Do you know which of your customers are most profitable to your business? Or even how to measure customer profitability?
One of the best ways to gauge the value of a customer is to perform a recency, frequency, and monetary value (RFM) analysis of your customer data.
Here’s how RFM analysis works and seven ways you can use insights from RFM for a smart marketing strategy.
How RFM Analysis is Done
RFM analysis looks at all the transactions in your customer database in a specific time period, usually the last two to three years. The purpose of the database analysis is to determine the value of your customers based on how much they buy from you, how often they buy, and how recently they’ve made a purchase.
With RFM, you assign a value to the recency of the transaction (the more recent, the better); the frequency of transactions in the analysis time period (the more frequent, the better); and the monetary value of those transactions (the higher the monetary value, the better).
Once the analysis is complete, you have a measure of each customer’s profitability, so you can rank customers from most profitable to least. You can then divide this ranked list into ten equal customer groups (deciles).
The top two deciles (top 20%) are your best, most profitable customers, the ones who have bought from you most recently, who buy from you most often, and who purchase at the highest dollar amounts. Deciles 3-7 are your next best customers. Deciles 8-10 are your least valuable customers.
7 Ways to Use RFM for a Smart Marketing Strategy
Here are seven ways to use RFM to target your marketing campaigns more precisely and utilize your marketing resources more effectively:
- Understand your best customers. Once you’ve identified your best customers, you can create demographic profiles to gain insights into the characteristics they share. You also can append data to their records, such as company size or NAICS code, for an even fuller picture.
- Find the low-hanging fruit among your next-best customers. Take a careful look at the customers in deciles 3-7 whose demographic profiles are similar to your best customers. This is likely to be your best upselling opportunity.
- Target the right prospects on rented mailing lists. Armed with information about the characteristics of your best customers, you can be extremely selective about the names you rent on commercial mailing lists, which can cut your costs and increase response.
- Reallocate sales support. RFM can help you reassess the level of sales support appropriate for each customer based on their value and potential. Your goal should be to deploy your most expensive sales resource – your sales team – on customers who already generate the most profit or have the highest potential to buy more.
- Develop tiered direct marketing campaigns. Focus high-end direct marketing campaigns on your highest-value customers and mail less expensive campaigns to lower-value customers. You might send best customers a personalized direct mail package with a product sample, for example, while others get a simple selfmailer offering a free product sample on request.
- Test a high-end marketing campaign to high potential customers. Once you’ve identified customers in deciles 3-7 with the same demographics as your best customers, test a more elaborate direct marketing campaign to these customers to try to increase their profitability.
- Decide which customers to drop from marketing. Customers in deciles 8-10 probably should be dropped from your mailing lists and marketing campaigns because of their low value. It may be costing you more to sell to them than they’re worth.
Why Marketing Strategists Can’t Live by RFM Alone
Knowing your best (and worst) customers can give you important insights for a smart marketing strategy. As a marketing consultant, I’ve used RFM analysis for several business-to-business marketing clients, including a large bank in Ohio and a major retail merchandising company near Cleveland.
But although RFM is a great tool, smart marketers know not to rely on RFM alone when developing a marketing plan. You also need to consider input from your sales team, feedback from your customers, and the results of prior marketing initiatives to decide how best to market to your current customers and targeted prospects.