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RFM analysis is a tool to identify a firm’s best customers by measuring 3 quantitative factors:
Recency – How recently a customer has made a purchase
Frequency – How often a customer makes a purchase
Monetary Value – How much money a customer spends on purchases

80% of your sales come from 20% of your customers. As a small business owner, even if you’ve never heard of the Pareto Principle, you know this rule of thumb intuitively. Your best customers support your business through tough times. Recently, we read about a few important business metrics  in a previous article.

Thus, the efforts to understand and retain these set of customers prove valuable to the company. One requires the characteristics of the best customers
1) to continue to provide this group with what they’re looking for and keep them as customers, and
2) to target your marketing efforts toward prospects who resemble your best customers.

Focusing on getting the the right customers is important. These customers will then be loyal from the beginning.
Before you can start to understand your best customers, you first need to identify them. And that’s where a simple database tool called recency, frequency, monetary analysis (or RFM) comes into picture

The purchasing behavior is identified. Then, one arranges the results from most valuable to least valuable. This makes it straightforward to identify best customers.

RFM Analysis

The idea behind RFM is quite simple:
1) Customers who have purchased from you recently are more likely to buy from you again than customers who you haven’t seen for a while.
2) Customers who buy from you more often are more likely to buy again than customers who buy infrequently.
3) Customers who spend more are more likely to buy again than customers who spend less.

The order of the attributes in RFM corresponds to the order of their importance in ranking customers. Recency is the most important factor. Why?

Because the longer it takes for a customer to return to your business, the less likely he or she is to return at all. You can fix problems with good customers not coming in as often or spending as much, mostly because they’re still coming in. But when good customers stop coming in altogether — that problem is much harder to fix.
Recency alone won’t sort out your good customers from your new ones. You need frequency for that. Frequency measures the intensity of a customer’s relationship with your business. And good customers, by definition, do business with you more often. You’re part of their habit.

How much a customer spends on average or in total is the final measure of his or her value. The M in RFM adds another level of detail to the customer picture, helping you distinguish between relatively light and heavy spenders. Its effect is often, but not always, highly correlated with frequency.

rfm analysis

RFM SCORES | CALCULATION

Find the values of three attributes for every customer:
1) most recent purchase date,
2) number of transactions within the period (year,month,week,day),
3) total or average sales attributed to that customer

There will be many categories for each RFM attribute (Avg 3 or 5). If you decide to code each RFM attribute into 3 categories, you’ll end up with 27 different coding combinations ranging from a high of 333 to a low of 111. Generally speaking, the higher the RFM score, the more valuable the customer.

E.g. Customers can be assigned to frequency category 3 if they have made 10 or more purchases in the past year, category 2 if they have made 3-9 purchases, and category 1 if they have made 1 or 2 purchases.

You also have to remember to sort your customers on recency first, then sort on frequency in each recency category, and, finally, sort on monetary value in each combination of recency and frequency categories. This way, you end up with an equal number of customers for each RFM score.

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RFM SCORES | APPLICATION

Best customers have the highest score. Analyze the characteristics of each set. Observe the purchasing behavior of this group and try to understand what distinguishes them from typical customers.

Ask the following questions :
Are they buying any other products or services?
Are the neighborhoods similar?
What is the lifestyles and/or life stages?
Why do they buy from you/give more value to you?

RFM is easy to understand and implement. The trade off with more advanced methods is that, from a small business perspective, they are not easy to understand or implement.

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