What Yale University and UC Berkeley can teach you about Word of Mouth Marketing

You wouldn’t be surprised to hear Buyapowa evangelizing how word of mouth is the most effective marketing there is because we’ve spent over a decade obsessing about all things referral marketing. But you might be a little skeptical about taking our word for it, given that we have ‘skin in the game’. But when two of America’s most prestigious universities, Yale and UC Berkeley, publish research on the effectiveness of word of mouth, and the reasons why it works so well than we think that’s worth a few moments of your time.

Since this research was first published in 2020, there have been other studies that have shown that referral marketing drives more valuable customers who not only spend more and stay longer but are more likely to refer new customers to a brand, as well as an interesting study from Harvard into the value of friend incentives in referral. And Buyapowa’s own research showed that 95% of respondents claimed to have referred a friend in the past year, and that eight out of ten consumers expect to be able to refer their favourite brands and that two thirds of respondents said that they would view a brand positively if it had a referral program. But the research from Aniko Öry from Yale School of Management and Yuichiro Kamada from the Haas School of Business UC Berkeley remains one of our favorite studies into the motivation for referrals.

The importance of WOM

I’m sure you know that word-of-mouth marketing, or WOM if you’re strapped for time, is that elusive marketing gold that brands always chase. It helped create titans like Uber, Airbnb and Dropbox, and reportedly accounts for a whopping $7-10 trillion of all consumer spending. Quite simply, it turns happy customers into brand advocates that then help those brands acquire new customers through their evangelism.

Now, word-of-mouth marketing’s key success factor is trust. The reason that those brand advocates are able to recruit new customers for a particular brand or product is that those referrers are trusted. In fact, 88% of consumers trust recommendations from friends and family, and 73% of all consumers consider word-of-mouth to be a critical influence in purchase decisions. And that makes sense; how often have you watched a film or binged on a series streamed on Netflix or Amazon Prime, dined at a particular restaurant, or even signed up with a specific mobile phone carrier — all because someone you trust recommended it?

But it’s important to remember, that word-of-mouth marketing can be fueled and nurtured. It’s not random and it’s certainly not out of your control.

So how do you nurture and fuel WOM?

In their research Dr Aniko Öry from Yale School of Management and Dr Yuichiro Kamada from the Haas School of Business UC Berkeley looked at the two best methods for fueling WOM: using a freemium model and referral marketing.

In summary, they found that each strategy—or a combination of the two—is effective at driving customer acquisition, depending on the size of your audience and whether your project has a social aspect and network externalities.

“I think rewards play a very important role. For a start, they’re a thank you for your client. Your client spends some effort on your behalf. So it’s just fair that you say thank you. Also some research from Yale and Berkeley, [a few years ago]showed that it actually helps overcome psychological barriers to referring, so it actually serves a really important purpose.”
Peter Cunningham, Director of Marketing – Buyapowa

What role can Freemium play?

In many instances, employing a freemium model, meaning offering a limited version of the product for free and encouraging new customers to try the premium features for a short period of time before upgrading to the paid version, can provide customers with a direct, experiential way of boosting word-of-mouth. This encourages them to try it risk-free, and their satisfaction with the product can then drive them to become a paying customer and then recommend it to their friends and family after having tried it first-hand.

But the researchers point out that freemium works best when your service or product is new and has positive network externalities—that is, one where users benefit from interacting with others like, say, Instagram or Dropbox. Obviously, in some cases, a freemium model isn’t exactly practical, particularly where each product or service delivery has a high set up or incremental cost. How many restaurants would survive if they gave you a meal for free and then gave you the option to upgrade to a premium version later that came with a glass of wine? I don’t know about you, but I’m teetotaling and eating for free.

So how does referral marketing specifically boost WOM, then?

That’s the million-dollar question, isn’t it?

Well, what did the team at Yale and UC Berkeley have to say on this?

