Understanding the theory behind a customer referral program

Customer referrals are an essential marketing and sales tool for many businesses. The main benefit of customer referral programs is their ability to attract valuable new customers, all whilst giving back to existing ones.

The idea behind standard referral programs for most companies is simple:

It’s clear that customers have a lot to gain from participating in loyalty programs. Both existing and new customers have the chance to acquire discounts and other rewards.

But, at first glance, you may wonder what the businesses themselves have to gain from offering these rewards. All their customers have to do is refer their friends.

There’s no guarantee that a new customer will continue shopping with a brand after they’ve received their initial referral reward. In that case, the rewards given to customers wouldn’t really benefit businesses in the long run.

In reality, referral programs are important because they give back to the customer. They help:

Referral program examples show their effectiveness in enhancing customer satisfaction. But the real benefit for the businesses that run them is new customers. The incentives on offer to existing customers effectively encourage them to act as recruiters for the brand.

Because there’s a reward on the table, the advocates will put more effort into finding new friends or acquaintances to refer. This way, the company can attract new customers through their existing ones, rather than having to rely on advertising campaigns.

Even more than just bringing in new customers, referral programs allow businesses to attract more valuable customers. There are a couple of reasons for this. The first is the fact that referred customers tend to match better with a brand’s product than non-referred customers.

This matching can be broken down into two separate types - active and passive:

Linking the advocate’s reward to the amount of money spent by their friend further increases the likelihood that the new customer will be more valuable to a business.

A significant body of research around the topic of referred customers has built up over the years. The data shows that they are indeed more valuable than non-referred customers.

For example, a study published in Harvard Business Review revealed that, in comparison to normal customers, referred customers at a large German Bank were:

Customers who have been referred hold greater value compared to those who haven't, especially within the initial two to three years of their customer journey. Beyond this period, their value aligns with that of any other customer.

All-in-all, referred customers are significantly more valuable to brands than non-referred customers. This is why referral programs play such an important role in many businesses.