High referral rewards = worse customers
Large referral rewards (e.g. Get $50 if you invite a friend) boost the referral rate (+750% in one experiment) but lower the average profitability of newly referred customers (-48%).
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A higher referral reward (e.g. $50 vs $10) will bring you more new customers.
But will those customers be profitable?
P.S.: Keep an eye out and get excited for what’s coming up next week! It’s something that will benefit you all ;)
Higher referral rewards increase referral rates but reduce profitability
Impacted metrics: Customer acquisition | Customer lifetime value
For: B2C. Can be tested for B2B
Research date: October 2020
Carefully choose the size of your referral incentives (e.g. “Refer a friend and get $30”, “Gift $10 to a friend if they join, you will also get $10”).
High financial rewards greatly increase the number of referrals but strongly reduce the average lifetime value of newly referred customers.
You could easily end up acquiring customers at a loss.
Larger referral rewards increase the number of referred customers but reduce their average value.
A European online bank tested two referral reward sizes on 160,883 existing customers and measured the effect on referred customers after 2 years:
€20 reward (small):
Average referral profitability: €84.46
Profitability after reward cost: €64.46
Referral rate within 30 days: 0.042%
€50 reward (large):
Average profitability: €43.77 (48% lower)
Profitability after reward cost: -€6,23
Referral rate: 0.357% (750% higher)
An analysis of a telecom provider’s data over 3 years found that referrals doubled when the reward was €15 (vs €5) but average profitability fell by 15%.
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🧠 Why it works
Referred customers are more valuable than average because:
We tend to refer friends that we think are a very good fit with the product
There is additional social value and loyalty when using a product that a friend also uses
A larger reward motivates us to look beyond that group, to also include:
Anyone that could be interested in the product (even if it’s not a great fit for them)
People we have weaker ties with, who won’t feel more loyal to the product just because we use it
Larger referral rewards may also attract a chain of more price-sensitive customers, who tend to be less profitable.
We don’t know how not offering a financial reward at all (and simply reminding customers to please refer a friend) compares to offering small or large rewards, both in terms of referral rates and profitability.
🏢 Companies using this
Companies tend to mainly focus on referral rates when testing their referral programs, and often forget to measure their impact on profitability.
Online banks such as Revolut and Wise have been experimenting with increasing their referral rewards (e.g. €40 and $115 respectively). However, they also have ‘eligibility’ controls in place, such as a minimum of 3 transactions for referred customers, which may control for the negative effect on profitability.
⚡ Steps to implement
Model the predicted effects of your referral rewards’ size on referral rates and profitability. Find the sweet spot that maximizes referral volume with an acquisition cost that’s tolerable for your expected customer lifetime value (e.g. 1 year).
If you’re using large rewards, you can use ‘eligibility filters’ or signals to not count referrals that will likely be unprofitable. For example, the referred new customer needs to spend at least $100 to unlock the reward. Be careful to not overwhelm customers with information.
You can boost your referral rates by framing the referral as a gift to a friend and offering rewards to both.
Remember to properly promote your referral program if you want people to use it.
🔍 Study type
Field experiment (on 247 referrals of a major European online bank from 2013 to 2015) and market observation (of 20,564 referred customers of a German telecom provider from 2009 to 2012). Germany
Wolters, H. M., Schulze, C., & Gedenk, K. (October 2020). Referral reward size and new customer profitability. Marketing Science.
University of Hamburg, Frankfurt School of Finance & Management, and Xing. Germany
Remember: This is a scientific discovery. In the future it will probably be better understood and could even be proven wrong (that’s how science works). It may also not be generalizable to your situation. If it’s a risky change, always test it on a small scale before rolling it out widely.
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