RFM in ActionRFM was initially utilized by marketers in the B-2-C space - specifically in industries...

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RFM in Action
RFM was initially utilized by marketers in the B-2-C space - specifically in industries like Cataloging,
Insurance, Retail Banking, Telecommunications and others. There are a number of scoring
approaches that can be used with RFM. We'll take a look at three:
RFM - Basic Ranking
RFM - Within Parent Cell Ranking
RFM - Weighted Cell Ranking
Each approach has experienced proponents that argue one over the other. The point is to start
somewhere and experiment to find the one that works best for your company and your customer
base. Let's look at a few examples.
RFM - Basic Ranking
This approach involves scoring customers based on each RFM factor separately. It begins with
sorting your customers based on Recency, i.e., the number of days or months since their last
purchase. Once sorted in ascending order (most recent purchasers at the top), the customers are
then split into quintiles, or five equal groups. The customers in the top quintile represent the 20% of
your customers that most recently purchased from you.
This process is then undertaken for Frequency and Monetary as well. Each customer is in one of the
five cells for R, F, and M
Experience tells us that the best prospects for an upcoming campaign are those customers that are
in Quintile 5 for each factor - those customers that have purchased most recently, most frequently
and have spent the most money. In fact, a common approach to creating an aggregated score is to
concatenate the individual RFM scores together resulting in 125 cells (5x5x5).
A customer's score can range from 555 being the highest, to 111 being the lowest.
RFM - Within Parent Cell Ranking
This approach is advocated by Arthur Middleton Hughes - one of the biggest proponents of RFM
analysis. It begins like the one above, i.e., all customer are initially grouped into 5 cells based on
Recency. The next step takes customers in a given Recency cell - say cell number 5, and then ranks
those customers based on Frequency. Then customers in the 55 (RF) cell are ranked by monetary
value.
RFM - Weighted Ranking
Weightings used by RFM practitioners vary. For example some advocate adding the RFM score

2. together - thus giving equal weight to each factor. Consequently, scores can range from 15 (5+5+5)
to 3 (1+1+1). Another weighting arrangement often used is, 3xR + 2xF + 1xM. In this case, scores
can range from 30 to 3.
So which to use? In reality, there are many other permutations of approaches that are being used
today. Best-practice marketing analytics requires a fine mix of mathematical and statistical science,
creativity and experimentation. Bottom line, test multiple scoring methods to see which works best
for your unique customer base.
Establishing a Score Threshold
After a test or production campaign, you will find that some of the cells were profitable while some
were not. Let's turn to a case study to see how you can establish a threshold that will help maximize
your profitability. This study comes from Professor Charlotte Mason of the Kenan-Flagler Business
School and utilizes a real-life marketing study performed by The BookBinders Book Club
(Source:Recency, Frequency and Monetary (RFM) Analysis, Professor Charlotte Mason, Kenan-
Flagler Business School, University of North Carolina, 2003).
BookBinders is a specialty book seller that utilizes multiple marketing channels. BookBinders
traditionally did mass marketing and wanted to test the power of RFM. To do so, they initially did a
random mailing to 50,000 customers. The customers were mailed an offer to purchase The Art
History of Florence. Response data was captured and a "post-RFM" analysis was completed. This
"post analysis" was done by freezing the files of the 50,000 test customers prior to the actual test
offer. Thus, the impact of this test campaign did not effect the analysis by coding many (the actual
buyers) of the 50,000 test subjects as the most recent purchasers. The results firmly support the use
of RFM as a highly effective segmentation approach.
Purchased the book = yes; months since last purchase = 8.61; total # purchases = 5.22; dollars
spent = 234.30
Purchased the book = no; Months since last purchase = 12.73; total # purchases = 3.76; dollars
spent = 205.74
Customers that purchased the book were more recent purchasers, more frequent purchasers and
had spent the most with BookBinders.
The response rate for the top decile (18%) was twice the response rate associated with the 5th
decile (9%).
Results from this test were then used by BookBinders to identify which of their remaining customers
should receive the same mailing. BookBinders used a breakeven response rate calculation to
determine the appropriate RFM cells to mail.
The following cost information was used as input:
Cost per Mail-piece $0.50
Selling Price $18.00
BookBinders Book Cost $9.00

