People don’t really like being marketed at: this is common knowledge. All the way back in 2004, Yankelovich Partners Inc. found that 65% of people feel bombarded with too many marketing messages. 61% feel the volume of marketing messages is “out of control”.
In a world saturated with advertising, people put more trust in the recommendations of the people they actually know. According to Nielsen’s 2021 Global Trust in Advertising report, 88% of customers “trust recommendations from people they know more than any other channel”.
Referred customers are more profitable, too — as much as 25% more profitable than non-referred customers.
Generating referrals is clearly very important. Especially for small businesses, which, on average, attribute 60% of revenue to referrals.
But it doesn’t always happen naturally. 83% of customers are willing to make referrals, but only 29% do so without being prompted.
So what’s needed is a strategic, structured approach to prompting referrals. This is known as referral marketing. And that’s what we’re talking about here. Not the happy-accident word-of-mouth acquisition — wonderful though that is — but the deliberate incentivization of customer referrals.
In this guide
– Referral marketing: pros and cons
– The psychology of referrals
– The core referral marketing channels
– Defining your referral marketing strategy
– Examples and case studies
– How to measure your referral marketing program
Referral marketing: advantages and disadvantages
Advantages of referral marketing
1. Referral marketing is cost-effective
Compared to your average advertising effort, referral marketing is cheap. Sometimes it’s free — a satisfied customer just spreads the word out of the goodness of their heart.
Sadly, this word-of-mouth magic isn’t that common. Most of your referrals will come as a result of the incentives you offer.
Although these referrals aren’t free — if you’re giving $10 off to both the referrer and the referred, you’ve spent $20 — they’re cost-effective. The cost per acquisition (CPA) for referred customers is usually low.
And they’re especially worthwhile, too, because…
2. Referred customers are, on average, more valuable
You might think that incentivized referrals would lead to lower value customers who disappear once they’ve used their discount. But research shows overwhelmingly this isn’t the case.
On average, customers who are referred by someone else have a 16% higher lifetime value. This is partly because they’re cheaper to bring on board, and partly because they have a 37% higher retention rate.
And it’s not just the referred customers who tend to spend more…
3. Customers who refer others also have a higher lifetime value
When you incentivize referrals through discounts, your existing customers — the ones doing the referring — will be inclined to make more purchases in order to spend the discounts they earn.
And the more they buy from you, the more referrals they’ll make. The more referrals, the more purchases. And so on.
The cumulative effect here is an increase in customer lifetime value (CLV), which was likely already above average anyway — after all, it’s your happy customers who are more inclined to tell their friends about you.
4. Referrals are naturally targeted to highly relevant people
When marketing is aimed at the wrong people, it can cause wastage and even have a negative impact on the perception of your brand.
But referral marketing is inherently targeted — without you having to do anything. People only promote your products to those they think will care or share an interest.
5. Referral marketing has viral potential — if you put the right strategy in place
When you give your customers a unique referral code or link, they can share it en masse through social channels, which can get your product in front of thousands of potential customers.
Drawbacks of referral marketing
1. Referrals don’t tend to scale — and they’re heavily reliant on having the right customer base
Even the most social of butterflies only knows so many people. With referral marketing, your potential audience is limited to the networks of your existing customers. And even with incentives, you can’t actually control who makes a referral, to whom, and when.
On average, engaged customers refer 2.68 people. But many of your customers won’t make any referrals at all, either because they’re not engaged or simply because they don’t know anyone who would be interested.
This can create problems with volume. The global average referral rate — that is, the proportion of new customers generated from referrals — is estimated at around 2.35%. That means 2.35 of every 100 new customers will come from a referral.
For all the benefits of referral marketing — higher lifetime value, better customer retention, low acquisition costs — it often needs to go hand in hand with more expansive (and expensive!) marketing tactics if you need to generate large numbers of new customers quickly.
2. Referral marketing often doesn’t help you enter new markets or reach a new kind of customer
Referral marketing can be limited in terms of the kinds of new customers you can reach, not just the number of new customers.
