns
going forward.

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The “RFM” in RFM analysis stands for recency, frequency and monetary

•how recently a customer has transacted with a brand

Benefits of RFM Analysis

How Does RFM Analysis Work?

RFM Analysis for Customer Segmentation

Computing RFM for real-world application typically requires special analytical

Steps of RFM Analysis

Divide the Customer Segment

Select the Targeted Customer Group(s)

Craft a Personalized Marketing Strategy

Why RFM is Effective for Small and Medium-Sized

Scaling RFM to the Enterprise

The most advanced enterprise-class CDPs serve as an engine for creating

The Limits of RFM Analysis: What to Avoid

Some businesses may use RFM analysis as an excuse to bombard high-

How Relevant the RFM Model is Today

With or without these more sophisticated approaches, marketers can use

Increase the effectiveness of email marketing campaigns: Build an

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