As a customer, you’ve no doubt received invites from companies to refer your friends to their company for a reward. I’ve personally received invites to refer my friends from companies like Starbucks (60 reward stars to get a friend to join the rewards program), Turo (a $25 credit for me and my friend once they use the peer-to-peer car sharing service), and Docusign ($20 for each friend that buys an annual electronic signature plan).
Anecdotally, there are some incredible success stories associated with customer referral programs. In September 2008, when Dropbox began its customer referral program, it had 100,000 registered users. Fifteen months later, Dropbox had 4,000,000 registered users, and 35% of daily sign-ups in that time period had come from the referral program in which both the referrer and the referred received extra storage space.i
Unlike some marketing programs, however, the evidence for the positive bottom-line impact of a customer referral program is not limited to company success stories. In fact, one study in a banking context found that referred customers were both 15% less likely to churn and 25% more profitable than customers who were acquired through other means.ii
Since they are potentially very effective marketing tools for a company, it’s important to consider how they might be done with maximum positive impact. There has been some interesting research on the design characteristics that make a referral program more or less effective. You can see my Powerpoint summary here.
The impact of a referral program can also be improved if we understand the customer psychology behind why it works. And that is the focus of a recent paper published in Journal of Marketing Research. The paper, “How Customer Referral Programs Turn Social Capital into Economic Capital,” reports research in a banking context that looks at how the characteristics of a referrer-referral pair impacts the profitability and loyalty of 1,799 customers who joined the bank based on its referral program.
Why Do Customer Referral Programs Work? Better Matching
Two possible mechanisms for why referral programs might lead to higher customer profitability and loyalty are explored in the research. One possible explanation is due to better matching of the referred-customer to the firm. When someone is a customer of the business, and especially when they are willing to refer the business to others, they presumably have some level of fit to the products and services that the business offers. In other words, they ‘match’ the business. Since we know our friends well and since our friends are often like us in terms of needs, preferences, and values, then it also makes sense that referred friends are more likely to be a good match to the business as well.
The analytics to test the better matching explanation are pretty complex, but ultimately showed that it is a valid explanation for referred-customer profitability. Essentially, an analysis demonstrated that a significant part of the variance in customer profitability was dyad-specific – what the authors referred to as a “shared unobservable” within referrer-referred pairs because it could reflect shared needs, preferences, or values that are relevant to customer profitability but not observed (i.e., measured) because it’s not known what they are.
The research further demonstrated that better matching explains referred-customer profitability by showing that the higher profitability of referred customers compared to non-referred customers (i.e., customers who were acquired through other means) increases the longer the customer who makes the referral has been with the bank. This is evidence of a matching effect because only customers who have been with a company for a while are in a position to know the company well enough to refer their friends who are likely matches.
Why Do Customer Referral Programs Work? Social Enrichment
The second possible explanation for why referral programs might lead to higher customer profitability and loyalty is called social enrichment. Essentially, this explanation is that the bond that initially exists between the referrer and the referred-customer is an important part of why the referred-customer is committed to the business. Although the research did not find that this explanation was useful for explaining referred-customer profitability, it did help to explain referred-customer loyalty.
Specifically, the research team found that referred customers whose referrer is still with the bank were much less likely to leave the bank themselves than were referred customers whose referrer had left the bank. In fact, this latter group of customers is even more likely to leave the bank than non-referred customers.
When Are Customer Referral Programs Likely to Work?
Since the research shows that better matching explains why a customer referral program increases customer profitability, this suggests that referral programs will be more valuable to companies that have difficulty getting insight into the needs and preferences of prospective customers. It also suggests that referral programs will be more valuable to firms that sell complex and risky products since customer needs may be more difficult to understand in these situations.
Since the research shows that social enrichment explains why a customer referral program increases customer loyalty, this suggests that referral programs will also be more valuable to companies that depend on customer trust and attachment. For example, this is more likely to be the case with non-subscription services such as banking, retail, and medical practices.
In keeping with prior research, the current paper also reinforces the positive impact on a firm’s bottom-line of sending invitations to serve as a referrer to “higher-margin customers who have been with the [company] more than a few months and are less likely to churn” (p. 144).
How Can Customer Referral Programs Be Made More Effective?
Finally, the paper concludes with several questions to help managers make decisions about their referral program. I highlight three here along with a few brief comments on each.
- Are there prospects (e.g., those with complex needs) who we expect to exhibit greater matching or enrichment benefits? If so, how do we design our program to target them? Not all customers within a given company are the same. Some customers have pretty straight-forward needs; others have more complex needs. The research suggests that targeting customers with more complex needs is important since these customers are more likely to benefit from the matching effect. In a similar way, some customers may benefit more than others from having a connection to other customers. In a medical practice, for example, patients who are managing a chronic condition are more likely to benefit from having a confidant than those who just use the practice for annual checkups.
- Do customers who are acquired through strong-tie referral tend to exhibit higher margins and lower churn than those acquired through weak-tie referral? If so, how can we nudge potential referrers toward activating strong rather than weak ties?
A strong-tie referral is essentially someone who is a close friend versus a weak-tie who is more of an acquaintance. The matching effect suggests that strong-tie referrals will be better for referral program effectiveness. While there are many ways that strong-tie referrals might be motivated, other research indicates that referrals of close friends are more likely when the referral reward is split between the referrer and the referred (e.g., $25 for each).
- Can we develop diagnostic tools and community support tools to help our customers produce better matches and enrich the experience of their referrals?
Since better matching via referrals is a good thing, then perhaps the company can help current customers to determine which of their friends will most likely be a good fit for the company. In parallel, since social enrichment drives referred-customer loyalty, a company should consider ways to make the current experience even more social in terms of support, insight, feedback, and the like. In the medical context mentioned previously, for example, a doctor’s office could take the lead with forming support groups of individuals with shared conditions and/or health interests.
Read the full article.
From: Christophe Van Den Bulte, Emanuel Bayer, Bernd Skiera, and Philipp Schmitt (2018), “How Customer Referral Programs Turn Social Capital into Economic Capital,” Journal of Marketing Research: February 2018, Vol. 55, No. 1, pp. 132-146.
Go to the Journal of Marketing Research
iVeerasamy, Visakan, “Referral Program Examples – An Epic List Of 74 Referral Programs [Updated 2018!],” Accessed on August 1, 2018 at: https://www.referralcandy.com/blog/47-referral-programs/
iiSchmitt, Philipp, Bernd Skiera, & Christophe Van den Bulte (2011), “Referral Programs and Customer Value,” Journal of Marketing, 75 (January), 46-59.