3. Shipping Costs $3.00
Breakeven is achieved when the cost of the mailing is equal to the net profit from a sale. In this case:
Breakeven = (cost to mail the offer/net profit from a single sale)
= $0.50/($18-9-3)
= ($0.50/6)
= 8.3% = Breakeven Response rate
So, according to the test offer, profit can be obtained by mailing to cells that exhibited a response
rate of greater than 8.3%
RFM dramatically improved profitability by capturing 71% of buyers (3,214/4,522) while mailing
only 46% of their customers (22,731/50,000). And the return on marketing expenditures using RFM
was more than eight times (69.7/8.5) that of a mass mailing.
Number of Cells and Cell Size Considerations
As previously mentioned, RFM was initially utilized by companies that operated in the B-to-C
marketplace and generally possessed a very large number of customers. The idea of generating 125
cells using quintiles for R, F and M has been a very good practice as an initial modeling effort. But
what if you are a B-to-B marketer with relatively fewer customers? Or, what if you are a B-to-C
marketer with an extremely large file with millions of customers? The answer is to use the same
approach that is used in data mining -- be flexible and experiment.
Establishing a minimum test cell size is a good place to start. Arthur Hughes recommends the
following formula:
Test Cell Size = 4 / Breakeven Response Rate.
The Breakeven Response Rate was addressed above in the BookBinders case study. The number "4"
is a number that Hughes has found works successfully based on many studies he has performed.
BookBinders Breakeven Response Rate was 8.3%. Using the above formula, you would need a
minimum of 48 customers in each cell (4/0.083). BookBinders actually had 400 customers per cell,
so they had more than adequate comfort in the significance of their test. In reality, BookBinders
could have created as many as 1,041 cells if they were comfortable using the minimum of 48 per
cell. As an example, they could have used deciles as opposed to quintiles and established 1,000 cells
(10 x 10 x 10). The more cells the finer the analysis, but of course the law of diminishing returns will
arise.
Other weighting considerations can be used for small files. If your Breakeven Response Rate is 3%,
your minimum cell size would be 133 customers (4/0.03). Therefore, if you have 12,000 customers
you could have about 90 cells (12,000/133). As such, a 5 x 5 x 4 (100 cells) or a 5 x 4 x 4 (80 cells)
approach may be appropriate.
Conclusions
RFM, BI and data mining are all part of an evolutionary path that is common to many marketing

4. organizations. While RFM has been practiced for over 40 years, it still holds great value for many
organizations. Its merits include:
- Simplicity - easy to understand and implement
- Relatively low cost
- Proven ROI
- The demand on data requirements are relatively low in terms of variables required and the number
of records
- Once utilized, it sets up a broader foundation (from an infrastructure and business case
perspective) to undertake more sophisticated data mining efforts
RFM's challenges include:
- Contact fatigue can be a problem for the higher scoring customers. A high level cross-campaign
communication strategy can help prevent this.
- Your lowest scoring customers may never hear from you. Again, a cross-campaign communications
plan should ensure that all of your customers are communicated with periodically to ensure low
scoring customers are given the opportunity to meet their potential. Also, data mining and the
prediction of customer lifetime value can help address this shortcoming.
- RFM includes only three variables. Data mining typically finds RFM-based variables to be quite
important in response models. But there are additional variables that data mining typically use (e.g.,
detailed transaction, demographic and firmographic) that help produce improved results. Moreover,
data mining techniques can also increase response rates via the development of richer segment/cell
profiles that can be used to vary offer content and incentives.
As stated before, successful marketing efforts require analytics and experimentation. RFM has
proven itself as an effective approach to predicting response and improving profitability. It can be an
important stage in your company's evolution in marketing analytics.
By: Jim Stafford
Article Directory: http://www.articledashboard.com
About the Author Jim has worked for leading companies in the Marketing Automation space (BI, data
mining, campaign management and eMarketing) for over 12 years. He has Directed SPSS' pre-sales
engineers in North America and has played the role of Product Marketing Manager for Unica's
Model application. Stafford has developed response models for many industries including:
catalogers, financial services, retailers, and hospitality. Learn more about Jim's services at
www.StaffordSBSG.com.