We were thrilled to read the recent research Referral Contagion: Downstream Benefits of Customer Referrals by Rachel Gershon of UC San Diego and Zhenling Jiang of the University of Pennsylvania. The research, which analyzed the anonymized data of 41.2 million customers of a large US mobile technology over a 10-year period from May 2012 to May 2022, compared the behavior and value of referred-in customers against those acquired from other channels and found that referred-in customers:
- Spend more and have higher customer lifetime values (CLTVs) than non-referred-in customers.
- Are themselves more likely to refer in friends and family than customers acquired from other channels, creating an acquisition chain of higher value customers.
- Are more likely to refer friends and family if reminded of the fact that they too were referred to the brand.
As a result, not only are referred-in customers more valuable on their own than those acquired through organic sources, advertising or affiliates, but if we fail to consider the additional value from referrals from those referred-in customers, we’re likely to underestimate their total value by up to a third.
The authors state that when evaluating how much to invest in acquiring a referred-in customer against investing in other marketing channels, it’s important to consider not only the value of the customers own purchases but those from the extra referrals they generate. In other words, you should potentially spend more for each referred-in customer than for a customer from paid search, paid social or affiliates etc.
You can see a podcast from Professor Zhenling Jiang explaining the research here on the Knowledge at Wharton website.
Proving the value of referred-in customers
We have long made the business case for referral marketing, citing examples of world leading businesses that were built on the back of referral marketing, and asserting that referred-in customers spend more and stay longer with a brand, leading to higher CLTVs with lower churn rates. We also find that referred-in customers tend to cost up to 53% less than customers acquired by other means.
The problem, however, is getting independent evidence to demonstrate this. Much of the data that backs up these statements belongs to our clients and is locked in their back end systems, such as the purchase history of each of their customers. Often we don’t have access to this private data and, even if we do, we don’t have the right to use it or share it. Which is why we welcome this study as a valuable asset in proving the value of referred-in customers.
Prior to this research, the leading study in this field was the oft-quoted research by Philipp Schmitt, Bernd Skiera and Christophe Van den Bulte from Wharton University in 2013, which compared two groups of consumers acquired by a leading German bank over a three year period.
This study compared some 10,000 accounts and found that, compared to a control group of randomly selected customers, those referred-in by customers generated higher profit margins, were more loyal and had a CLTV. In particular, referred-in customers:
- Were 4.5 cents a day more profitable than other customers.
- Had a contribution margin of 37.6 cents a day compared to non-referred-in customers at 30 cents a day – which means that they were 25% more profitable. The difference was more pronounced in the first year but declined over time.
- Churned at an 18% lower rate, and in contrast to the contribution margin, this difference did not erode over time.
- Had a 16% higher LTCV over six years, a figure which was higher for younger customers and retail customers compared to commercial clients
- Based on paying a referral reward to 25 Euros, and generating a higher LTCV of 40 Euros, and before allowing for the fact that the customer acquisition cost was 20 Euros less, the researchers calculated a conservative 60% ROI over six years on referrals.
While still valuable, this research seems somewhat dated and due to the smaller data set and the fact that the study was carried out with a bank in Germany may lead to some doubts as to its applicability elsewhere.
Lesser known is research from Iris Roelens of Ghent University in 2019 found that, in a telecom context, referred-in customers are more valuable than non-referred customers and that referrals of weak ties also provide value to a firm by accessing new communities of potential customers.
So the first thing that the authors of this new research did was to validate the findings of the Wharton research to prove that referred-in customers are indeed more valuable. They did this by comparing 12.2m accounts from referred-in customers (30% of the total 41.2m customers acquired over the period) against all other customers and found that, referred-in customers made 8.11 more purchases on average than non-referred-in customers, an increase of 32% against the baseline of 25.05 purchases from non-referred-in customers.
In other words, they agreed with the Wharton research that referred-in customers spend more and are more valuable than other customers.
“So if we think about customer value to a company, very often, we start thinking about the value that they bring to the company themselves…. So the typical CLV, or customer lifetime value type of concepts.
And what we know from the previous work, it’s kind of well established that referred customers actually tend to be more valuable from their interaction with the firm. So they tend to buy more, they tend to stay longer. So overall, [that] makes them a more valuable customer. And what we add in this research is to say that they are not only more valuable because of their own interaction with the companies, not only in kind of more purchases, staying longer, but they also refer more customers.’”
Zhenling Jiang, Assistant Professor of Marketing at the Wharton School – Wharton School, University of Pennsylvania
Why referred-in customers are more valuable?
