Customer segmentation gives you a way to target your marketing campaigns to the people most likely to buy, and send them promotions for the products they are most likely to purchase.
If you have 50,000 customers, for example, you can’t pay attention to every one of them. But if you group them into 10 segments, you can easily pay attention to those 10 customer types.
Segments make it easier to visualize your customers, and get a picture of their buying habits. That helps you optimize your marketing spend.
There are a variety of ways to segment customers – for consumers we can profile by zip code using MyBestSegments (formerly PRIZM); for businesses we could profile by NAICS (North American Industry Classification System) or SIC (Standard Industrial Classification) code.
Over the past two decades, rapid advances in technology have made segmentation by buying patterns more available, affordable, and effective.
RFM Analysis
Recency, Frequency, Monetary (RFM) Value Analysis is the most tried and true method of segmenting by buying patterns. Unlike statistical modeling, it requires no knowledge of statistics, using straightforward algebra to segment the customer database.
Pareto’s 80/20 rule applies for most organizations: 80% of your revenue comes from 20% of your customers. When you identify that 20% and target most of your marketing to them, you generate substantially greater returns from your marketing dollars.
Using RFM to score and segment your customers allows you to find the customers most likely to respond, and eliminate mailings to marginal customers who waste your valuable marketing budget.
Recency
Recency is the date of a customer’s most recent order. Of the three variables, recency is the strongest. It trumps frequency and monetary value as the best predictor of potential sales.
WiseGuys sorts all customers into 5 groups based on the recency of their last order. Those with the most recent dates get a higher score (in WiseGuys software, 5 is the highest), and the oldest dates get a lower score (1 is the lowest).
Why? Because if a customer – even one of your best customers – does not have a fairly recent order or file, they may have lapsed without your knowledge. In fact, they may already be someone else’s best customer.
Frequency
Frequency is a count of customer orders, starting from a date you define. Inside each of the recency groups, customers are sorted into 5 groups on the basis of frequency, with more orders scoring a 5 and fewer orders scoring a 1. So each recency group has 5 groups inside it, based on the frequency of their orders.
Frequency is more important than monetary value because most customers buy once and disappear. Scoring on frequency ensures that customers who buy twice or more are given a higher score, because they are more loyal.
Monetary Value
Monetary value is the sum of all dollar purchases, starting from a date you set. Optionally, WiseGuys can calculate monetary value based on the average order amount.
Each of the frequency groups is scored by monetary value. The highest score is 4; the lowest is 1. The monetary value score is more important for some business models than others, but it is usually considered to be the least important of the three variables.
After scoring for recency, frequency, and monetary value, you now have 100 test cells (5x5x4). You can decide which test cells are appropriate for the campaign you are planning, and eliminate the expense of mailing to the others.
