RFM segmentation: Using data to drive customer value

By: Mark Patron | November 28th, 2008

One of the most commonly used forms of segmentation is RFM (recency, frequency and monetary value). RFM is a good way to define and understand customer value. As well as helping customer development it can also form the basis of a good customer retention strategy.

What is segmentation?

Segmentation is the process of partitioning markets into groups of customers and prospects with similar needs and/or characteristics who are likely to exhibit similar purchase behaviour. Strategic segmentation is for planning business and marketing strategy. Tactical segmentation is when a marketing manager wishes to prioritise marketing activities across a fairly large customer base, targeting certain products, offers and creative to certain customers. A good segmentation strategy supports both strategic and tactical activity.

Benefits of segmentation

Segmentation is the best way to make marketing relevant, better matching customer needs.
By segmenting markets the target consumer can be reached more often and at a lower cost.
By marketing products that appeal to different customer preferences a business can retain customers who might otherwise switch to competing products and brands.
Provides a framework for the company to make more money. It provides a lens through which marketing can be continuously improved in the future.
Manage different types of customers differently across the various customer touch points and through the customer lifecycle.
Allocate different resources and investment levels to segments and deliver superior value to distinct groups of customers.

Segments need to be

Large enough to be economic
Have similar attributes
Reachable or targetable
Relevant to business needs
Actionable

Each part of a good segmentation solution will yield typically between four and nine segments. Too few segments tend to result in very general segments, and too many segments results in lots of small segments that may not be usable or meaningful. Segmentation development should be driven by economic incremental gain; for example, the benefit of a new email segmentation must be more than the cost of any extra creative or analysis required. While there are numerous types of segmentation, RFM segmentation is often chosen because of its simplicity and ease of use.

Customer Development

Past and current customer behaviour is the best predictor of future customer behaviour. This is the reason why direct marketing works. For example, customers who have purchased recently are more likely to buy again versus customers who have not purchased for some time. Customers who purchase frequently are more likely to buy again versus customers who have made just one or two purchases. Customers who have spent the most money in total are more likely to buy again. The most valuable customers tend to continue to become even more valuable. Recency is normally found to be the most predictive of the three variables and monetary value the least.

RFM is closely related to another important direct marketing concept, lifetime value. Lifetime value is the expected net profit a customer will contribute to a business over the period of time a customer remains a customer. Because of the linkage to lifetime value, RFM techniques can be used as a proxy for the future profitability of a business. High RFM customers represent future business potential because the customers are more likely to buy again and have a high lifetime value. Low RFM customers represent less of a business opportunity, low lifetime value, and highlight that something needs to be done to increase their value.

Customer Retention

RFM segmentation is a good way to start to develop a customer retention strategy. The example below shows that 20+ buyers are lapsing at around six months. Knowing this a simple customer retention strategy is to contact customers in the 20+ segment who have not bought for five to six months. For example phoning these lapsing customers can qualify if these high value customers have simply changed their registration details or have a problem that needs to be rectified.

Conclusions

RFM segmentation is a relatively cost effective, quick and easy way to improve analysis and profiling of a customer database. RFM is a good “lens” through which to analyse a database, it can help discover a lot of useful, previously hidden knowledge and potential in the database.