Understanding the theory behind customer referrals

Customer referrals are an essential marketing and sales tool for many businesses. The main benefit of customer referral programs is their ability to attract valuable new customers, all whilst giving back to existing ones.

The idea behind standard referral programs for most companies is simple:

• Give existing customers (advocates) their own referral code to pass on to their friends

• New customers enter their friend’s referral code for a discount on their order, or some other kind of reward

• The existing customer (advocate) receives a reward of their own when their referral code is used

Why are they so popular?

It’s clear that customers have a lot to gain from participating in loyalty programs. Both existing and new customers have the chance to acquire discounts and other rewards.

But, at first glance, you may wonder what the businesses themselves have to gain from offering these rewards. All their customers have to do is refer their friends.

There’s no guarantee that a new customer will continue shopping with a brand after they’ve received their initial referral reward. In that case, the rewards given to customers wouldn’t really benefit businesses in the long run.

In reality, referral programs are important because they give back to the customer. They help:

• Increase customer satisfaction

• Improve the relationship between business and customer

• Foster brand loyalty among customers

Attracting new customers

Referral programs do increase customer satisfaction. But the real benefit for the businesses that run them is new customers. The incentives on offer to existing customers effectively encourage them to act as recruiters for the brand.

Because there’s a reward on the table, the advocates will put more effort into finding new friends or acquaintances to refer. This way, the company can attract new customers through their existing ones, rather than having to rely on advertising campaigns.

Attracting more valuable customers

Even more than just bringing in new customers, referral programs allow businesses to attract more valuable customers. There are a couple of reasons for this. The first is the fact that referred customers tend to match better with a brand’s product than non-referred customers.

This matching can be broken down into two separate types - active and passive:

• Active matching: Active matching relies on the advocate’s knowledge of the brand and the new customer. Because they receive an incentive, they will use their knowledge of both parties to try and find referrals which represent the best match. Active matching can also refer to active efforts by a company or other party to find appropriate new customers.

• Passive matching: Passive matching relies on the assumption that customers will know and refer people who have similar interests, traits and purchase behaviours as themselves. This means that referral programs usually bring in a higher quality of new customers.
  

Linking the advocate’s reward to the amount of money spent by their friend further increases the likelihood that the new customer will be more valuable to a business.

How much more valuable are referred customers?

A significant body of research around the topic of referred customers has built up over the years. The data shows that they are indeed more valuable than non-referred customers.

For example, a study published in Harvard Business Review revealed that, in comparison to normal customers, referred customers at a large German Bank were:

• 16% more valuable in terms of profits

• 18% more likely to stay with the bank

• 16-25% more valuable to the brand over their customer lifetime

Referred customers are significantly more valuable than non-referred customers primarily during the first two to three years after becoming a customer. After this they become as valuable as any other customer.

All-in-all, referred customers are significantly more valuable to brands than non-referred customers. This is why referral programs play such an important role in many businesses.

Referral programs are one of the key features on offer in Talon.One's Promotion Engine. If you'd like to know more about referral programs and how our Promotion Engine runs them, take a look in our Content Library.