RFA or RFM, Which is Better?

Monetary or Average Order – is RFA Better than RFM?

For decades direct marketers have used RFM as their primary segmentation tool, and the M (Monetary) traditionally stood for “Lifetime Spending to Date.”

Personal experience provided a couple of indications that Monetary wasn’t what it was cracked up to be.

  

Back in the 90’s, a catalog client asked for a list of best catalog customers, so he could send each one a thank you note.  Upon reviewing the list, it became obvious that about a third of the higher-dollar, recent, frequent customers had many, many orders.  They ordered small items (in this case, a paperback book) one-at-a-time, and spent hundreds of dollars.  But each individual sale was so small, given the cost of fulfillment, the catalog actually lost money on each order.  

The list of “best customers” was really about 2/3rds best and 1/3rd worst customers.

Then by sheer chance two different jewelry retailers brought us results where they had tested three segments; high-dollar coupons, low-dollar coupons, and a control group. Both had the same strange results. 

Upon reviewing the results, we found the high dollar offer worked best with high average order customers, followed by the control group (that got nothing), and then the low dollar offer.  For high average order customers, the low dollar offer actually suppressed response below the un-mailed control group.

The opposite – or maybe we should call it the same – happened on the low-dollar end.  The low dollar offer won, followed by the un-mailed control group, followed by the high-dollar offer that actually suppressed response.

For those in fundraising, this is hardly a shock.  The best ask is in the range, maybe a little higher, than the typical or most recent gift.  But for direct marketers targeting segments with common offers, does it really matter?

To try to answer the question, we went used a similar 20,000 name list like what we used for checking the 40-40-20 rule that’s described in another blog.  This time we used only the key-coded segment as the groups to create the analysis, and looked at both likelihood of response and dollars-per-name.  Dollars-per-name is defined as (response rate * average order) and it is a good indicator of the profitability of a segment.

RFM versus Response Rate gave us an R-Squared of 0.73, so it explained 73% of the difference in response among segments.

RFA versus Response Rate gave us an R-Squared of 0.80, so it explained 80% of the difference in response among segments. A clear winner!

If we look at the individual impact of Monetary versus the individual impact of Average Order inside a 95% statistical confidence window, we see Average Order is always positive.  That means the higher the average order, the higher the expected response rate.

Monetary, on the other hand, could have either a positive or slight negative impact on response rate, if we look at it in the same 95% confidence window. In other words, statistically speaking, Monetary did NOT improve our response prediction.  To confirm this we left Monetary out of a regression equation and just used Recency and Frequency.  R-Squared went UP to 0.76!

So far, that is just looking at response alone.  If we look at Dollars-per-Name, we tip the scales even more in favor of RFA.  RFM did well predicting Dollars per Name with an R-Squared of 0.79, but RFA did extremely well with an R-Squared of 0.91.  91% of segment to segment variation explained – that is very, very powerful.

Looking at slope in the regression, there was a wide range within 95% confidence for Monetary, varying by a factor of seven from low to high.  But the slope for Average Order varied only from 0.65 to 1.00, so it fell in a fairly narrow range. That is due largely to the high correlation in expected order amount with previous average order.

While the advantage of tailoring offers based on average order is obvious, even with the same offer to all segments Average Order statistically has a substantial advantage over Monetary in predicting both response rate and dollars per name. 

Which one do you use?