We are here again with a new article & hope this finds you in good health.
We hope that our previous article on marketing analytics would have given you a very basic knowledge about their importance in marketing of today. Going one step ahead, now we would like to start with this article on customer segmentation through RFM (metrics) which will break your perception of segmenting customers in traditional ways. The article will only give you the basic understanding of a concept & will be followed by upcoming articles for a deeper analysis.
What is Segmentation of Customers?
This is one of the basic things that marketers should know. Most of the times, the companies segment their customers based on demographics, geographic, lifestyle or attitudinal based groups which are the most conventional source of measures.
But today, when data is the most important thing for us & is being considered the most valuable in all terms, do we need to do the same thing? Or can we try something new?
Therefore, this article will show you how important it is for a company to segment customers on the basis of purchase behavior rather than only concentrating on the conventional metrics of segmentation. For this, we use the “RFM Model” that is Recency, Frequency & Monetary.
What is RFM Analysis?
The basic objective of using the RFM model is to find out the Customer Lifetime Value (CLV).
It all starts from the historical data of the customers. Remember that if you don’t have the previous purchase data of the customer you can’t segment them with this analysis.
It needs at least 3 years of their purchase history which will help the company to segment the customers on the basis of these three metrics.
RFM stands for Recency, Frequency, and Monetary value, each corresponding to some key customer trait. These RFM metrics are important indicators of a customer’s behaviour because frequency and monetary value are important metrics to evaluate the customer lifetime value & recency shows the retention of the user/customer by the company.
What is Customer Lifetime Value?
The customer lifetime value (CLV) represents the total amount of money a customer is expected to spend in your business, or on your products during their lifetime. This is an important figure to know because it helps you make decisions about how much money to invest in acquiring new customers and retaining the existing ones.
For example, the CLV of a Mercedes owner might be as much as 1 crore and if they are happy with their car & services, they might end up buying several through the years. The CLV of a regular coffee drinker might be even higher than that, depending on how many cups of coffee they drink a day and where they buy it. Therefore, in a big picture CLV is a gauge of the profit associated with a particular customer relationship, which should guide how much you are willing to invest to maintain that relationship.
RFM analysis helps marketers find answers to the following questions
- Who are your best customers?
- Which of your customers could contribute to your churn rate?
- Who has the potential to become valuable customers?
- Which of your customers can be retained?
- Which of your customers are most likely to respond to engagement campaigns?
How it actually works?
Historical data is being fed into the software like Python where all the relevant calculations of the recency, frequency & monetary values are already given, having a unique customer ID. With the help of the model, the system calculates the R- score, F-score & M-score of each customer – which will give a RFM score of individual customer by just taking the average of R,F & M scores as shown in the table below. It is sorted rank-wise which can further be used to calculate CLV for each customer. With this analysis, we can rank customers accordingly & allocate the marketing resources on those customers which contribute the highest value for an organization.
Later with this, we also categorize these customers into potential risks, champions, gold, platinum & silver groups which helps the company to see the marketing channels they can use at each group.
This is just for a basic understanding & we will give you the deeper insights with an example in our next articles. Till then, have a good time and happy learning!