The curious case of PayPal’s referral programs.
Not many people today are aware that PayPal ran a very successful referral program, long before Dropbox did. PayPal’s referral program was actually the inspiration behind Dropbox’s!
This was in the early 2000s, before social media started to become a thing. Despite that, it was incredibly successful. It helped them get 7 to 10% daily growth, catapulting their user base to over 100 million members.
“They literally paid people.”
According to David O Sacks, original COO and product leader of Paypal, Paypal used to literally pay people to invite their friends:
- “Initially users just had to sign up, confirm their email address, and add a (unique, authorized) credit card.* The money was simply added to their account.
- This was real money. Users could send it to someone else or withdraw it. So it was a real cost to PayPal. We must have spent tens of millions in signup and referral bonuses the first year. (PayPal acquired 1 million users by March 2000 and 5 million by summer 2000.)
- The bonuses were gradually phased out, first by reducing them to $5, then by adding more verification hoops (like bank account verification) so they became more difficult to get. Then they were eliminated altogether.”
It turned out to yield better marketing ROI. Once they achieved a critical mass of early adopters they dropped the Refer-A-Friend bonus, but they kept it for Merchants. They dropped the Merchant bonus too, once they reached their target numbers. [Source]
Here’s an excerpt from Peter Thiel’s CS183 startup class describing PayPal’s decision-making process:
PayPal’s big challenge was to get new customers. They tried advertising. It was too expensive. They tried BD deals with big banks. Bureaucratic hilarity ensued. Over ice cream, the PayPal team reached an important conclusion: BD didn’t work. They needed organic, viral growth. They needed to give people money.
So that’s what they did. New customers got $10 for signing up, and existing ones got $10 for referrals. Growth went exponential, and PayPal wound up paying $20 for each new customer. It felt like things were working and not working at the same time; 7 to 10% daily growth and 100 million users was good. No revenues and an exponentially growing cost structure were not. Things felt a little unstable. PayPal needed buzz so it could raise more capital and continue on. (Ultimately, this worked out. That does not mean it’s the best way to run a company. Indeed, it probably isn’t.)”
If it worked so well, why did they remove it?
I can’t find any explicit explanation from any of the PayPal folks, but I can make an educated inference: It was probably a simple business decision borne out of cost-benefit analysis.
- Diminishing returns at (massive) scale. PayPal is a payments system, which is greatly dependent on network effects. The more people use PayPal, the more it becomes worth it to join the bandwagon. Eventually, the number of people using PayPal alone would’ve been incentive enough for new users to sign up, rendering the incentive unnecessary.
- Customer Acquisition Cost begins to exceed Customer Lifetime Value. Signups are free to do, and so it’s practically a certainty that the system would’ve been gamed by eager opportunists. For any other business, this would’ve turned out really, really ugly. PayPal probably factored in exploitation and misuse into the cost of customer acquisition. Also, when you have MILLIONS of customers, the load on your infrastructure must be unbearably costly.
“It occurs to me now that PayPal is one of the few businesses where you could use a direct financial incentive like that and not have it be an excessively extrinsic incentive to use the site.” – Yishan Wong, early PayPal employee, now CEO of Reddit [source]
What are the implications for regular businesses running referral programs of their own?
- For ecommerce businesses, I recommend incentivizing the purchase, not the sharing or signup. If you pay people to share or signup for an account, you’ll end up with loads of shares and signups, but few purchases. Also, the ugly thing that happens where the high-quality influencers you want to court get turned off by the spammy behavior associated with your product. Don’t do that.
- Study your business carefully. This is the responsibility of anybody running a business, and you probably shouldn’t outsource it to anybody else. If you make a $20 profit on a product, giving a $10 referral reward is very reasonable for every successful sale. You still profit AND get great marketing. You may be tempted to sacrifice more profits for greater reach, but you may face diminishing returns. You’ll have to study your costs very carefully, and experiment prudently.
- Ensure that your product/service is compelling even without any added incentives. This should go without saying!
Referrals worked great for PayPal, but that doesn’t mean your business will flourish if you give away money the way they did. (Paypal was taking hefty risks because it was trying to dominate a ‘winner-takes-all’ market, and there were people willing to finance such risks because of the potential returns).
An effective referral program has to have incentives that are not only substantial but relevant. Specifically, you want to incentivize the customer behavior that makes sense for your business.
- Substance: People will refer a good product to their friends without incentives, but it’s possible for incentives to be so low as to be insulting, tarnishing what would otherwise have been a gesture of goodwill. Anything less than $5 is usually not worth the trouble for most customers. Many firms (for instance) seem to settle on $10 as the “Goldilocks” amount. (Not too cheap, not too expensive.)
- Relevance: Consider the “lifeblood” of the product. For Dropbox, it was storage space. For World of Warcraft, it’s in-game social proof. For PayPal, it’s money. What about for ecommerce businesses? It depends on your business model.
- Sense: What are you selling? What is the problem that you’re solving? Who are you solving it for, and what sort of utility are they getting out of it? The better you understand this, the better you’ll be able to structure your incentives.
As always, it’s important to remember that referrals aren’t magic. You can’t just create them out of thin air, you need to have a product that people actually want to talk about. Once you’ve got that, the most you can do is to set things up such that it easier for your delighted customers to share their love for your product with others. That can make all the difference.
- Paypal-community.com – Does Paypal have a referral program or affiliate program?
- Paypal.com – Referral FAQ
- Quora – How was PayPal able to structure the $10 sign-up bonus?
- Quora – How did PayPal acquire users in its early days?
- Quora – How did PayPal’s early viral growth work?
- Quora – What was PayPal’s most important strategic decision early on in achieving widespread customer adoption?
- AskDaveTaylor.com – Does PayPal have a merchant referral program?
- PinoyMoneyTalk.com – Paypal ends merchant bonus program
- Blakemasters.com – Peter Thiel’s CS183 startup class 2 notes essay
- GlobalSecurity.org – Entrepreneur Tries His Midas Touch in Space
Fun trivia: According to David Sacks it was Elon Musk who came up with the $10 referrals idea. (Interesting to think about this in tandem with Musk’s reported attitudes towards marketing. I think it’s pretty clear that he’s a marketing genius.)
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