LTV and RFM for Non Profits DMA Non Profit Forum Friday February 4 2005 10:30 - 11:45 The Capitol Hilton Washington, DC Arthur Middleton Hughes Vice President / Solutions Architect KnowledgeBase Marketing

What KnowledgeBase Marketing Does

Two goals today Explain how to compute donor lifetime value, and use it to improve marketing strategy Explain how RFM works, and how you can use it to improve response rates

Two Kinds of Database People Constructors People who build databases Merge/Purge, Hardware, Software Creators People who understand strategy Build loyalty and repeat sales You need both kinds!

How a modern database marketing system works Data Access And Analysis Software Customer Transactions Marketing Staff Inputs from Retail, Phone, Web Appended Data Website

Lifetime Value

We can determine the lifetime value of every donor Lifetime value is the net revenue we will receive from each donor during his lifetime with our cause Using historical data, we can compute this for every donor, and put it in their record.

What is lifetime value? Net present value of the profit to be realized on the average new customer during a given number of years. To compute it, you must be able to track customers from year to year. Main use: To evaluate strategy.

How to use lifetime value Compute a base lifetime value Dream up a new strategy. Estimate the benefits and costs Determine whether your new lifetime value goes up or goes down Don’t undertake any new strategy until you can prove it will be successful

Discount Rate Basic Formula Market Rate of Interest...5% Assume Risk (Double rate)...10% Years = n Interest = i Formula: D = (1 + i)n Calculation of rate after 2 years: D = (1 + .10)2 = (1.10)2 = 1.21

New Strategies Add a website that takes donations Make website interesting with lots of interesting info on the cause being promoted. Collect donor’s emails. Send appeals by both direct mail and email Sent retention communications besides just appeals Personalize all messages to existing donors Personalize web site “Welcome back, Susan”

Results of new strategies

Compute LTV of all donors Use software to insert the actual donor record of each donor Use the spreadsheet to pretend that there are 200,000 donors just like each donor Put the resulting LTV into each donor database record. Let’s look at Susan Smith

Segment donors by LTV – Develop a marketing strategy for each segment GOLD Spend Service Dollars Here Spend Marketing Dollars Here Reactivate or Archive Your Best Customers - 80% of Revenue Your Best Hope for New Gold Customers Move Up 1% of Total Revenue These may be losers

RFM Analysis

Recency Frequency Monetary (RFM) Analysis Used for marketing to customers Always improves response and profits Better than any demographic model The most powerful segmentation method for predicting response

How to Apply Recency Codes Put most recent purchase date into every customer record Sort database by that date - newest to oldest Divide into five equal parts - Quintiles Assign “5” to top group, “4” next, etc. Put quintile number in customer record

Response by Recency Quintile

How to compute a Frequency Index Keep number of transactions in customer record Sort Recency Groups from highest to lowest Divide into five equal groups Number groups from 5 to 1 Put Quintile number in customer record

Response by Frequency Quintile

How to compute a Monetary Index Store total dollars purchased in each customer record Sort Frequency Groups from highest to lowest Divide into 5 equal groups (Quintiles) Number Quintiles 5, 4, 3, 2, 1 Put Quintile number in each record

Response by Monetary Quintile

R F M RFM Code Construction One Sort Five Sorts Twenty-five sorts Database 5 4 3 2 1 35 34 33 32 31 335 334 333 332 331

Appended RFM Codes

Creating an Nth Customer Database Nth 300,000 Records 30,000 Records For Nth by 10, select every tenth record. Nth Result will be statistical replica of database 30,000 Records

Result of Test Mailing to 30,000

Test Response Rate by RFM Cell

Profit from Test Mailing

Test, Full File & RFM Selects Compared

Test Vs Rollout Response Rates

RFM Deals with Very Small Numbers Only a small percentage (such as 5%) of customers respond to the typical offer 95% or more will not respond at all RFM tells you which customers are most likely to be in the responsive 5% Those who respond may not be your most profitable customers

Retroactive RFM Test Many times there is not enough time or funding to run an Nth test in advance Solution: apply RFM codes to last year’s completed outgoing promotion. Since you know who responded, you can determine response rates by cell Use last year’s rates to govern this year’s rollout.

Recent Case History User sells personalized product by mail 45,000 selected for a test

Second Recency Quintile Had More Responses. Why?

Even so, First Recency Quintile Had Higher Sales

Recent buyers spend more per order

Lowest two recency quintiles did not break even

Frequency was very predictive of response

Monetary did not predict response rate very well

But Monetary does predict average sales by quintile

RFM Cells clearly show who to mail to, and who to drop

When NOT to use RFM If you use it all the time, half your customers will never hear from you They will be lost The others will suffer from File Fatigue Use it sparingly; when you need a boost Use it to identify your best customers Don’t go hog wild!

Books by Arthur Hughes From McGraw Hill. Order at www.dbmarketing.com Contact Arthur: arthur.hughes@kbm1.com

Thank You