To demonstrate RFM analysis, suppose J.

Crew is ready to do a mailing on January

1, 2014 to a subset of 5,000 customers. You are given data on 100,000 sales transactions

involving these customers. Use the fi le RFMexample.xlsx to retrieve the data

for this example and to illustrate how RFM analysis works. A subset of the data is

shown in Figure 30-1. The fi rst transaction, for example, involves Customer 4184

purchasing $30.00 of items on 9/30/2011.

Figure 30-1: RFM data

Computing R, F, and M

To begin, compute for each customer the following quantities:

■ The most recent transaction

■ The number of transactions per year for each customer

■ The average amount purchased each year by each customer

To accurately perform the calculation of these quantities, proceed as follows (see

Figure 30-2):

1. Name each column with its row 6 heading by selecting Create from Selection

from the Formulas tab.

2. In the Q7 array enter (see Chapter 3 for details) the formula

=MAX(IF(Customer=O7,Date," ")). This creates an array that contains the

transaction date if the transaction involves Customer 1 and a blank otherwise.

Then the MAX function fi nds the last date for a transaction involving Customer
1 (9/1/2013). Copy this formula to Q8:Q5006 to compute for each customer

the date of the most recent transaction.

Figure 30-2: Calculation of R, F, and M

3. Similarly, in the R7 array enter the formula =MIN(IF(Customer=O7,Date,"

")). This creates an array that contains the transaction date if the transaction

involves Customer 1 and a blank otherwise. Then the MIN function

fi nds the fi rst date for a transaction involving Customer 1 (1/31/2010). Copy

this formula to R8:R5006 to compute for each customer the date of the fi rst

transaction.

4. Copy the formula =($Q$4-R7)/365 from S7 to S8:S5006 to compute the number

of years the customer has been with you as of the date of the mailing. For

example, as of 1/1/2014 Customer 1 has been with you 3.92 years.

5. Copy the formula =SUMIF(Customer,O7,Amount)/S7 from T7 to T8:T5006

to compute the average amount purchased per year by each customer. For

example, Customer 1 purchased an average of $239.00 per year.

6. Copy the formula =P7/S7 from U7 to U8:U5006 to compute for each customer
the average number of transactions per year. For example, Customer 1 was

involved in an average of 3.83 transactions per year.

Now determine how each customer ranks on R, F, and M:

1. Copy the formula =RANK(Q7,Most_recent,1) from V7 to V8:V5006 to compute

each customer’s rank on recency. The last argument of 0 ensures that

the customer with the most recent purchase gets a rank of 5,000, and so on.

For example, Customer 1 is ranked as the 2,117th lowest on recency.

2. Copy the formula =RANK(U7,Frequency,1) from W7 to W8:W5006 to compute

each customer’s rank on frequency. For example, Customer 1 is ranked

as the 497th lowest on frequency.

462 Part VIII: Retailing

3. Copy the formula =RANK(T7,Monetary_Value,1) from X7 to X8:X5006 to

compute each customer’s rank on monetary value. For example, Customer 1

ranks 442nd lowest on monetary value.

4. Use VLOOKUP formulas to convert a customer’s ranks on R, F, and M to the

wanted 1–5 rating by copying the formula =VLOOKUP(V7,rfmlookup,2) from

Y7 to Y7:AA5006. This converts ranks of 1–1,000 to 1, 1,001–2,000 to 2,

2,001–3,000 to 3, 3,001–4,000 to 4, and 4,001–5,000 to 5. The range

AB5:AC10 (see Figure 30-3) is named rfmlookup. For example, Customer

1’s R rank of 2,217 converts to 3, her F rank of 497 converts to 1, and her M

rank of 442 converts to 1.

Figure 30-
Figure 30-3: Calculation of R, F, and M response rates

To Which R, F, and M Values Should You Mail?

The next step in an RFM analysis is to identify the RFM combinations (there are 53

= 125 combinations) that appear (based on customer data) likely to yield a profi t.

RFM Analysis and Optimizing Direct Mail Campaigns 463

First perform a break even analysis to determine a response rate that would enable

J.Crew to break even. Defi ne Profi t = Expected profi t per order, Response_Rate =
chance a customer will respond to a mailing, and Mailcost = cost of mailing the

catalog to a customer. J.Crew will break even if the expected profi t received per

customer equals the mailing cost or both of the following are true:

Response_Rate * Profi t = Mailcost

Response_Rate = Mailcost/Profi t

Therefore J.Crew should mail to segments for which Response_Rate is likely to

exceed Mailcost/Profi t. Assume J.Crew expects to earn a profi t of $20 per order

and mailing a catalog costs $0.50. Then J.Crew should mail to RFM combinations

for which it expects a response rate exceeding 0.50/20 = 2.5 percent. To be on the

safe side, assume J.Crew will mail to RFM combinations that have at least double

the break-even response rate (or 5 percent). Column N (see Figure 30-4) tells you

whether a given customer responded to the last mailing (1 = response and 0 = no

response). For example, Customers 2 and 5 responded to the last mailing.

Now you are ready to determine the profi table R, F, and M combinations. To

begin, list in the range AC14:AE138 the 125 possible RFM combinations that range

from 1 1 1 through 5 5 5. Then proceed as follows:

464 Part VIII: Retailing

1. Copy the formula =COUNTIFS(R_,AC14,F,AD14,M,AE14) from AG14 to

AG15:AG138 to count the number of customers falling into each RFM category.

For example, 260 customers fell into the 1 1 1 category.

2. Copy the formula =COUNTIFS(R_,AC14,F,AD14,M,AE14,actualrresponse,1)

from AH14 to AH15:AH138 to calculate the number of customers in each RFM

combination that responded to the last mailing. For example, 24 customers in

1 1 1 responded to the last mailing.

3. Copy the formula =IFERROR(AH14/AG14,0) from AF14 to AF15:AF138

to compute the response rate for each RFM combination. For example,

the response rate for 1 1 1 is 9.2 percent. The IFERROR function is

needed to prevent a #DIV/0! from appearing in R F M cells containing no

observations.

4. Use Excel’s Conditional Formatting Formula option to highlight all RFM

combinations yielding a response rate of at least 5 percent. To do so fi rst put

the cursor in the upper-left corner (AC14) of the range you want formatted

(AC14:AF138) and select the wanted range.

5. From the Home tab, select Conditional Formatting, choose New Rule, . . . and

then select Use a Formula to determine which cells to format. This brings up

the dialog box shown in Figure 30-5.

6. In this dialog box fi rst enter a formula that when copied down and across the

selected range will evaluate to TRUE for each cell you want formatted. You

can use the formula =$AF14>=0.05 for this example.

7. Dollar sign Column AF to ensure that each selected cell will be highlighted

if the entry in Column AF of the cell’s row is at least .05.

8. To finish filling in the Select Rule Type dialog box, select Format and

from Fill tab, select a color (orange in this example). All RFM combinations

with response rates of at least 5 percent are now highlighted (refer

to Figure 30-3).

NOTE If the database is small in size, the marketing analyst might want you

to create terciles (only three categories) for R, F, and M to ensure that sui cient

observations exist in each R, F, and M cell to accurately estimate an average

response rate.