Quick Profits with RFM Analysis

Probably the greatest single advantage to RFM analysis is that anyone can do it. You don’t need to be a statistician, or to hire a modeler to do the analysis. It can all be done on a spreadsheet. The results are amazingly accurate. Take a look at the following graph which compares the predicted response rates of the 34 cells that were mailed in the rollout with the actual response rates achieved:

We have been teaching the principles of RFM in our seminars at The Database Marketing Institute in Washington, Toronto and elsewhere for the past three years. Inevitably the question always comes up: “How do we do the coding of the customer database?” Our answer was always, “You have to get your programmers to do it for you.”

That is easy to say, but harder to do. As we all know, asking MIS programmers to write new marketing software is like pulling teeth. They are busy with something else, and marketing always has a low priority on the MIS pecking order. Last year at the Institute, we decided to do a little R & D. We commissioned a professional software house to write a Window’s based RFM program that would do everything necessary to code customer databases for RFM, select test groups using an Nth, select records by RFM cell, and provide reports so that the marketers could do the entire job themselves without the assistance of either a statistician or a programmer. The resulting program, called RFM for Windows is now in Beta Test in twenty five marketing companies in the US, as well as in Canada, Holland, the UK and Brazil. The product will be available for interested marketers in the late spring of this year.

It is interesting how we found the firm to write the software. We really didn’t know how to go about our search, so we turned to the Internet. Looking from place to place, we found something called “Software University”. We figured that perhaps there was a professor there who would like to moonlight writing code, so we sent an e-mail message to Software University asking if anyone would like to write PC code for money. We got three answers the first day. The first was from the President of Software University, whose message was “Don’t post such messages here!”. He deleted our e-mail message. Before he was able to do this, however, we received two other responses, one of which came from a representative of the firm that we subsequently engaged for the job. Where is this firm located? In the Kharkov in the Ukraine – in part of the old Soviet Union. What do they know about PC programming in the Ukraine? Plenty. They did the job rapidly, and came up with scores of ideas – and beautiful graphics – that we would never have thought of ourselves. I believe that the final product is better than we could have had created in the US in the time available. Incidentally, we found the firm through their agent, David Margolius of M&M Data Systems in Bellevue, Washington. (206) 869-9236.

News of the development of RFM for Windows has produced comment and controversy around the globe. One correspondent from London raised the question, “Why select exact quintiles? Why not make the RFM categories exact dates and numbers such as 0-3 months, 3-6 months etc.?” He has a valid point. During the past thirty years, RFM has traditionally been “hard coded” into exact quantities. Why change the system?

The answer goes to the heart of RFM. Using exact quantities assumes several things: 1) You have to know your file well in order to select the categories. 2) You have to use a programmer to write the code to do the selection. 3) You will keep this programmer busy changing categories since, over time, the number of customers in each category will shift. If you are doing your job well, the number in 0-3 months will grow so big that it becomes unwieldy. You will have to shift to 0-2 months, and readjust all your other categories at the same time.

In short, hard coding is expensive in terms of programmer time. What is the purpose of RFM? To make profits by reducing costs. If the method you have selected for coding RFM is an expensive one, you have defeated the purpose of RFM from the outset.

If you use exact quintiles, the job can be done without a programmer. You save thousands of dollars a year by that step. You let the program decide who is in each of your quintiles. Of course, using exact quintiles, there will be a certain arbitrary quality to the coding. If your dividing line between the top quintile and the next lower quintile is February 12^th, for example, some people with that purchase date will lie just above and some just below the dividing line, and so will be arbitrarily a 5 or a 4. Don’t worry about it! RFM coding should be done regularly – certainly before every customer promotion – so the arbitrariness one month will be corrected in the next month when the dividing line falls on some other date.

Another good question concerns the number of cells needed. Quintiles results in 125 cells (5 x 5 x 5). For some small business to business databases, that number may be too big. For some very large databases, it may be too small. There are really two conflicting goals of RFM: 1) you want to have as many cells as possible so that you can more accurately predict exactly who is going to respond to your offer. 2) you want to have as few cells as possible, because each test cell has to be large enough to be statistically valid, and many cells make for expensive tests. For RFM for Windows we developed a panel that reconciles these two goals:

The recency sort is done first. Each of the five recency groups is sorted by the number of transactions to create twenty-five frequency groups. Each of the 25 frequency groups is sorted by monetary amount to create the 125 final RFM cells. These cells differ in size from one another by only one customer. There are 31 different sorts in all needed to create 125 RFM cells. For a large database, this may take some time. It should be repeated, however, on a monthly basis. The previous month’s cell code should be stored in the customer record to keep track of which customers are moving up and which moving down as a result of your marketing efforts.

Arthur Middleton Hughes is Vice President of The Database Marketing Institute that does research and consulting for e-mail and database marketing companies. He would love to hear about your problems. Perhaps he could help.  He can be reached at Arthur.hughes@dbmarketing.com or 954 767 4558. His new book Strategic Database Marketing 4^th Edition is due out from McGraw-Hill in 2011.