Using RFM Scores to Predict Profits
# 58: 7/2005
Drilling Down - Turning Customer
Data into Profits with a Spreadsheet
Customer Valuation, Retention,
Get the Drilling Down Book!
In This Issue:
# Topics Overview
# Best Customer Retention Articles
# Using RFM Scores to Predict Profits
Hi again folks, Jim Novo here.
This month, we're taking a deep look into an actual RFM scoring
case from one of your fellow Drillers. It's a beautiful set-up,
and we get to talk about subsidy costs and everything!
OK, I don't get out much...
We also have a couple of great customer marketing article links.
The first finds managers creating KPI's (Key Performance Indicators)
that don't really tell them anything new. Ideally, some KPI's
should predict the future, not measure things already being measured
in other ways. The second article speaks to the hidden costs of
e-mail blasting, a topic that is finally getting some attention
outside of this newsletter.
On to the Drillin'...
Best Customer Marketing Articles
Look at KPI's
July 1, 2005 DM Review
Some bumps in the road in KPI land. Apparently, some executive teams are
choosing KPI's that are outcomes rather than causes, results rather than drivers
of success. In other words, a lot of stuff they get from other reports
already. If possible, KPI's should really be
predictive, not reactive.
To Spam or Not to Spam-
That's a Dumb Question
August 1, 2005 CMO Magazine
Ah, now we're getting somewhere. There is a real hard cost to
e-mail blasting untargeted messages, as I have said
before. Delivering the wrong messages at the wrong times has
measurable direct costs but there are indirect costs
Questions from Fellow Drillers
Using RFM Scores to Predict Profits
Q: Since our last conversation few months ago, we went
ahead and tested 3 different promotions using RFM.
The 1st promotion was the test for RFM method itself to see what
patterns emerge for response rate, incremental sales, etc. The
next 2 promotions targeted the customers from RFM cells with the
highest incremental lift from the 1st test promotion. Here is
what we saw. Since the targeted audience were our loyalty card
members, they transact and spend at a fairly high level (the data
below is modified but the trend is maintained). For the response
rate, we saw a sawtooth pattern:
(Jim's note: RFM is the 3 digit score, Rate is
Response Rate). More on RFM here
Q: As you can see, the response rates decline fairly uniformly from
555 to 511, then rise for 455 and decline uniformly to 411, rise again
for 355, and so on. That's what I implied by a sawtooth
pattern. Is the above pattern fairly normal? Based
on this data, can you tell if RFM is the right sequence of variables
for us? How do you tell if only 2 variables (RF or FM, e.g.) are
predictive and throwing in the 3rd variable messes things up?
A: Well, first let me say, if you are testing a
sub-group of the population - loyalty card members - then you may see
these kinds of shifts. Loyalty card holders especially are a
unique group, often driven by Frequency as a result of incentives
given. Hard to tell without looking at the program, but it's
possible the program is modifying expected behavior. After all,
that's what you do a properly constructed loyalty program for - to
modify behavior! So in your data you might be seeing the
footprints of your program at work.
I wouldn't say the data is "messed up", it just follows a
slightly different pattern, caused either by the population selection,
the loyalty program, or some combination. As long as this
pattern is consistent though, you can still identify and target
If you would rather see a consistent "parabolic" type
response curve, try sorting / scoring the Frequency quintiles *within*
each Recency quintile, rather than across the entire population (if
you did it this way). This will effectively boost the importance of
Frequency in the score and have a smoothing effect. If you
really want to go all out, then also sort Monetary *within* each
Frequency quintile rather than across the entire population.
This "sorting within quintiles" approach is a ton of work
manually but is in effect the way professional RFM software does it.
The bottom line though is in the ability of RFM to segment
customers into groups which behave predictably so that you can
maximize profit. The numerical score is not really an issue;
it's how people with a certain score behave. But if you have a
preference as to the way the scores fall, that's fine too!
Q: Besides these questions, where we really got
tripped up was in looking at the incremental lift per customer (sales
per targeted customer minus sales per control customer; the test and
control group were well matched and went through statistical rigor to
ensure that there weren't inherent differences in them). Here is
what we saw:
Jim's note: RFM is the 3 digit score, Profit is
the profit per customer for that score)
A: Yes...beautiful thing, isn't it? Always amazes
me to see this data...
