Referral Marketing is Sick - Use it to Go Viral

by Jonathan Krieger

In startup circles Viral Marketing is often discussed as a low cost way to acquire new customers and rapidly scale a business.

David Skok of Matrix Partners uses this blog post to break viral marketing into two components:

  1. Viral coefficient – Number of new customers acquired for each existing customer
  2. Viral cycle-time – Length of time required to acquire a new customer 
The higher the viral coefficient and lower the cycle time, the more “viral” the company and the faster it will grow.

One way that companies can impact their viral coefficient is through referral marketing. Referral marketing uses incentives to encourage specific customer behavior- in this case new customer acquisition. Referrals occur when an advocate recommends your product or service to a friend who becomes a new customer. A 2010 study found that 83% of satisfied customers reported a willingness to recommend services to others, however only 29% of customers actually do so. Referral marketing aims to close this gap, providing incentives that motivate the remaining 54% of satisfied customers to become advocates.

Referral incentives are the rewards offered to motivate advocates, and can come in a variety of forms:

Monetary incentives are easy-to-quantify rewards that can be directly linked to financial gain. These include cash, gift certificates, company credit, and future or retroactive rebates and discounts. 
Non-monetary incentives are more opaque rewards that are still desired by your advocates. These may include special access to products, experiences (i.e. consultations/training) and information or public recognition and credit (e.g. badges/certificates).
Companies should use incentives that are:
  1. Tailored to their target advocates 
  2. Encourage customer engagement and 
  3. Allow for profitable customer acquisition cost (CAC) 

According to David Skok, best practice for recurring revenue businesses is to target CAC that is no more than 1/3rd of customer lifetime value (LTV)*

A University of Chicago study found that non-cash incentives were 24% more effective at boosting performance than cash incentives.* While cash may be a simple, and cost effective way to encourage referrals, companies should think critically about how they can move beyond cash to reward advocates in meaningful ways.

Cloud based storage service Dropbox provides a best-in-class example of how referrals can drive business growth. In April 2010 an impressive 35% of new Dropbox signups came through referrals.*** Their referral program offers an additional 250 MB of storage space to both the advocate and friend for each new signup. This reward meet’s all the aforementioned criteria. It is highly desired by Dropbox users who quickly fill-up the 2 GB included in their free trial. It also encourages deeper customer engagement; making Dropbox more “sticky” as customer use it to store and share more data, and it is extremely low-cost (approx. $0.014 per month – based on Amazon S3 pricing).

Dropbox also uses a very effective two-sided (win-win) reward system to give extra storage space to both advocates and friends. One of the main factors contributing to the success of referral programs is their ability to leverage pre-existing trust between advocates and friends. Introducing referral incentives to this relationship can create skepticism, distrust and misalignment. “Are you referring me to Dropbox because I’ll love it, or because they’re paying you to do so, and what does this say about our relationship?” Transparently rewarding both parties, resolves this problem, and according to a 2007 study in the Journal of Marketing this two-sided system is the preferred means of close-tie referrals.

By using incentives Dropbox increases the number of successful referrals and, thereby, it’s viral coefficient. Several other internet startups including Fab.com, Birchbox and Gilt Groupe also use effective referral marketing to drive business growth. While the success of referrals will vary across companies and industries, referral marketing can be a highly effective customer acquisition tool that deserves a place in any company’s marketing mix.

* Skok, D. “Startup Killer: the Cost of Customer Acquisition,” For Entrepreneurs, 2009.
** Scott, J., “The Benefits of Tangible Non-Monetary Incentives” University of Chicago, 2004. http://www.forentrepreneurs.com/startup-killer/
***Eisenmann, T. Pao, M, Barley, L. “Dropbox: “It Jut Works,” Harvard Business School, 2011.

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