Episode 31 - The Psychology & Practicalities of Referrals

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📰 Top Story - Referral Programs 

A referral program is a scheme in which the brand identifies and contacts existing customers and asks them to refer friends, family, or colleagues to that brand. The referrals are typically made in exchange for a reward for one or both parties. 

When implemented well, referral programs improve retention since customers who refer others are more loyal, spend more and have longer tenure. 

Referral programs can also be a great acquisition mechanic with low CAC and often result in the acquisition of high value customers. According to the White House Office of Consumer Affairs, referred customers have a 16% higher lifetime value than non-referred customers.

You might think the best type of referral is unprompted and unincentivised. If you have generated customer love (see episode 25 of this newsletter for more on the retention power of customer centricity), you will likely deliver high volumes of unprompted referrals. 

And you probably do want unprompted referrals. Typically, though, it is much better to ensure referrals are driven through a referral program because: 

1. Without a referral program, you cannot track referrals to an individual customer. Therefore, you cannot identify, recognise and reward your nodes of influence without a referral program.  

2. Referral programs are essential to calculating Customer Lifetime Value (CLV), particularly for identifying unseen high-value customers. A customer may have low direct revenue and short predicted tenure but high referral rates and, therefore, would be considered high value in a CLV model which includes referrals (see episode 26 of this newsletter for more on CLV).

3. Without a referral program, you can’t calculate earned growth correctly. Your earned growth rate is the proportion of your revenues or ARR driven by referrals. The chart below explains how:  

Types of Referral Program 

Broadly, there are four types of referral programs: 

1. Doubled side: A reward for the referrer and the person being referred 

2. Single-sided: Typically a reward for the referrer only (sometimes the referred) 

3. Private referral programs: An exclusive program for specific customers. 

4. Referral contests or multi-level referrals: These offer rewards for increasing the number of referrals, either as a contest or an incentivised ladder, with more significant benefits for more referrals from the same person. 

The Psychology of Referral 

Incentives can encourage customers to take action, but the underlying motivation for customer referrals is rooted in social psychology. When a customer refers a friend, they essentially link their reputation to the company's. As a result, a recommendation can only occur if the customer believes the brand will deliver an exceptional product and a positive experience.

At the moment when the referral incentive is presented, the customer asks themselves:  

• Do I know someone who would benefit from this service? 

• If yes, will my friend judge me if I make this recommendation? 

• If the answer is no, they will ask if the recommendation will enhance their relationship with their friend. 

Only once you pass all these tests will a customer act and refer a friend, and often, these questions will be answered rapidly in the customer's mind in the spur of the moment. 

So, if you practice customer love and your organisation operates to a high degree of customer centricity, you are much more likely to pass all these tests and drive referrals and earned growth. You may not pass these tests if your brand is difficult to deal with, has poor service levels or complex processes.  

If you pass these tests, the referrer's recommendation is much more likely to be trusted than any other marketing you do. According to Nielsen, 92% of consumers trust recommendations from friends and family over any other form of advertising.

When to Serve a Referral Program: 

The best time to serve a referral program will depend on your product or brand. Pre-purchase, at the end of the check-out and in-life can all be leveraged.

Typically, requesting a referral after a delightful interaction or when a customer provides a high NPS score or a positive testimonial can be very effective. Reciprocity bias is at play here: If the customer feels you have done well for them, you are more likely to be referred. 

Which Sectors Should Use Referral Programs + Tesla Case Study 

Referral programs are particularly relevant for B2B SAS brands, which often have high acquisition costs and customer lifetime value. Thus, the economics are robust. 

They also work well for e-commerce businesses, where cohorts purchasing a particular product often have friends with similar interests. For example, Huel, the meal replacement and protein brand, offers its referral program after purchase because it knows that people interested in healthy eating or working out often have friends with similar interests. 

Referral programs also work well for network-effect businesses like Uber and for subscription businesses.  

One great referral program worth highlighting is from Tesla, where the numbers are pretty significant. Tesla has zero advertising budget, and all growth is driven by word of mouth, social media, and its highly effective referral program. The current incarnation in the UK ensures that for every referral, the referred customer receives £1000 off, while the referrer earns £500!

But there have been various versions of the Tesla referral program since the program first launched in 2015, with increased incentive amounts, leaderboards - with the top prize being a new vehicle and multi-level rewards where customers who refer 10 others get invites to the next vehicle unveiling event or exclusive not-for-purchase rims or jackets. 

The program has driven a 40X ROI, fostered a sense of loyalty among owners (remember, if you refer, you are more loyal), and amplified a behaviour that was already occurring. 

Many brands offer referral programs, and this medium article lists 25 different brands referral programs and their mechanics. 

Final Thoughts

If you do not have a referral program yet, there are five reasons why you should: 

1. More accurate CLV 

2. Lower cost acquisition 

3. Higher value acquisitions 

4. Improved customer retention 

5. Ability to calculate earned growth 

If you want to discuss building an effective referral program for your brand, get in touch.

Until next week,

Tom

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