Q: As you can see, the incremental lift is all over the place. Some of
the lower RFM cells show up higher in lift while some of the higher
ranking RFM cells (e.g., 554, 542, 532, etc.) show negative
lift! While I am showing the numbers from one mailing, the
results are fairly consistent in the other mailing in that some of the
mid- and low-ranking RFM cells show the highest incremental lift
whereas many of the high-ranking RFM cells show negative lift.
How do you interpret this data? What do we change? Any
advice you can provide would be very valuable.
A: I can see you don't see the "beauty" in this
data...yet! Why do "mid- and low-ranking RFM cells show the
highest incremental lift whereas many of the high-ranking RFM cells
show negative lift?"
The short answer is that RFM is a response model, not a profit
model (though it can be used to construct a profit model, as you have
seen). What you are seeing is normal; response does not always
You have just proven this idea with your data but it continues to
elude most marketers. The problem with sending promotions to
people who are already highly likely to respond (have high RFM scores)
is many would have *bought anyway without the promotion*. And
the profits from low scores? Direct evidence your promotions are
retaining customers and making money.
Did you read Chapter 29, Expense and Revenue You Might Not be
Capturing: Subsidy Costs and Halo Effects? It's late in the book
and I have found over the years many people get excited about the
implementation and perhaps skip some of the later chapters...
Anyway, your "higher ranking RFM cells show negative
lift" is proof positive that subsidy costs exist, and are why it
often is a bad idea to do some kinds of promotions to best customers.
You literally decrease their value with each promotion, because the
subsidy loss is money they *would have spent anyway* without the
promotion. It is quite common with these high-scoring groups,
for example, to see a loss of about $4 with a $5 discount. That
means, on average, 80% of the people with that score would have made
the purchase anyway without being sent a $5 off promotion. You
get some lift but it's not enough to cover the cost of the total
Another way to look at it is like this: say you have a customer
segment that spends on average $100 a month. You send them a $10
off coupon and that month they spend $100 again - minus the $10 off
coupon. So you net $90 in spend and end up with less profits.
You left $10 on the table.
On the flip side, when you see lower scoring segments making a ton
of money, that is cold, hard as steel evidence that your retention
program is working. Literally, this data represents money that
was previously left on the table because controls did not spend it and
the test group did.
Look at this, the top 10 most profitable scores in the numbers you
4 of the top 10 money-making segments basically contain defecting
customers - RFM scores below 350. If the top profit driver 345
segment contains 10,000 customers, you grabbed close to $20,000 in
sales from this segment that you never would have seen if you didn't
do the promotion. Look at that 135 segment. These are
former best customers, big spenders who have not been active at all
for a long time - looks like you have "wakened the dead", so
to speak. If that's not making money with a retention program I
don't know what is! It's a beautiful thing.
Here are the 10 lowest incremental sales (highest subsidy cost)
generators in the data:
So, why do some high scores generate profits and others losses?
Why do some low scores generate profits and others losses?
We've discussed some of the potential reasons above. But this
question really is unimportant. What is important is knowing you
can generate $1.95 in sales per customer doing a certain promotion to
345's. And that you lose $1.16 in sales doing the same promotion
Don't over-think the results, they simply are what they are.
Over time, based on a deep understanding of your business, testing
different promotions, and watching the consistent (by score) patterns
of profitability provided by the RFM scoring, you will build a theory
as to why people in certain scores behave as they do.
Here's a tip: if you must send discounts to high RFM scores with a
tendency to create high subsidy costs, try "thresholding"
the discount at the average ticket.
In other words, if the average transaction of 532's is $50 a month,
then send a "$5 off purchase over $50" discount.
Better yet, customize the offer to the average transaction of each
customer for the past 60 days or so.
By using the actual response and profitability behavior of your
customers to target offers, you will learn over time what types of
promotions drive the highest profits for each RFM score. Once
you crack that code, you are on your way to driving serious profits!
If you are a consultant, agency, or software developer with clients
needing action-oriented customer intelligence or High ROI Customer
Marketing program designs, click
That's it for this month's edition of the Drilling Down newsletter.
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'Til next time, keep Drilling Down!
- Jim Novo
Copyright 2005, The Drilling Down Project by Jim Novo. All
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