The rise of social has brought Word of Mouth (WOM) marketing to the fore once again in recent years, as study after study has found that people are much more likely to use a service or buy a product that has been recommended by a friend.
WOM is nothing new of course, from the very earliest incidences of retail, it’s fair to say that WOM has always worked in business’ favour, one way or another. These days, it’s all about online, of course and in this instance WOM is more commonly referred to as referral marketing.
The question is, do modern referral schemes work in such a competitive online environment, or are they not to be taken seriously? A report out last year suggests that often, the latter is the case, not because referrals don’t work, but because of the haphazard and badly-managed approach that many businesses take to them.
However, a study, Referral Programs and Customer Value , carried out in 2010 by researchers from Goethe University Frankfurt and University of Pennsylvania didn’t agree. The research found that not only do referral programs have a higher customer retention rate, but they are valuable in both the short and long term.
What is a referral program?
According to the research, referral programs can be defined using their three distinctive characteristics:
1.They are deliberately activated and managed – this is very difficult with organic WOM thanks to the spontaneous manner in which customers tend to spark conversation. However, with referral marketing, this is controlled by the company at all stages of the sales funnel.
2.Utilises the social connections of existing customers – this is key to converting the new customer.
3.Offers a reward – this incentivises the customer to bring the non-customer on board by offering something of value to one or both parties.
Methods employed by researchers
For the study, the researchers tracked 5000 customers of a top German bank that had been acquired through a referral program and offered a 25 Euro reward for those that brought on new customers through the scheme.
They then tracked the customers for 33 months, comparing the profitability and loyalty of them with 4600 customers that had been acquired through other marketing activities.
It was found that, overall, there were key differences between referred and non-referred customers, with profits, retention rates and lifetime customer value being much higher for referred customers.
- Profit margins were found to be higher in referred customers to the tune of 25%, certainly not to be sniffed at, even for the most sceptical of managers. However, this levelled out after 29 months and eventually became even. Despite this, the study found that the average lifetime customer value for referred customers was 16% higher.
- Loyalty was also found to be higher, with the probability of remaining with the bank at 82% for referred customers and 79.2% for those that hadn’t been referred. This equated to the probability that a customer would leave at 18%, for those that had been referred.
According to the researchers: "Contribution margin, retention, and customer value all were significantly and sizably higher for referred customers. In short, referred customers are more valuable in both the short and long run.”
What it all means
Until the study took place, there was no real provable model in place to illustrate ROI when it comes to implementing a referral program. This has led to many companies managing referral schemes badly as they lack executive support, which in turn leads to cost and corner cutting, effectively devaluing the program.
However, one study is unlikely to convince many leaders and so it’s necessary to give a good example of when referral schemes have clearly worked. Take Dropbox , for example, the cloud storage provider offers its members additional storage space when they refer a friend and has driven much of their success .
What makes a good referral scheme?
Bearing all of this in mind, it’s clear to see that well organised, implemented and managed referral programs do work. However, where does a company start when getting their own scheme together?
- Decide what constitutes a referral: will this be given for any recommendation or do customers have to participate via a referral link or voucher?
- What reward/incentive will you offer: this can be anything from a discount to a free gift, free part-subscription or even something that’s not related to your business, such as a special gift?
- Who will benefit from the incentive: will it be just the referring customer or both? In order to give the most motivation, this works better if incentives are offered both ways.
- How will you track the program: will this be through links, vouchers or time-sensitive offers? How will you get the momentum going, will you be using social media, newsletters, emails and website?
Like the majority of things in business, referral programs take planning if they are going to provide ROI and be successful. The key is to carry out the planning stage effectively, thinking about the resources that will be necessary, costing it honestly and implementing it effectively.
Referral marketing software-as-a-service (SaaS) providers like Vouchfor! and Extole are two of a growing number of companies that specialise in helping organistions set-up and run referral programs.
There’s little doubt that referrals can really help a business to gain high quality customers that perform better in terms of profitability and loyalty. For companies, this can be taken advantage of by managing the process, from start to finish effectively, if it’s to succeed.