Part 1: Why Referral Marketing?

"There is no substitute for word-of-mouth marketing"
- Ryan Holiday

Picture the last new product (or service) you bought. Maybe it was a pair of headphones, a subscription membership, or a deliciously dark cacao bar.

Now do you remember why you bought it? How did you come to want that product or service? 

Do you even remember?

A lot of the time, products and services land on our radar unknowingly. We see them, we want them, we buy them. But behind the scenes — whether we realize it or not — a bigger force is at play: word of mouth recommendations (or as we’ll go on to call them: referrals).

Yep, there’s an 86% chance the last product or service you bought was recommended to you by a friend or someone you trust.

And that’s hardly unusual. According to Nielsen, 84% of consumers consider recommendations from friends, family and colleagues to be the most trustworthy source of buying information — if someone we like likes something, chances are we’ll like it too.

Long before content marketing and social media — and much longer before Google Ads or Facebook Ads — people relied on personal recommendations to choose what to buy. People are social animals, after all. We listen to what our friends say and value their opinion. 

Referrals －or "word of mouth"－ is the oldest, most genuine form of marketing. It's about human relationships and trust. 

And it's the only marketing channel that will never go out of fashion.

Referral marketing: what does it mean?

Referral marketing can be defined as the method (or marketing channel) that enables your customers to refer their network (aka: friends and family) to your company, in exchange for rewards.

This has the same effect as spontaneous word-of-mouth, but is initiated and managed by a company.

There are many different types of referral marketing: giveaways, pre-launch viral lists, ambassador programs, etc. But for the purpose of this guide I’ll focus on the most common (and most effective) type: customer referral marketing, where existing customers of your business refer their friends to buy from you too.

Compared to other marketing channels, referral marketing is almost too good to be true

Acquisition channels are getting saturated and expensive.

The average CPC (cost-per-click) on Google Adwords and Facebook has gone up for 15 consecutive years! And content marketing can produce great results (if you have the patience and the consistency to get it right) but takes a very long time.

What’s worse, on paid channels your competitors can always outbid you on your keywords. It ultimately becomes a competition to see who can pay the gatekeeper (Google or Facebook) the most.

And all it takes is a small tweak to Google’s algorithm, and your content goes from page 1 to page 15. Yikes.

Now compare this with a referral program.

A well designed and well run referral program produces ROI (return on investment) almost immediately and lowers CAC (customer acquisition cost) by an average of 50%.

Your referral program depends solely on you. You have full control of every single aspect and once it's set up, it can run virtually forever with very little maintenance at all.

Compared to traditional acquisition channels, referral marketing is almost "too good to be true".

But it’s not...

The referral paradox: why aren’t more brands doing it?

Okay, so if referral marketing is so great and it’s used by some of the best companies in the world — why isn't every company using it?

From my own experience running a referral marketing platform for 5 years, and seeing thousands of referral programs, I’ve got a few theories:

Firstly, there's an old myth that goes like this: "Happy customers will spread the word about your business organically, without any incentive". 

Sorry, but no. It's time to bust this myth. 

A study by Texas Tech has found that while 83% of customers are willing to provide referrals only 29% actually do so. The same study found that 88% of consumers want some kind of incentive to share products they like. And that number increases to 95% among 18-35 years old.

Yes, some people (about 10%, your hardcore fans) will share your product with their friends without incentive. But your referral program is not for them. It's for everyone else: the 90% or more that needs an incentive.

Secondly, some companies give up on their referral program way too soon. They try it for a month or so, don’t see the results they’re after, and sack it all in. 

While referral marketing can produce ROI much quicker than other promotional activities, it’s still a long term marketing channel. Your referral program will be refined and improved over time, and — as a result — will work harder the longer you stay at it.

The third reason — and in my experience the most common one by far — is that most people don't know how to design a great referral program. They might understand the basics, but they’re missing the big picture; they can’t see how all the components come together.

This guide answers these questions.