In their initial research, Schmitt, Skiera and Van den Bulte postulated that the reason for referred-in customers being more valuable was because:
- as the referral was rewarded, customers felt obliged to only refer customers that would be valuable to the brand;
- referrers also feel better when the referral works for the referred-in friend, meaning that they would only refer friends or family members if they believe it would be relevant and useful for them; and
- Informational advantages from the referrer’s knowledge of the products meant that they would have been likely to have discussed the advantages of the product with their friend before referring.
As for higher loyalty, they suggested that having a close friend who was also a customer increased trust in the brand and, provided that the referrer did not churn, would increase the likelihood of the new customer remaining with the brand.
In an interesting aside, the researchers felt that referrals would be more beneficial for products and services where the advantages were not immediately apparent to an outsider. These are likely to be more considered purchases such as banking, insurance, telecoms, and utilities where the products may look the same from the outside and only a customer with actual experience of the service quality can really vouch for them.
In more recent research in 2019, the same researchers together with Emmanuel Bayer, at the Keller Center for Research at Baylor University, published reasons for the effectiveness of referrals, which they summarized as being better matching and social enrichment.
Better matching comes from two elements:
- Passive matching results from the fact that people tend to connect with other people who share their interests, values and demographic characteristics. So a good customer is likely to know other good potential customers.
- Active matching which is when a referrer deliberately looks through his or her network to find contacts he or she knows or believes would appreciate the offer.
Social enrichment results from the fact that the referrer, particularly in the case of a longstanding customer, knows the both his or her friend very well and the products and services of the brand. So the referrer can make very targeted and credible recommendations.
In addition, our own recent research, The Referral Myth Debunked found that referral marketing does bring in incremental customers, with less than half of respondents claiming to have known a brand before it was referred to them.
“So combined all together, if we think about what is the value of a customer to a company, part of that is coming from my own interaction with a company. How much I purchase, how long do I stay? And the important part is my social value. So do I bring in more customers by being [a customer at these] companies? So then what we establish in this research is that we also need to consider this second component, this social value, this referring other customers component as my total value as a customer to the company.
We find that for referred customers, they will bring in 30 to 50% more new customers to the company, which comprises a very large social value
Zhenling Jiang, Assistant Professor of Marketing at the Wharton School – Wharton School, University of Pennsylvania
Referred-in customers are more likely to refer others in turn
One of the most interesting aspects to this research is the finding that the probability of referrals was higher, at 11.9%, from customers who had been referred-in compared to 7.6% from non-referred customers.
The reason posited for this was that a customer will find it more socially acceptable to refer someone to the brand when they were originally referred to the same product.
An interesting side experiment found that reminding those customers that they themselves were referred-in boosts the likelihood of referral by between 20-27%.
This result was achieved by testing a simple message to customers who had previously been referred to the brand stating “You were referred in – now refer your friends!” against a control message “Refer your friends!”. Those who got the first message made 20% more referrals.
So we uncovered a new mechanism of why they refer more, and that is the social appropriateness. So what I mean by that is, for a referred customer, which means that this customer themselves has joined the company from a referral. You know, their friends referred them in the first place. So they would find that it’s appropriate for me to also refer my friends, and I may get some incentives from the companies.
So, because they have experienced the act of referring themselves, they would, in turn, feel it’s more appropriate….They experience less psychological cost for referring other friends. And we think this is a very important phenomenon.
Zhenling Jiang, Assistant Professor of Marketing at the Wharton School – Wharton School, University of Pennsylvania
The authors suggested that this helped overcome the fear, as identified by Jin and Huang in 2014, that the presence of a referral incentive may create social costs in that the potential referrer may worry that the recipient will feel that the referrer is more motivated by the reward than making a good recommendation. Reminding the potential referrer that they too were referred and enjoy the product can make the referral seem more socially acceptable. Separately, research from Yale and UC Berkeley found that the presence of a referral reward can help overcome psychological barriers to referral, namely that the referral could turn out to be a bad recommendation.
When we note that the main reason most referral programs fail is due to a lack of marketing, this simple and low cost promotion tactic can greatly increase the performance of your program, it would be a shame not to use this as part of your efforts to market your program.
Summary
Hopefully, the above research amply illustrates the value of referrals, not just from the initial referred-in customer but from the chain of referrals this is likely to generate if you have a great product or service, happy customers and an effective referral program. Although as we’ve written previously, success is more than just software and you should consider the value of a SaaS plus Service model.
We’d be happy to talk to you about how to create your first referral program or how to improve your existing one.