The RFM principle stands for Recency, Frequency and Monetary Value. Using these three principles you can develop your customer loyalty program through calculating customer lifetime value, or put simply, how important the purchase patterns of each customer is to your business.
This is achieved by monitoring their purchases over time and selecting a weighting factor for each of the areas of;
You then apply a factor to each area, for example,
20 Points if within last 3 months
10 Points if within last 6 months
5 Points if within last 9 months
3 Points if within last 12 months
1 Points if within last 24 months
Number of Purchases within 24 months x 4 points each (Maximum = 20 points)
For Monetary Value;
Dollar value of purchases within 24 months x 10% (Maximum = 20 points)
The weighting factors are for a total of 10, and are usually applied as 2, 3 and 5. For example if Frequency (of purchase) was the most important factor for your business right now, then you would weight this as 5. This might be followed by Recency (of purchase) set at 3, then Monetary Value (of the purchase) set at 2. The good thing about this process is that you can alter these factors based on the relevance to your business at any given time.
By using the RFM principle you can clearly see which customers are the most important to your business, based the relevance that you select. Many businesses just concentrate on the big money customers, and their focus is on the purchasers of volume products.
Whilst this is reasonable approach, the facts are that these are the most vulnerable group of customers by far. Some of these customers may buy big and not very often, which means they could be ripe pickings for your competitors, when time is right, and when you least expect it!
The RFM principle helps you focus on those customers that have purchased Recently, Frequently and by the Monetary Value of the purchase. You set your own parameters for the monitoring of the purchasing patterns, and then you can clearly see the true customer lifetime value. This might assist you in developing your customer experience management program.
The RFM Principle and the 80/20 Rule
Many people associate the RFM principle with the 80/20 rule (or Pareto's Law). The process does condense the customers purchasing patterns in some form of 80/20, whereby 80% of the sales come from 20% of the customers and this is a further extension of analysis that you can derive from this process.
The important thing however, is not to lose focus on the customers that have a lower ranking (the 20%) for now. You should focus your efforts on nurturing these customers into the higher rankings, this can be achieved through:
Increased call cycle activity
Increased email marketing broadcasts
And as a result of these activities you can then monitor their progress through the RFM process, this will also aid in the evaluation of the effectiveness of your marketing activities. See also 80-20 rule
Developing a Customer Loyalty Program
When you use the RFM principle you can also easily develop a customer loyalty program based on the purchasing patterns of your customers. Where you have points assigned for Recency, Frequency and Monetary Value, you could assign the same amount (or a different points concept) of points for loyalty to your product or service.
Consider using a range of customer loyalty concepts to develop and measure customer loyalty, and reward your customers who keep coming back to buy from you and not your competitors!