Do Referral Programs Bring You Better Customers?

Published January 10, 2011 by ReferralCandy+ in Referral Marketing

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).

Some background to start with:

The researchers tracked around 5,000 customers that a leading German bank acquired through its referral program. A 25 Euro reward was given 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 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 referral programs don’t just bring you more customers, they bring you better customers.

If you’re hungry for more details, you should definitely check the full paper here.

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