Put simply, referral marketing drives word-of-mouth behavior by offering a reward to existing customers for successfully referring a brand or product to their friends and family, and, in turn, those referred-in friends are provided with an incentive to become customers themselves. It’s nice and simple. Now both the reward and incentive are equally important. After all, it’s one thing to give customers a reason to refer, but it’s something else to encourage those friends to then become customers themselves, for example by giving them an offer that they can’t find elsewhere.

Now, I’m a fan of examples, so let’s lead with one. Let’s say you’re a prominent telecom that provides a mobile service to millions of happy customers. So, you deploy a refer-a-friend scheme that offers, say, a $25 gift card to successful referrers. Now your customers are incentivized to become brand advocates who help spread the word about your service to other potential customers. And, in turn, by offering a similar incentive to those referred-in, you can dramatically boost conversion rates and ensure they become a happy customer themselves. It drives the conversation forward and, in fact, assigns an opportunity cost to not referring you to friends and family.

The researchers looked at Uber, a product with mass-market appeal that many people are willing to pay for but where there is no direct social aspect of using the service. In this case, they concluded that the optimal marketing scheme is not to use freemium but to offer referral rewards, which was exactly Uber’s strategy at the time of the research, and contributed to them becoming the titan of ride-sharing they are today. Although Uber has since shelved its consumer referral program for the reasons set out here, it continues with a very successful program for driver referrals.

Now, while that’s referral marketing in broad strokes, when deployed cleverly, advocate marketing can actually get much more surgical than this and help you achieve very specific goals, like helping you target particular customer types or promote specific products and product categories.

Hear from Buyapowa’s Referral Experts on the role rewards play in referrals.

Okay, but what’s the catch?

While referral marketing is especially powerful at driving the word-of-mouth behavior that would otherwise be at the whims of the cosmos and your existing customers’ generosity; it does cost. And there are two costs involved here, as the researchers point out. One is for the company, in the form of the rewards and incentives handed out, which it’s worth mentioning come with a price tag that’s typically a fraction of the cost compared to other traditional channels. The other, which is the most important part, is for the customers themselves.

But, as the Yale and Berkeley researchers write, the price tag for the customer is less a financial one and more of a psychological one. There is a barrier for people to talk about brands or products since there is a risk of losing social currency if that recommendation turns out to be a bad one. If a friend recommends a restaurant to you and you have a bad time, it’s going to be tough for that experience not to reflect back on that friend. And, as a result, you might think twice before accepting another food-related recommendation from that person. And there is also an opportunity cost involved. After all, there are other things you could be doing with your time than recommending a brand or product to a friend, like going online and complaining about a product you bought that broke down within weeks.

The key here is that the rewards and incentives you offer must balance both the material cost to your company and outweigh the social cost to your customers referring you to their friends and family.

“The thing is I might refer a brand at some point, so at some point this year I might tell you about a brand, but you want me to do it now. You don’t want me to wait. So it’s about overcoming inertia. It’s about actually making something happen when the brand wants it to happen. It’s about controlling that and tracking that and all of those things. The way you do that is you offer people rewards and it gets everything moving.”
Robin Brand, Director of Brand – Buyapowa

Freemium and referral together?

As the researchers found, provided that your costs of production are low like Dropbox, then the best strategy for fueling word-of-mouth for a brand or product is both deploying a referral program that encourages existing customers to refer-in their friends and family and leveraging a freemium model that enables customers to try a product risk-free.

But whereas freemium seems limited to cases with low production costs, referral marketing works in just about every context. So it’s imperative that you have a referral program up and running, otherwise, word-of-mouth might just remain forever out of reach.

With the science on referral’s side, whether you already have a referral program or are just looking to get started, we would be happy to share what we have learned from working with over 350 leading brands and retailers across 21 countries. And of course, as we don’t pretend to have all the answers, we would also love to learn from your experiences and hear what has or has not worked for you. So why not reach out and let’s begin a conversation?