Referral Programs – Who Should You Reward?

In a previous post, we found out that referral programs bring you better customers and also brings in the dough. Now that we know that a customer referral program is beneficial, the next order of business is to decide what kind of customer referral reward scheme to implement.

There’s been some recent research by the good people from the University of Pittsburgh and Korea University on this issue [pdf here]. They examined the how different referral reward schemes affected referral likelihood.

Some background to start with

The study examined the effect of brand strength on 2 common types of reward schemes, a “Reward Me” scheme in which the recommender (the existing customer) receives the reward, and a “Reward Both” scheme in which both parties (the existing customer and the new customer) are rewarded.

Two levels of brand strength were pitted against each other; stronger brands versus weaker brands. Stronger brands are brands that are well-established and have high brand awareness. Consumers of stronger brands feel more brand commitment to the brand than consumers of weaker brands.

298 mobile phone subscribers using different mobile services in Korea were examined. There are 3 major mobile services in Korea, the leading brand having 53% market share and the two follower brands having 31.5% and 15.5% share. The leading brand was used as the stronger brand, while the two follower brands were used as weaker brands.

The subscribers were told that their mobile phone provider was embarking on a referral reward program. The reward was 60,000 Korean won in free calls (about $50 at the time of the study) in the Reward Me condition or 30,000 won in free calls each in the Reward Both condition.

They were then tested for whether they would refer their phone service for the different reward schemes. Read the rest of this entry »

Do referral programs bring you better customers?

Are referred customers more valuable than non-referred customers? This is the question that researchers from Goethe University Frankfurt and University of Pennsylvania set out to answer in their paper “Referral Programs and Customer Value” (pdf here).

If you’ve some time to spare, you should take a look at the paper. Otherwise, I’ve summarized the main findings here.

Some background to start with

The researchers tracked around 5,000 customers that a leading German bank acquired through its referral program. The program carried out was simple. A 25 Euro reward to existing customers for each new customer brought in.

The profitability and loyalty of these new customers were tracked for 33 months and compared against a random sample of about 4,600 customers acquired through other methods in the same period.

What they found

The study revealed several interesting financial differences between referred and non-referred customers. It turned out that profit margins, retention rates and lifetime customer value were significantly higher for referred customers. Here are some of the key insights:

1. Referred customers have higher profit margins
Referred customers started out with profit margins that were more than 25% higher than non-referred customers. After 29 months, the higher margins of referred customers became equal to those of their non-referred counterparts.

The researchers think that the initial higher profit margins were due to the referred customers being a better fit for the bank. This was because the referrer would likely select friends that he or she thought would be a good match for the firm.

Another possible reason for the higher margins was that friends of the referring customer would be more like them and have similar needs and values. And the bank could use these similarities to better serve the new customer and get higher margins.

However, these advantages gradually vanished as the bank accumulated the same amount of information about both referred and non-referred customers. Also, non-referred customers who weren’t a good match for the bank were more likely to leave as time went by.

Even though profit margins became equal over time, the study still found that the average lifetime customer value of referred customers was 16% higher than that of non-referred customers.

2. Referred customers were less likely to leave
The research showed that the probability of remaining a customer by the end of the study was 82% for referred customers and 79.2% for their non-referred counterparts. Analyzing this data, researchers found that customers acquired through the referral program were 18% less likely to defect than non-referred customers.

In a nutshell, referred customers were more profitable and less likely to leave than non-referred customers.

How does this apply to me?

So what does this all mean? We now know why referral programs work and why it’s worth paying for them – because they help you attract more loyal and profitable customers. Applying the study to your own business, we can see that in addition to bringing you more customers, referral programs also help you get better customers.

So that’s the paper in brief. If you’re hungry for more details, you should definitely check the full paper here.