Now that we understand the difference between ROI and ROEs, let's discuss customer profitability or CP. Customer profitability is a way to track which customers are well profitable. CP is often used in B2B advertising to manage clients but can also be used in B2C to segment customers. You may have heard of the 80/20 rule where businesses often find that 20 percent of their customers provide 80 percent of profit. This metric, customer profitability, focuses on seeing if that's true. Understanding which of your customers are good, meaning they require low effort and result in high spent and which are not so good, meaning high effort and low spend in return. The general formula for customer profitability can be seen here. It's the revenue earned from a customer in one year minus the cost of supporting that customer in that year. What are the steps to calculate this? First, we want to define our customer costs. This can include but is not limited to things like marketing costs, customer service cost, returns, shipping costs. Next, we want to look at our customers' spend. We can do this using your customer relationship management system or CRM, or other spent tracking software that you may have. Subtract customer cost from customer spend and get your customer profitability. But that customer profitability doesn't tell you how your customers behave, or what is influencing their actions. In order to do this, we'll need to segment our customers. You may already have a segmentation analysis done for your customers and if so, feel free to use that. If not, you have a few options to segment out your audience depending on your business; B2B vs B2C, segmenting out individual customers versus businesses. Customer personas, segmenting out the type of buyer your customer is. You may have this type of segmentation from a cluster analysis you ran for instance. Recency, frequency, monetary, or RFM analysis. An RFM analysis is one of the most common ways to segment users to gauge customer profitability. An RFM analysis explores questions like, who are my best customers? Which customers have potential to spend more? Which customers should we pay less attention to? To answer these questions, RFM looks at recency, how recently someone purchased; frequency, how often they purchase within a set time period; monetary, how much they spent within a set time period. In order to do an RFM analysis, you'll need to decide your segments beforehand and create a scale of one to five for each, with five being the greatest. Here you can see an example for an established brand. It's important to note these may be different for your business and you should understand the lifecycle, and average order value of your customers in order to assign these parameters. From here, analyze each customer, and then push their RFM numbers together to create a three-digit code which tells you their RFM. Generally, your CRM software can run an RFM analysis for you but you can also do this in Excel if you're just starting out or do not have a CRM. Let's walk through an example. Say you have a customer file with the five customers indicated here. In this case, recency is in days. Using our segmentation we previously determined, we can then assign scores to each of these variables. Once we assign scores, we push the three numbers together to get an RFM score. Those closest to 555 are best customers, while those closest to 111 are lowest scoring customers. If you'd like to plot or manipulate the data, you can also take the average of the three numbers to get a simplified RFM score. When doing this, you also may decide that you want to rank one factor more than another in your formula, so you may multiply that to give it more weight. In this example, we've given more weight to recency and multiplied it times 1.5 in order to weight that factor higher. Once you've done your RFM scoring, you'll want to plot them out and name your segments. Some common segments include champions. These are our 555s that you'll want to segment out and target with specific offers. New customers, those with a high RFM score but low frequency. You may also want to target them with a special offer. At-risk customers, those who rank highly for monetary and frequency, but low for recency. Remind them of previous purchases or encourage subscription. A marketer will want to tailor their messaging and offers to each one of these segments. While customer profitability is often used by product or finance teams, CP is another excellent tool in a marketer's toolbox to determine what messages may resonate with their consumers.