“If you build it, they will come.”
Even if you have never seen Field of Dreams with Kevin Costner, I guarantee you have heard those words. Now, that may be a compelling reason to build a baseball field in the middle of Iowa, it is not, however, a sound business practice.
Unfortunately, that is how a lot of businesses approach referrals and referral marketing.
What is Referral Marketing
Referral marketing is the intentional approach to developing more referrals from your existing customers. It is a part of a wider concept known as word-of-mouth marketing, which is separate from traditional marketing such as print or TV advertising.
McKinsey notes the importance of word-of-mouth marketing stating that it is a primary factor behind 20-50% of purchasing decisions. They classify three different types of word-of-mouth communications. They are:
- Experiential – which accounts for 50-80% of word-of-mouth activity. This results from a consumer’s direct contact with a product or service that “deviates from what’s expected.” It can be positive, such as a glowing review posted online, or negative, like complaining to a friend about something specific that woefully under-delivered.
- Consequential – which is when consumers pass on traditional forms of marketing. A good example of this is all the chatter generated about a really good, or really bad, Super Bowl commercial.
- Intentional – which is when companies directly try to create a conversation about their product or service. A celebrity endorsement is a perfect example of intentional word-of-mouth marketing.
Experiential word-of-mouth marketing is what most people think of when discussing the topic. These conversations turn into a referral when a current customer relates their exceedingly positive experience along with a recommendation to another consumer. All businesses can benefit from these exchanges.
Unfortunately, it does not happen as often as you might think. While a large majority of customers who have a positive Customer Experience say they are willing to provide a referral, a minority actually follow through.
According to a Texas Tech University study, 83% of customers with a positive experience say they are willing to provide referrals, but only 29% actually do.
This is true across different industries with surprisingly similar results.
The Harvard Business Review reports that 68% of financial service customers said that they would provide referrals, but only 33% actually did, and 81% of telecommunications customers would give one, but only 30% did so.
The good news for your business is that your customers are willing to refer your business to their friends and family after a positive experience. The bad news is that a minority are actually doing it. You can, however, change that by implementing a referral marketing program.
Referral Marketing Is More Trusted
By developing a referral marketing program, your business can tap into the most trusted type of media.
Word-of-mouth is, above all other types of media, the most trusted. According to Nielson, 92% of people around the word say they trust recommendations from friends and family over any other type of communication. The key takeaways from that study are:
- Close friends and family are the most credible sources of information,
- Consumer trust in traditional paid advertising is decreasing, and
- Consumer confidence in online and mobile advertising is increasing.
Businesses, however, are not taking these factors into account. Most advertising dollars are still spent on traditional media campaigns.
McKinsey notes that as consumers have become overloaded by traditional media campaigns they have become skeptical and “increasingly prefer to make purchasing decisions largely independent of what companies tell them.”
A recommendation is 50 times more likely to trigger a purchase if it comes from a trusted source. It is best summed up when the article states: “it’s the small, close-knit network of trusted friends that has the real influence” over consumer purchasing decisions. Developing a referral marketing program can help your business tap into that network.
Recommendations from friends and family are the most trusted form of communications, but if those recommendations bring in new customers, those referred customers are also more loyal and profitable than customers acquired through traditional media campaigns.
Referred Customers Are More Loyal and Profitable
People who come to your business through another customer’s referral are likely to end up being your best customers. A study conducted by the Wharton School and the Goethe University in Germany demonstrates that referred customers really are worth the effort of actively pursuing referrals.
The study, which was conducted in the banking industry, analyzed 10,000 accounts over a 33-month period. It found that customers who were referred were more likely to stay with the bank than customers acquired through other means. In fact, there was 18% less customer churn for referred customers compared to others.
Not only were the customers more loyal, but they were more profitable as well. Referred customers had a higher customer lifetime value. This value, over a 6 year period, was on average 16% higher than other customers.
This was most felt during the first 2.5 years, after which they were equal to other customers that had not been referred. So, your referred customers have a higher impact, and it comes right after the referral and lasts for an extended amount of time.
In the study, the referral program used an incentive program, offering a small reward of €25 to each existing customer that brought in a new customer. One of the concerns was whether the reward would be recovered in the new customer relationship. The study found that, on average, the new customer’s lifetime value recovered the fee and had a return on investment over a 6-year period of 60%. The referral incentive paid for itself and increased profitability.
The Harvard Business Review, reporting on the Wharton study, found that the age of the referred customers also made a difference on the customers lifetime value. On average, younger referrals tend to be far more profitable when compared to non-referred customers of the same age.
