Segmenting customers is the first step in making your marketing efforts more effective. By targeting customers based on similarities and buying behavior, you can then create and build customer loyalty.
This applies to any form of marketing, regardless of industry. So, it works for e-commerce and for B2B industries and businesses.
Besides the four main types of customer segmentation, namely demographics, geographic location, psychographics, and behavioral patterns, there’s another type called RFM.
RFM doesn’t consider the abovementioned four aspects. Instead, it groups customers using different criteria that’s more focused on monetary value.
In this post, we’ll help you understand what RFM is, how it works, why it works. We’ll also show you how to use RFM customer segmentation in e-commerce.
What is RFM?
RFM stands for recency, frequency, and monetary value of a customer.
It’s a customer segmentation tactic that focuses on customers’ spending habits generally and inside your store. It looks at spending based on:
- when the customer last made a purchase in your store (recency)
- how often the customer purchases from you (frequency)
- how much the customer pays per transaction (monetary value)
Businesses that use the RFM method can get a clearer picture of their customers’ lifetime value. Accordingly, they can decide which types of customers they’re better off retaining.
If you’re a business that’s using customer segmentation to target customers, you’re one step ahead in the game.
“RFM is…used to identify a company’s […] best customers by measuring and analyzing spending habits to improve low-scoring customers and maintain high-scoring ones.” Investopedia
When you segment customers based on recency, frequency, and/or monetary value, the resulting segments are called RFM segments.
What is an RFM analysis?
To analyze recency, frequency, and monetary value data, you’ll need to conduct an RFM analysis.
To do so, you’ll need to assign scores for your customer categories based on recency, frequency, and monetary value. The resulting scores are called RFM scores.
RFM scoring works by having you give customers scores ranging from 1 to 5. In RFM, a score of 1 is the lowest and a score of 5 is the highest.
You’ll need to create a list of questions and score customers based on your answers to those questions.
However, it’s worth stressing that you’ll need to calculate the score for each RFM method separately.
You’ll notice, however, that not all businesses can apply all three RFM criteria at the same time.
Businesses selling long-lasting products like refrigerators, cars, wardrobes…etc. won’t be able to measure recency because purchases are several years apart.
In this case, these businesses will only use two of the three RFM segments, which are frequency and monetary value.
Breaking down RFM customer segmentation in e-commerce
To get loyal customers, you need to offer unique and exciting customer experiences.
Using an effective customer engagement strategy can help you stay top-of-mind. This makes you the more likely brand to pop up in their minds when they need products like yours.
When looking or measuring RFM for e-commerce, you’ll need to ask yourself several questions for each RFM metric.
To measure recency, you’ll need to look at when customers last bought a product –or products–from your store. Was it last week? Last month? Six months ago?
Be sure to review the types of products they bought too.
You can group customers based on what they’re buying too. For example, if you sell books, you may see which customers are buying fantasy books and who is buying horror books.
Frequency: How often…?
Once you know what customers are buying, you’ll need to see ‘how often they’re buying those products?’
Is it once a week? Once a month? Maybe twice every 10 days? Is there a pattern to their buying certain products over others?
Let’s say you have a grocery store. Are customers buying milk once a week but only get eggs once every two weeks?
Monetary value: How much…?
Finally, it’s time to see how much customers are spending. You can look at the average order value (AOV) or average basket size.
The dashboard you’re using may offer other ways to group customers by how much they’re spending. You’ll need to look at the largest numbers first.
How to measure RFM
To measure RFM, you’ll need to review your data or findings based on the 1 to 5 scoring scale. A score of 1 is the lowest score, while 5 is the highest.
If you give a customer or group of customers a 1 in recency, this means their last purchase was a while ago. How long is a while is something you’ll have to determine before you start scoring.
If you give customers a 5 in recency, then they likely purchased from you in the past few days.
You’ll need to score each group from 1 to 5. For a customer to score a 5 across all three RFM segments, they need to
- have bought products recently (recency)
- be regular buyers (frequency)
- have a high AOV (monetary value)
While you may hope to find customers who check all the boxes, those are super-hard-to-come-by dream customers.
RFM disadvantages and points to consider
There are a few disadvantages to using RFM for customer segmentation.
- RFM focuses on your most valuable customers. If you’re a brand that sells long-term durable products, RFM may not be for you. Or you may choose to look at monetary value and redefine what recency means for you.
- If you’re a new business, RFM isn’t for you either. You probably don’t have a large customer base yet so your RFM data will be inaccurate.
- RFM measures three criteria, which means it falls short on other customer segmentation options. For example, RFM lets you group customers by recent purchases but doesn’t consider what categories these purchases fall under.
However, if you’re using Gameball’s RFM tools, you can combine RFM with other segmentation criteria. This way you can ensure a stronger and more effective customer segmentation strategy.
RFM customer segmentation and CLV
Customer loyalty is the ultimate goal every business, e-commerce or otherwise, aims to achieve. After all, loyal customers are the ones who buy from you regularly.
And because they’re loyal regulars, they’re more likely to refer you to others.
One of the metrics for measuring customer loyalty is customer lifetime value (CLV).
Companies calculate their customer lifetime value to measure how much a customer is worth to them throughout their relationship with their brand. You can use RFM customer segmentation to increase your CLV.
Recency, frequency, and monetary segmentation is a customer segmentation method that can be useful for many businesses.
However, the types of products you sell and the stage your business is in may decide whether RFM is for you or if you can only use specific RFM metrics.
You can use RFM customer segmentation to further analyze your customer segments. Use the results from your analysis to determine your next steps in your customer acquisition and customer retention strategies.
To learn more about how to use RFM for customer segmentation in e-commerce, we’ve prepared a special Gameball guide featuring examples and use cases. Check it out here.