The RFM Model stands for recency, frequency, and monetary analysis and can be defined as a marketing analytical tool to determine quantitatively which customers are the best ones for the company by analyzing and examining how recently a customer has purchased the products (recency), how often they purchase the products (frequency), and how much the customer spends on the purchase of the products of the company (monetary).
The RFM Model is based on the marketing adage signifying that 80% of your business comes from 20% of your customers.
Importance of the RFM Model
- It utilizes numerical scales that are objective in nature and yields a precise and high-level informative depiction of the customers of the firm.
- It is quite simplistic in its nature and approach and the marketers can use it effectively without the requirement of the data scientists or any sophisticated software.
- It is intuitive as the output of this segmentation method is easy to understand and interpret by the management of the firm.
- Recency can be explained as how much time has been elapsed since a customer’s last activity or the purchase indulgence with the brand? Activity is usually a purchase, although there are certain variations such as the last visit to a company official website or use of a mobile app. In most cases, the more customer has interacted or transacted with a brand, the customer will be more likely responsive to communications from the brand.
- Frequency can be explained as to how often a customer transacted or interacted with the brand during a specific period of time? Customers with frequent activities are more engaged and involved and probably more loyal to the brand as compared to the customers who rarely do so.
- Monetary factor reflects how much a customer has spent with the brand during the specific period of time. Big spenders having high disposable income should usually be treated differently than customers who spend little on the purchase of the products from the brand.
Steps to building the RFM Model
The first and foremost step in building an RFM Model is to allocate Recency, Frequency and Monetary values to each and every customer of the firm. The raw data to conduct this step should be readily available in the company’s CRM software or transactional databases can be compiled in an Excel spreadsheet:
- Recency is simply the amount of time since the customer’s most recent transaction with the firm indulging in the purchase of its products.
- Frequency is the total number of transactions made by the customer with the firm in a particular period of time.
- Monetary is the total amount that the customer has spent across all transactions during a particular period of time.
The second step involved dividing the customer list into tiered groups for each of the three dimensions of the model (R, F, and M) using Excel or any another software tool used by the firm. Unless the firm used any specialized software, it is advised to divide the customers into four tiers for each of the dimension of the model so that each customer will be assigned to one tier in each of the dimension of the model.
Recency Frequency Monetary
R-Tier-1 (most recent) F-Tier-1 (most frequent) M-Tier-1 (highest spend)
R-Tier-2 F-Tier-2 M-Tier-2
R-Tier-3 F-Tier-3 M-Tier-3
R-Tier-4 (least recent) F-Tier-4 (only one transaction) M-Tier-4 (lowest spend)
This technique results in 64 distinct customer segments (4x4x4), into which customers will be segmented accordingly. Three tiers can also be used that will result in the 27 segments.
The third step of the model involves selecting the groups of customers to whom specific types of communications will be sent, based on the RFM segments in which they appear.
It is quite helpful to assign names to segments of interest of the customer.
- Best Customers – This group consists of the customers who are found in R-Tier-1, F-Tier-1 and M-Tier-1as they have transacted recently, do so often and spend more than other customers of the firm. A shortened notation for this segment is 1-1-1; we’ll use this notation going forward.
- High spending New Customers – This group consists of those customers in the category of 1-4-1 and 1-4-2. These are customers who have transacted only once, but very recently and they spent a lot on the purchase.
- Lowest Spending Active Loyal Customers – This group consists of those customers in the category of 1-1-3 and 1-1-4 and they have transacted recently and often do so but spend the least).
- Churned Best Customers – This segment consists of the customers in the categories of 4-1-1, 4-1-2, 4-2-1 and 4-2-2 and they have transacted frequently and spent a lot, but it’s been a long time since they’ve transacted with the firm.
The fourth step of the RFM Model actually goes beyond the RFM segmentation by crafting specific messaging that is tailored for each customer segments. By focusing on the behavioral patterns of the particular groups of the customers, the RFM Model allows marketers to communicate with customers in a more effective and efficient manner.
- Below mentioned are a few examples for illustration, using the groups named above:
- Best Customers – Communications with this group should make them feel valued and appreciated by the firm. These customers generate a disproportionately high percentage of overall revenues for the firm and thus focusing on keeping them happy should be a top priority of the management. Further studying and analyzing their individual preferences will provide additional opportunities for even more personalized messaging and means of communication.
- High spending New Customers – It is always a good idea to nurture all new customers of the firm because these new customers spent a lot on their first purchase. Like with the Best Customers group, it’s important to make them also feel quite valued and appreciated by giving them terrific incentives to so that they continue to interact with the brand.
- Lowest Spending Active Loyal Customers – These repeat customers are active and loyal, but they there spending capacity is quite low. Marketers should create specific promotional campaigns for this group to make them feel valued and incentivize them to increase their spending levels. As loyal customers, it also pays to reward them with special discount offers so that they also spread the word about the brand to their friends earning the referrals for the firm.
- Churned Best Customers – These are valuable customers for the firm who have stopped transacting a long time ago. While it’s often challenging to re-engage with them for the firm, the high value of these customers makes it worthwhile trying to get them back. Likewise the Best Customers group, it’s vital to communicate with them on the basis of their detailed preferences with the data derived from their earlier transactions.
Caveats of the RFM Model
RFM Model and its segmentation approach is a straightforward and powerful method for customer segmentation. But the RFM Model only looks at three specific factors meaning that the method may be excluding other variables that are equally important such as products purchased, previous campaign responses, and other crucial demographic details of the customers.
The RFM Model is a historical method by nature and looks at past customer behavior that may or may not precisely specify future activities, preferences, and responses.
The other advanced customer segmentation methods are based on predictive analytics technologies that are far more accurate at predicting future customer behavior with the firm.