Strategic Customer-Based Value

Metrics
 RFM
• Group of three metrics used together to evaluate
customer behavior and value
• Recency, Frequency and Monetary Value
• Recency – How long it has been since a customer
last purchased from the company
• Frequency – How often a customer buys in a
given time period
• Monetary Value – Amount customer spends on an
average transaction
• Applied only to historical customer data and not
on prospects data
 Computing RFM
• Two methods generally used
Method 1
– Sorting Customer Data based on RFM,
grouping and analyzing results
Method 2
– Computing Relative weights for R, F and M
value using regression techniques
 RFM Method 1
• Example:
– Customer base: 400,000 customers
– Sample size: 40,000 customers
– Firm’s marketing mailer campaign: Rs. 150 discount
coupon
– Response rate: 808 customers (2.02%)
 RFM Method 1…
Recency coding: Analysis
– Test group of 40,000 customers is sorted in a descending
order based on the criterion of ‘most recent purchase date’.
– The earliest purchasers are listed on the top and the oldest are
listed at the bottom. The sorted data is divided into five equal
groups (20% in each group)
– The top most group is assigned a Recency code of 1 and the
next group a code of 2 and so on, until the bottom most
group is assigned a code of 5
– Analysis of customer response data shows the customers
grouped under a particular code to have the highest response
rate.
 Response and Recency
R ecency V s. R esponse

5.00% 4.50%

4.00%
Customer Response %

2.80%
3.00%
R es pons e %
2.00% 1.50%
1.05%
1.00%
0 .25%
0.00%
1 2 3 4 5
R e ce n cy C o d e (1 - 5)
 Response and Frequency
Fre que ncy Vs. Re sponse

3.00%
2.45%
2.50% 2.22% 2.08%
Response Rate %

2.00% 1.67% 1.68%

2.50% 2.35%
2.05% 1.95% 1.90% 1.85%
2.00%
Response Rate %

1.50%
Res pons e %
1.00%

0.50%

0.00%
1 2 3 4 5
M o ne ta ry V a lue Co de (1-5)
 Limitations
• RFM method 1 independently links customer response
data with R, F and M values and then groups
customers, belonging to specific RFM codes
• May not produce equal number of customers under
each RFM cell since individual metrics R, F, and M are
likely to be somewhat correlated
• For practical purposes, it is desirable to have exactly
the same number of individuals in each RFM cell
 RFM Cell Sorting
• List of 40,000 test group customers is first sorted for Recency and
grouped into 5 equal groups of 8000 each
• The 8000 customers in each group is then sorted based on
Frequency and divided into five equal groups of 1600 each- at the
end of this stage, there will be RF codes starting from 11 through
55 with each group having 1600 customers
• In the last stage, each of the RF groups is further sorted based on
monetary value and divided into five equal groups of 320
customers each RFM codes starting from 111 through 555 each
having 320 customers
• Considering each RFM code as a cell, there will be 125 cells ( 5
recency divisions * 5 frequency divisions * 5 monetary value
divisions = 125 RFM Codes)
 RFM Cell Sorting (contd.)
M
F
131
11
132
R 12
133
13
1
134
14
135
2 15

41
3 441
42
442
43
4
443
44
444
5 45
445
Customer
Database Sorted Once Sorted five times Sorted twenty five times
 Breakeven Value
• Breakeven - net profit from a marketing promotion equals
the cost associated with conducting the promotion
• Breakeven Value (BE) = unit cost price/ unit net profit
• BE computes the minimum response rates required in
order to offset the promotional costs involved and thereby
not incur any losses
• Example: In mailing Rs.150 discount coupons,
- The cost per mailing piece is Rs 1.00
- The net profit (after all costs) per used coupon is Rs. 45,
Breakeven Value (BE) = 1/45 = 2.22%
 Break Even Index
• BEI = (Actual RR – BE)/BE *100
• Example
– If the actual RR for a RFM cell is 3.5%, and BE was
2.22%
– BEI = (3.5-2.22)/2.22*100= 57.66
• Positive BEI value means some profit was made
from the group of customers
• 0 BEI value means the transactions just broke
even
• Negative BEI value means the transactions
resulted in a loss
 RFM and BEI
1400

1200

1000

800

600
BEI

400

200

RFM Cell Codes

455

531

552
434
153

413
111

132

224

245

321

342
 RFM & Profitability
Test All RFM
Average response 2.02% 2.02% 15.25%
rate
# of responses 8080 8080 2732.8
Average Net 45 45 45
profit/Sale
Net Revenue 36360 363600 122,976
# of Mailers sent 40,000 400,000 17920
Cost per mailer 1.00 1.00 1.00
Mailing cost 40,000 400,000 17920
Profits (3640) (36400) 105056
 RFM Example
• Assuming -
– Rs. 100 Cost of per Mailer Including printing and
postage
– Rs. 500 profit per redeemed coupon
– Total Customer Base of 13500
– Test Sample of 135 customers
– Each RFM code to have 3 levels
– BEI values >0 to be accepted
– The test results and individual RFM observations for
the sample are given in the sheet
• Compute the RFM codes and evaluate the profitability
aspect.
• Also comment on the suitable customer profile for mailers