That’s because customers tend to refer people like them. And this is great if the referring customer is high-value and high-spending, but it’s less useful if you’re trying to reach a different kind of person, reposition yourself within the market, or enter new markets altogether.
3. You lose control of your marketing messages
When you run an advertising campaign, you can tweak your messaging and fine-tune your creative.
But when customers are spreading the word, you can’t control exactly what they say about your business.
This isn’t usually a huge issue — you’d hope your customers’ positive experiences reflect your branding. But if unique, consistent branding is a major part of your offering, it’s something to consider.
4. Designing a good reward system can be daunting
Designing an effective and sustainable reward system is crucial but can be daunting. You need to balance sufficiently tantalizing rewards with healthy profit margins.
Too stingy, and nobody will make referrals. Too generous, and you won’t be making the most of the low-cost customer acquisition that makes referral marketing such a powerful tool for your brand.
5. Referral marketing isn’t always easy to measure
There are lots of clever metrics associated with referral marketing — we’ll cover them later in this article — but tracking the real value of referrals is more complicated than many other channels.
Unlike, say, a social media advertising campaign with clear, obvious goals — earn more money per customer than you spend acquiring them — referral marketing is a nuanced mix of brand awareness, acquisition and retention.
To track all of that effectively, you need a sophisticated system of key performance indicators (KPIs).
The psychology of referrals
Social capital
Beyond the cold, hard reality of financial incentives, referrals are built on the idea of “social capital”. That is, everyone wants to be the person with the knowledge and the answers, the person to whom their friends turn when they need a recommendation.
And people with social capital are trusted. When that particularly well-informed friend of yours recommends a brand, you tend to listen.
That’s why word-of-mouth referrals — those that don’t come through a structured, incentivized referral program — have a 32% conversion rate.
Reward incentives
But social capital isn’t always enough. As we established earlier, despite a widespread willingness to refer others to a brand — assuming they have a good experience — only a small minority of people will do it without prompting — or, more likely, incentives.
Why are incentives necessary? Partly because people use a lot of products, and they don’t give most of those products a second thought. Incentives keep your brand front of mind. But it’s also because of the “social risk” associated with making recommendations.
Social risk
Social risk is essentially the other side of the social capital coin. If you recommend a product or service to someone and they have a terrible experience with it, you look a bit silly.
So every time your customer refers someone to your brand, they’re taking a risk. They’re risking a loss of social capital.
To overcome this, you need to offer a consistently great experience, so that your referring customers can be supremely confident their friends will get a similarly good experience. (This is a good reason to focus your referral marketing efforts on your happiest customers.)
Or you can overcome it by offering incentives. When discounts are involved, the social risk is lower, because the ability to offer discounts itself provides the referrer with social capital. And even if the person they refer has a bad experience — well, at least they got it cheaper.
The core referral marketing channels
Structured referral programs, email and social media are typically the most effective referral marketing channels. Each has its own strengths and weaknesses. For best results, combine them in complementary ways.
Customer referral programs
This is the core of your referral marketing strategy. Typically, these programs offer incentives like loyalty points, credits, or free products for each successful referral.
In e-commerce, this usually involves sharing a unique referral link or code.
How it works:
– You give your existing customers a unique referral code or link
– They share it with friends, family, colleagues, half-remembered social media acquaintances — the wider they share it, the better
– Those people make a purchase and use the code — or click on the link — and they get an incentive to convert
– The original customer gets a reward
Email marketing
On average, emails related to loyalty and referral programs have a 20% higher click-through rate.
That’s because they’re personalized and direct. They’re also pretty easy to set up, track and tailor to different segments of your audience.
Social media
Social media gives referral marketing scale. When your customers share their referral codes and URLs with their social networks, the potential audience grows from tens to maybe tens of thousands.
The downside — those referrals are typically less valuable. When customers personally refer someone, it’s meaningful. That recommendation has been made because the product is suitable for that particular person.
But through social media there’s likely a greater proportion of customers who are just chasing discounts.
Social media works best in combination with other referral channels. And customers are happy to use their social media channels to spread the word: 88% of Americans are interested in receiving incentives for sharing products on social media.
