Referral programmes also known as Word-of-Mouth marketing (WOM) have become a popular way to acquire customers. Yet, there is no evidence that customers acquired through such programs - referred customers for short - are more valuable than other customers. Customer referral programmes are a form of stimulated WOM that provide incentives to existing customers to bring in new customers. Referral programmes have three distinctive characteristics.

First, they are deliberately initiated, actively managed and continuously controlled by the firm, which is impossible or very difficult with organic WOM activities like spontaneous customer conversations and blogs. Second, the key idea is to use the social connections of existing customers with non-customers to convert the latter. Third, to make this conversion happen, the firm offers the existing customer a reward for bringing in new customers.

Whereas leveraging the social ties of customers with non-customers to acquire the latter is not unique to customer referral programmes, their three distinctive characteristics set them apart from other forms of network-based marketing. Unlike organic WOM, referral programmes are actively managed and monitored by the firm. Unlike most forms of buzz and viral marketing, the source of social influence is limited to existing customers rather than anyone who knows about the brand or event. Unlike multi-level marketing, existing customers get rewarded only for bringing in new customers. They do not perform any other sales function (e.g., hosting parties) and do not generate any income as a function of subsequent sales.
Consequently, referral programmes do not carry the stigma of exploiting social ties for mercantile purposes like multi-level marketing does. In most referral programmes, the reward is given regardless of how long the new referred customers stay with the firm.

According to a new study titled, “Referral Programs and Customer Value” (to be published in the January 2011 issue of the American Marketing Association’s Journal of Marketing), customer referral programmes are indeed a financially attractive way for firms to acquire new customers. The study — authored by Van den Bulte, Bernd Skiera and Philipp Schmitt, a professor and doctoral student, respectively, at Goethe-University in Frankfurt, Germany — was conducted over a period of three years and followed the customer referral program of a leading German bank (which remained anonymous) that paid customers 25 euro for bringing in a new customer.

This study addresses this gap and investigates to what extent referred customers are more profitable and more loyal. Using information from a database of 10,000 customers acquired by the bank in 2006 — about half of them through the institution’s referral programmes and the other half through traditional marketing efforts such as direct mail and advertising — the study tackled three questions:

* Do referred customers have higher margins than other customers?
* Do referred customers stay longer with the firm than other customers?
* Do referred customers have a higher customer lifetime value (CLV), the net present value of all the profits a customer generates over his or her entire association with the firm?

An analysis of customer activity from January 2006 until September 2008, a total of 33 months, showed that referred customers indeed generated higher margins than other customers. This difference was quite sizable at first, but eroded over time and came down to zero after about 1,000 days. The average value of a referred customer is at least 16% higher than that of a non-referred customer with similar demographics and time of acquisition. However, the size of the value differential varies across customer segments; therefore, firms should use a selective approach for their referral programs.

“As a customer, I know my bank better than non-customers do. I also know my friends better than my bank does,” Van den Bulte points out. “I have a better idea than my bank about which of my friends would be a good match for the bank, and vice versa. This is the better-matching argument: The existing customer knows both the bank and the prospect, and so has superior information to assess to what extent there is a good fit between the two. Using that information, I only refer prospects who I feel will match well with my bank.”

This “superior match” phenomenon explains why the margins documented at the beginning of the study were higher for the referred customer than for the customer acquired through traditional marketing efforts. Well-matched customers simply generate more revenue at a lower cost to the firm.

Many practitioners, including managers of the bank who made the data available, fear that referral programs suffer from “moral hazard,” where opportunistic customers bring in “deadbeats and other unprofitable new customers just to earn a referral fee,” Van den Bulte states. However, the study shows that the benefits of a customer referral program can outweigh such negatives, making the programmes pay off financially.

However, there are concerns that WOM stimulated by the firm may be substantially less effective than organic WOM in generating valuable customers : (i) targeted prospects may be suspicious of stimulated WOM efforts; (ii) such efforts often involve a monetary reward for the referrer who as a result may seem less trustworthy; (iii) programs providing economic benefits tend not to be very sustainable ; (iv) unlike organic WOM, stimulated WOM is not free, raising questions about cost-effectiveness; and (v) stimulated WOM is prone to abuse by opportunistic referrers.

Why does a study on the financial benefits of customer referral programs make sense now? The recent trend toward viral or social marketing is one reason, but Van den Bulte notes that there is also a general belief that the ROI on traditional marketing has been decreasing. Consequently, companies feel that something must be done to “get a bigger bang for our marketing dollars.” This in turn has put marketers under pressure to quantify the return on their expenditures. “Marketing accountability is a major trend nowadays. One of the appeals of using a customer referral program is that you know exactly how much you put into it and, as our study shows, you can also calculate how much you’re getting out of it.”