I wrote it to help you design a great referral program, avoid the common mistakes and build an evergreen acquisition channel for your business.

Is referral marketing right for your business?

At this point, this question might sound silly. An evergreen acquisition channel that also lowers the cost per acquisition — what company wouldn't want that?

But hold your horses for a second, it’s not quite that simple.

Some business models are far more likely to achieve success with a referral program than others. Before you decide to create one for yourself, consider the following questions:

1. Does my company have existing word of mouth?
   Your company should already have advocates. In other words, spontaneous (organic) word-of-mouth should already exist. If it doesn't, it might be a bad sign. Why aren't people already referring their friends? Investigate this question because it might be the thing that makes or breaks your referral program.
   
   Put simply: successful referral programs amplify existing word-of-mouth.
   
   Creating word of mouth where it doesn't already exist is very difficult and very expensive indeed. You're 100x more likely to succeed if you leverage what’s already being said.

2. Do my customers know more people like themselves?
   Your customers need to know other people who want what your company offers — and ideally in large numbers!  Are these people easily reachable to them? Or is what you’re looking for too niche? If you sell house plants to millennials, chances are they’ll know at least fifteen people who might be your customers. But if you’re a physical therapist who specializes in post-injury rehabilitation, you’d hope that each client wouldn’t have a friendship group going through the same thing!‍
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3. Does sharing my product increase the status of people?
   People share things with friends for two main reasons: either the thing they share is funny (e.g: cat memes) or because it makes them look smart/cool (e.g: New York Times report or being the first person to find a savvy deal). In short: people share things that increase their status/prestige/reputation.
   
   Now imagine you're selling a weight loss course. Will people want to share that they’ve enrolled in such a course with their friends? Probably not, because doing so would mean admitting they need to lose weight.
   
   As always, it's all about perception. And you can often change the way people perceive your product by repositioning it. For example, instead of positioning the course as weight loss, it could be positioned as a 3-month challenge for high-achievers. Now people who enroll are not "overweight" but "high-achievers who have the courage to challenge themselves".
   
   Answering these questions objectively will give you an idea of the "shareability" of your business and therefore the likelihood of a referral program to be successful.‍
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4. Does my product provide a competitive advantage?
   When solutions provide a competitive edge, customers simultaneously love it and are less likely to refer other customers.  Imagine your product helps ecommerce owners cut their costs by 20%, therefore allowing them to undercut the competition and make more profit.
   
   They may know lots of other ecommerce owners, but do they want to share this amazing secret? No! They’ll much more likely stay silent, keeping their cards close to their chest.
   
   In other words, sometimes having an incredible product might be why people don't want to spread the word about it!
   
   Notice that this is only true for B2B products. B2C products that give people an "edge" become immediately shareable because they are highly visible — and people like to make other people know they are cool.
   
   Which leads us nicely to the next question...

A quick note on B2C vs B2B

Based on the criteria listed above, it's obvious that B2C companies are much more likely to succeed at referral marketing than B2B ones.

Most B2B companies provide competitive advantages that help their customers win business against their competitors. Also, most B2B products are not "shareable" because they don't increase the status of the person who shares.

This is why referral programs for B2B products are much less common and usually work in a slightly different way.

When does a referral program work for a B2B company?

In my experience, the only instance in which a B2B referral program works is when the product doesn't provide a competitive advantage and actually increases the value of the product through network effects.

DropBox is a great example.

DropBox's ambassador program is legendary and companies have tried to replicate it with mixed results. DropBox's users have no problem in inviting other people to the service. If your competitor uses DropBox it doesn't affect you in any way. Indeed, DropBox's value increases when you invite other people. You can use DropBox in isolation but it's the collaborative features that make it a killer app.

The vast majority of referral programs in B2B-land are for collaborative tools like this. 

Ready to move on?

A referral program is one of the best marketing channels your business can have — but if you just build a referral program, they won't come. 

You need to objectively assess if a referral program is going to work for your business and then design a great one. And that’s exactly what the rest of this guide is about...