Defining your referral marketing strategy
Understand your audience
Before launching a referral program, it’s crucial to understand your target audience. What motivates them? What kind of rewards would they value? This understanding will shape your entire strategy, from the type of referral program you implement to the messaging and marketing channels you use.
Consider things like:
– Demographic data: some groups tend to be more receptive to referral marketing than others. Millennials, in particular, show a high trust in referral advertising, with 85% being influenced by referrals, and 48% saying it has more influence on them than other channels.
– Behavioral data: What channels do your customers use? If they’re big on social media, their referral codes could reach thousands of people, which could make referral marketing particularly relevant.
– Customer satisfaction: How happy are your customers? Are they regularly referring their friends already? Do you have a small cohort of “super customers”, or is there a broader trend of moderate satisfaction? This will help you figure out the best ways to launch and promote your referral program.
Figure out your rewards
This is the nuts-and-bolts of the referral marketing program. You need to figure out:
– How you’re going to reward customers: Most referral programs offer cash discounts as a reward, but dollar incentives aren’t the only way to incentivize referrals. Access to exclusive products is popular, too, especially in luxury markets — as are loyalty points more broadly.
– Who you’re going to reward: More than 90% of referral programs are “double-sided” — they reward both the referrer and the referred. In 72% of cases, both parties get the exact same reward.
But you don’t have to do this. If you find you get a lot of referrals anyway, but not enough of them convert, you may not need to reward the existing customer making the referral. And if you’re in an industry in which customers rely heavily on the recommendations of people they know, you might not need to reward the referred customer to get them over the line.
– How much you’re going to reward them with: The average referral program reward is $10 — but naturally this depends on the price of your product and the generosity of your profit margins. You don’t want to be making a big loss on products sold via referral.
Tell your existing customers about it
Promotion is crucial — your existing customers need to know about your referral program to make use of it.
Consider channels like:
– Social media — a good way to spread the word far and wide
– Email — easy to personalize and with a higher conversion rate
– SMS
– Your app, if you have one
Examples and case studies
Casper (the mattress brand)
How it works: Casper uses a “double-sided” referral program — both the referrer and the referred get a reward. But it’s not “mirrored” — they don’t get the same reward.
The person doing the referring gets a $75 Amazon gift card. They can refer multiple people and get multiple gift cards, up to a maximum of $599 per year in gift card rewards.
There are also rewards for referring people to buy pillows. The referrer gets a $10 gift card, the referred customer gets 10% off.
The results: In 4 years, Casper grew from nothing to $750m — their referral program is a huge part of that.
Why it works: For one thing, Casper makes it very easy to refer people, with pre-populated emails and templated social posts and SMS messages.
More mechanically, the reward system works because it understands buyer behavior in that market. Unlike most referral programs, which offer the same incentive (discounts) to the referrer and the referred, Casper offers an Amazon gift card to the person doing the referring.
This is because they know that people don’t tend to buy mattresses very often, so a discount or credit isn’t much of an incentive to make a referral.
By offering such generous referral incentives, they built a referral program that set them apart in a new market (ecommerce mattresses) that was quickly becoming crowded with brands that didn’t have much to differentiate them (Emma, Simba etc.). They offered similar products at similar price points with similar money-back guarantees.
Glossier
How it works: Glossier offers a standard double-sided discount. For the referrer, it’s $10. For the referred, it’s 10% off the first order. The referred customer’s discount expires after 3 months.
The results: Glossier, which has estimated annual sales of more than $180m, attributes 70% of its ecommerce revenue to referrals.
Why it works: By offering a percentage discount rather than a flat dollar amount, Glossier incentivizes referred customers to make a larger purchase. This encourages them to try out more products, which gives them more exposure to the overall range, which makes them more likely to buy more in future.
It’s a great way to increase average order value, and the 3-month expiry creates a sense of urgency.
They’ve combined this with a strong customer community, which gives customers more opportunities to share their referral codes.
Referral marketing is always a good bet in the beauty industry, because they’re consumable products that are purchased regularly. That means happy customers tend to have a high customer lifetime value (CLV), so the initial discount is a small price to pay for long-term revenue.
