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Having an expansive network of people referring their friends and colleagues to your business is a dream for many businesses and entrepreneurs.
In order to manifest that dream, you need to know what’s in it for them.
Traditionally, businesses offer a monetary reward called a referral fee. This is a powerful tool that has the potential to get a little out of hand when it isn’t fully understood.
In my experience, you need a full understanding of best practices, logistics, and potential pros and cons before moving forward with any kind of referral program.
So let’s dive into referral fees and how you can use them to take your business to the next level.
What is a Referral Fee?
At its most basic, a referral fee is a payment made to someone who brings business to your company.
It can be paid in cash, or as a sales credit or gift card. Whatever works best for your business.
The concept of referral fees has been around for a long time, but setting one up yourself can be tricky.
For example, if you offer too much money in your referral fee program, you might end up paying out more than what the customer is worth.
On the other hand, not offering enough money might discourage people from referring their friends and colleagues.
So it’s important to find a balance between what’s fair for both you and your referrers.
Why Pay a Referral Fee?
A referral fee can have huge benefits to your business.
It encourages customers to refer your business to their networks, tapping into new audiences and driving growth.
You’ll also help boost your customers' loyalty by showing how you value their support. Everyone likes to have their contributions noticed.
While a referral fee may seem like it’s cutting into your profits on a sale, it can actually be more cost-effective than traditional marketing.
When you calculate the ROI of referral programs, it ends up taking a lot less of your marketing budget with a lot more of a return.
The quality of leads is often better when coming from a referral as well. Someone coming in because of a friend will have way more trust in your brand than an organic lead.
It also gives you an in for people who are challenging to engage.
If your ideal customer is someone who is less likely to try new things on a whim, offering a reward to people who reach out to them for you is a great place to start!
Challenges of Offering a Referral Fee
The biggest challenge of offering a referral fee is finding the right balance. You need to make sure that you’re not paying out too much money, or not enough.
It can be difficult to get this balance right as there are so many factors involved, such as the size of your business and the type of customers who use it.
Another challenge is tracking all of your referrers and making sure they receive their payment at the right time.
This requires an effective system for tracking referrals and payments, which can be time-consuming and challenging to set up.
Using software designed specifically for managing referral programs is the best way to tackle this issue head-on.
ReferralHero can help you plan out your strategy for referral fees, keep track of what’s happened, and see if there are any areas that can be improved upon.
Does a Company Have to Pay A Referral Fee?
If someone’s referred a friend to your business, do you automatically owe them a fee?
No, not at all! While referral fees and finders fees are powerful tools, whether or not to offer one is ultimately up to you and your business.
Giving them money isn’t the only way to say thanks. You can also offer a discount, gift, or experience for those who help your business grow.
Again, getting some kind of reward will likely make the person more invested in bringing in more business for you in the future, but there is no obligation on your part to show your appreciation in this way.
Referral fee vs Commission vs Kickback
Referral fees are different from commissions and kickbacks, although they may look the same on the surface.
A commission is a payment that’s earned for successfully making a sale or closing a deal. It’s usually continual, as opposed to a one-time payout.
A kickback is also similar to referral fees; however, it tends to have more of a negative connotation.
It may involve offering incentives in return for false advertisement or favoritism. Referral fees, on the other hand, are given for honest recommendations.
Kickbacks should not be confused with referral fees, as they are illegal in many countries and, ultimately, a dangerous process to fall into.
Referral Fee Strategies
Having a plan in place is the first step in your journey with referral fees.
There are a few popular structures you can consider.
Strategy One: Flat Fees
This is the most popular structure for referral fees.
Offer a specific amount for every referral brought in, such as $50.
This can be paid out once the new customer makes a purchase, and is a great way to instate a referral program without putting in too much money upfront.
Strategy Two: Percentages
Just like the flat fee structure, this is a way to minimize your upfront costs.
Give a percentage of the first sale to the referrer, like 10%.
This has the added bonus of encouraging higher-value referrals.
Strategy Three: Blitz
Putting a time limit on your referral program uses the power of FOMO to get more buzz.
It’s a great way to spur immediate action and get customers coming in quickly.
Strategy Four: Tiered Bonuses
Another way to encourage higher-profile referrals is to have a tiered structure, offering more money for return customers.
To separate this from a commission, it helps to have specific benchmarks a referral has to meet to qualify.
This is where tracking comes in extra handy.
Using a mixture of these strategies allows you to customize your structure to your business’s individual needs.
How Much Should Your Referral Fee Be?
The amount of the referral fee can vary depending on your industry, and how much you’re willing to spend.
You need to consider how much business someone is bringing in from a single successful referral.
For example, if you’re running an accounting firm, you may want to pay a hefty bonus for each new client that signs up for services due to the referral.
On the other hand, if your company sells widgets online, you may be happy with paying out smaller bonuses since each sale could represent only a few dollars in revenue.
Keeping track of each referral allows you to adjust these numbers as you go.
Right off the bat, though, take a look at how much you’re already spending on each sale.
Consider:
- The commission for the salespeople
- Steps in the purchasing process
- Cost of making the product or delivering the service
- Current marketing budget
- Profit margin
Remember that even with a top-notch referral, many of these costs won’t change.
However, you need to make sure that the reward is enticing enough to make people want to make more referrals for you.
If your costs are too high to justify a decent referral fee, offering a small discount may be just as effective.
Tax and Legal Implications Of Referral Fees
Referral fees are considered taxable income, so you should make sure that you report any payments made to individuals on their behalf.
If they collect more than $600 in a year, you need to withhold taxes and issue a tax form.
This can be sidestepped if the person doing the referring is a precious customer.
You need to consider this reward a refund, discount, or rebate, and make sure it doesn’t exceed the amount they paid previously.
Either way, you can not forgo tracking the fees as they are distributed.
Another thing to keep in mind is that some states have laws that govern referral fees within certain industries.
Take the time to look into your industry and state laws before setting up your referral fee structure.
If you work in real estate, financial services, or automotive industries, this research is especially important.
The Bottom Line
Referral fees are a great way to reward individuals for their support!
Not only do they encourage positive customer experiences, but can also lead to increased customer loyalty and higher profits.
With the right incentives in place, tools to help you keep track of everything, and an understanding of what's allowed, paying referral fees could be an effective way to build relationships with customers and benefit your business in the long run!
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