This study goes a long way to address the uncertainty about the benefits of stimulated WOM in customer acquisition for managers facing demands to increase their marketing ROI and wondering whether or not to use this method. Small businesses have always used organic WOM to grow their businesses and they will continue to do so, says Karl Smith, founder of Business Networking South Africa. Smith concurs that stimulated WOM can erode trust if the referrers are not transparent in referring their networks for a referral fee. “If I say that I trust you, I say that I know that you will act in my best interest. It’s that simple!” says Smith. “If you simply refer me to a service provider for a fee without taking into consideration my needs, aspirations and values then you are not acting in my best interest. Can I really trust you?”

Copyright 2010 by Karl Smith
This article may be copied or republished with the following credit:
“By Karl Smith, Business Networking and Referral Coach, Cape Town, South Africa. +27 (0) 71 444 2210 karl@businessnetworkingsouthafrica.co.za “ www@businessnetworkingsouthafrica.co.za ”

Using Referral Prospecting to Build Your Business

Referral marketing can be described as the “science” and practice of initiating, developing, and maintaining deep trusting relationships to create business success. In today’s highly competitive, over-crowded world of services marketing, being ‘professional’ is a minimum expectation to get into and stay in business. Beyond that, you must also become known to and regarded by the kind of people who can best appreciate the beneficial difference you make in the life of a client. That is where marketing your services comes in. And, since you are not pushing a product off of the shelves in a retail environment, your methodology must be aligned with this reality: your marketing reflects the quantity and the quality of the relationships you develop with people who can help you grow your business or professional practice. Trusting relationships lead to referrals. To generate a large referral business, you must be in trusting relationships with the right people and they must be mutually beneficial relationships. A satisfied customer base is the foundation of referral marketing. Referrals will not happen if customers are unhappy with your product or service. 

Another expert in the area makes this distinction, Referrals work so well because of two main elements. First, commonality. The fact that your prospect and you know someone in common warms up the conversation from the very beginning. Usually, the better the relationship between your referral source and your new prospect, the warmer this first interaction will be.

The second element present is endorsement - either implied or explicit. An implied endorsement comes when you use the name of your referral source right away and mention that the referral was given because of the great service you provided. An explicit endorsement comes when your source speaks to your prospect before you call. These elements of commonality and endorsement do not just make the first conversation easier. They also significantly increase the chance of winning the new client. You will get fewer obstacles and objections, you will immediately operate from a higher level of trust, and your new prospect turned client will have a stronger sense of loyalty right from the start.

Prospects or clients have high expectations of what you might do for them. To provide great service, you must first learn about their previous experiences with others in your industry (and related industries). You must also learn what concerns they have and what they expect you to do for them. Only when you know these things, can you meet their expectations. Once you meet their expectations you can go on to exceed their expectations and turn them into referral sources. Make it a habit to ask every new client (or prospect) about why they chose you. Ask them about their past experiences. You will understand what they expect from you and having this conversation will help them trust you more.

Networking functions provide the opportunity to initiate contact, expand our contact list and to find leads, particularly when we create and nurture quality relationships. However, it is not enough to visit a networking group, talk to dozens of people and collect as many business cards possible. Building a network of trusting relationships with the right people is your most valuable asset in achieving any business goal. It is more valuable than business knowledge and specific skills. Smith says that few , if any at all, of the business commentators on reasons for the failure of businesses, in particular small business, focus on the one subject that virtually every entrepreneur says is critically important to their business—networking, referrals and social capital.

While some entrepreneurs, business owners, professionals and leaders  have a naturally ability to network  and to form trusting relationships others may find it is strenuous  to establish a large network of trusting relationships and maintain that network of relationships over time without the required knowledge, tactics, tools and systems to support that effort. For instance, it may not be easy talk to “strangers” at functions or “working rooms” such as conference, exhibitions, trade show. Others may find it difficult or even fail to ask for referrals without sufficient referral skills education.

Copyright 2007 by Karl Smith

This article may be copied or republished with the following credit:
“By Karl Smith, South Africa’s Business Networking and Referral Coach, Cape Town, South Africa. +27 (0) 082 7779431 “ karl@businessnetworkingsouthafrica.co.za” www.businessnetworkingsouthafrica.co.za