Dollar Shave Club (DSC)
How it works: DSC uses a one-sided discount of $5 for the referrer, which is automatically applied to their next order. The referred customer doesn’t get anything.
The results: It’s estimated that DSC has acquired 50,000 customers from referrals.
Why it works: Like Glossier, DSC recognizes that razor blades are consumables that need to be ordered regularly, so the high lifetime value makes the dollar discount a small price to pay.
Interestingly, DSC doesn’t offer an incentive to the referred customer. This could be because they recognize that subscription razor blades are commodities — one brand’s blades are going to be roughly similar to another’s.
Because of that, there’s less need to convince the referred customer to buy your blades specifically — they want the convenience of a subscription, so they go with the brand that will give their friend a $5 discount. It’s a kind of inversion of the social capital principle.
By taking this approach, DSC minimizes the cost of acquiring a customer through referrals, and thereby increases the profit margins on each new subscriber.
How to measure your referral marketing program
Measuring referrals can be a little complex, but there are plenty of established metrics you can use to get a sense of the value of your referral marketing.
1. Referral rate
Referral rate measures the percentage of your customers who are referring others. It’s calculated by dividing the number of customers who make a referral by the total number of customers.
A low referral rate suggests you could do more to promote your referral program to your existing customer base.
Formula: number of customers who made at least one referral / total number of customers
2. Conversion rate of referred customers
This metric tracks the percentage of referred people that convert into paying customers. A high conversion rate indicates that your referral program is attracting relevant, high-quality new customers.
Formula: number of people referred / paying customers gained from referrals
3. Customer lifetime value (CLV) of referred customers
Customer lifetime value (CLV) projects the total monetary value of a given customer.
If CLV is higher than the cost of acquiring a customer, you’re making a profit.
Loyal customers — who make more purchases and spend more per purchase — tend to have a higher CLV than non-loyal customers.
To calculate CLV, you need to first multiply average purchase value — total customer spend divided by number of purchases in a given year — and multiply that by average purchase frequency — number of purchases divided by number of customers.
This is your average customer value. You can then multiply this by the average customer lifespan — the amount of time, on average, a customer purchases from you — and you have a CLV figure.
So, if your average customer spends $20 per purchase, and makes an average of four purchases per year, your average customer value is $80. If your average customer buys from you for five years in a row, your CLV is $400.
A low CLV suggests your customers aren’t very loyal.
Calculate the CLV of your referral customers and compare it to your overall CLV — if it’s higher, referral marketing is delivering high-value customers. If it’s much lower, your referred customers aren’t spending as much as they could be.
4. Cost per acquisition (CPA) for referred customers
Cost per acquisition (CPA) tells you how much you have to spend, on average, to bring in a new customer. You can compare it with customer lifetime value (CLV) to figure out how profitable your customers are.
Loyal customers often recommend you to other customers, which is an extremely cost-effective form of customer acquisition. So, as you build customer loyalty, you should see a drop-off in CPA.
The formula is [total spend on marketing] / [number of new customers].
Typically, this figure is lower for referred customers than those acquired through, say, advertising. The main costs involved are the discounts you give the referred and referring customers.
If your referral CPA is higher than your overall CPA, it suggests your referral rewards are a little too generous.
5. Number of referrals per referrer
This measures the average number of referrals made by each referring customer.
It’s a good way to understand where your referrals are coming from. Do you have a small cohort of prolific referrers, or are lots of customers referring a small number of people? This can help guide your marketing. Maybe you need to do more to tell your existing customers about the referral program. Or maybe you need to improve the rewards so that each customer is referring more people.
Ready to build referral marketing into your loyalty program?
We’ve bombarded you with enough referral marketing statistics over the last 3,000 words, but if you can stomach one more: 55% of brands with a referral program consider their sales and marketing efforts as successful, compared to 35% without.
It can work for you, too. You just need the right incentives.
With a loyalty program that facilitates customer referrals, you can offer these incentives in a structured, systematic way.
LoyaltyLion makes running a loyalty program easy. When you’re ready to get started, book a demo.
Managing your program