Referred customers between 26 and 35 were 35.5% more valuable than non-referred customers. Those between 36 and 55 were 22.7% more valuable. But referred customers who were 56 or older, had a slightly lower lifetime value than non-referred customers by .5%. Clearly younger referred customers have a much higher lifetime value.
Not only are referrals growing the size of your business, but referred customers can also be some of your most loyal and profitable.
Some Industries Can Benefit More from Referrals
Some industries can benefit more from referrals than others. Those industries that sell a product or provide a service that tend to be more expensive or important to a consumer are more likely to benefit from referrals. The more resources or more risk tied to the purchase, the more willing a consumer will listen to trusted friends and family regarding their own experience about your business.
The Wharton study backs up this notion. The authors remarked that, “products and services that imply some sort of risk should benefit more than average from referrals because prospects are likely to feel the risk is lower when a trusted person has positive experiences.”
McKinsey also echoes these statements saying that customers require more research, more time, and seek more opinions for first time or expensive purchases.
The importance of referrals for these big ticket decisions, cannot be overstated. Some examples are medical care, legal services, buying a new home, or buying a car. Each of these decisions are very impactful on a consumer so they will be sure to reach out to friends and family for any personal knowledge or recommendations they may have.
Keep Metrics on your Referrals
The Wharton study also noted that “a referral should be monitored closely to see if it is effective at identifying good prospects and if acquisition costs do not exceed the subsequent value of the customers.” Collecting data from your referral program can greatly increase its effectiveness.
A customer’s total value is not only how many dollars they directly contribute to your business. The Harvard Business Review has stated that a customer’s value is greater than what he or she actually purchases.
They remarked that, “in these interconnected days, how your customers feel about you and what they are prepared to tell others about you can influence your revenues and profits just as much” as what they buy. In order to figure out that value though, you need to keep tabs on your referral marketing program.
The same HBR article discusses how to calculate a consumer’s lifetime value (CLV) and a customer’s referral value (CRV), which is how much they contribute to your business through you referrals.
It is not a guarantee that your most loyal customers, those with a high lifetime value, are also those who bring you the most referrals. In fact, there is often no discernable relation between the two metrics.
If you keep records of who provided referrals and use your business’s sales data, you will be able to group your customers into four distinct groups.
In a perfect word, all of your customers would have a high lifetime value and a high referral value. That, however, rarely happens. Instead, customers might have a high lifetime value and a low referral value, or a low lifetime but high referral value, or even a low lifetime and a low referral value.
The good news is that once you have classified and grouped your customers into these four different categories, you can then target them with specific advertising focused on whichever one they are lower in. The HBR article noted that you can move 4-5% of each group into a higher performing one with specific marketing for their category.
Not only will your customers bring in more business and referrals, but this type of targeted advertising has a much better return on investment. The final return on average for this type of marketing has an ROI of 13.6 times compared to standard marketing campaigns of 4-6 times.
The more information and customer data you have on hand, the better. You can adjust your messaging to determine which approaches and wording work best. Not only can you figure out what works and what doesn’t, but you can use your data to run better organized and targeted marketing campaigns. These specific and targeted campaigns can build a powerhouse marketing machine for your business.
Incentive Based Referrals
Some referral programs, like the Wharton study, use incentives to bring in new customers. They could be given to the new customer or the existing customer, or both.
Examples include a straightforward monetary reward for each new customer referred, an entry into a raffle to win a large prize, or a discount on future services.
You should, however, be careful of offering incentives that impart some sort of value, depending on your industry. There could be legal or ethical restrictions to running an incentive based referral program. Make sure to check with your professional organization or the state licensing board before starting up an incentive based referral program.
If you are in an industry that prohibits incentives for referrals, there are still things you can do to show your appreciation to a customer who referred a new one. Something as easy as a handwritten thank you note signed by the whole office can be very effective at showing your gratitude. By giving a personal touch, you can increase the existing customer’s already positive view of your business.
RenegadeWorks Referral Software
There are many different approaches to referral marketing. These could be as simple as training your staff to be intentional about asking current customers for referrals. It can sometimes be difficult for staff at first, but the benefits far outweigh any temporary awkwardness.
Other options exist as well. We have marketing software that make if easy for your business to ask existing customers for referrals. These referrals are stored and easily accessed so your team can follow up with them. Our software also has the capability to offer incentives or rewards if allowed by your industry.
The issue is not whether you should run a referral marketing program, but how. By specifically seeking referrals from your existing customers, you can get new customers that are more loyal, more profitable, and can form a stronger customer base for your business.
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