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How to design your referral program so you don't accidentally lose millions

· 11 min read

referral programs

In a perfect world, referral programs work seamlessly. You create a deal to tempt your users to refer their friends or professional contacts, and then magically gain additional users and sales. Often at a much lower customer acquisition cost than you pay via other marketing and sales channels.

But the world isn't perfect. Just ask one retailer who instituted a give $10, get $10 referral program and had current customers self-refer to the tune of a loss of over $1 million in one day.

While many large companies have built their success on the backs of their referral programs, companies have to be strategic about how they run them as a badly designed referral program can cost companies a lot of money. There are also all sorts of ways customers can potentially commit what some call 'referral fraud.'

The goal should be to design your referral program so that it helps both your customers AND your business, instead of incentivizing people to do things that will just help them. Well-designed referral programs put you and your customers on the same team!

We'll walk you through some of the hallmarks of good referral program design so you can ensure your next referral program will run exactly like you live in that perfect world we just talked about.

Three types of referral programs

There are three main types of referral programs:

  • Get referral programs. Programs where you refer a friend and get an incentive.
  • Give referral programs. Programs where you refer a friend and they get an incentive.
  • Give/Get referral programs. Programs where you refer a friend and you both get an incentive. In these, the incentives can be the same for both parties or uneven, if one party is harder to incentivize.

Any of the three types of referral programs can be extremely effective when run strategically. However, for obvious reasons, Give/Get referral programs are the most effective at acquiring users. Who wouldn't want to benefit personally while also helping out their friends?

What are potential pitfalls of referral programs?

There are a few ways that companies can design referral programs that hurt instead of help. These include not planning for or having the proper infrastructure in place to detect things like:

  • Self-referrals. Customers can use another email account to refer themselves and potentially both get and give (themselves) an incentive.
  • Repeat referrals. Customers can repeatedly refer the same friends to your service.
  • Account or return abuse. Customers' friends might take the benefit and then cancel their account or return the item they bought.
  • Account cycling. Customers and their friends can create and delete accounts for your service in order to take advantage of repeat referrals.
  • Discount sharing. Customers can share promo codes with friends or the entire internet giving people who were already going to buy from you and Googled your company a discount they didn't need.

All of these things make your referral program less effective or cause you to lose revenue from other paying customers. Worse, you will have spent a lot of money and not acquired a single new repeat customer.

That's a big referral program fail.

The 5 tenets of effective referral design

So, how do you avoid failing at your referral program goals? Easy. You just need to be smart about your referral program design. Think about it like you do your advertising spend. You don't just send it out into the world without a strategy. You have extensive lists of targeted keywords, demographics, job titles, and retargeting priorities.

Here are the things that make for a successful referral program:

1. Gate your referral program

One of the most important parts of a referral program is the qualifying criteria for getting the referral incentive. Your goal is to make the referral sticky. We'll walk you through two examples from different industries that show how you could deploy different gating strategies.

Subscription services

In the subscription business?

Your referral program goal is to acquire loyal new subscribers instead of subscribers who will cancel after a month. In that case, you need to design your referral program to incentivize your new customers to develop a habit of using your services. You should also think about the cost of your referral program versus the payback period.

  • Time gated. You might decide that a referred contact has to subscribe for two or three months without canceling their subscription.
  • Action gated. You could gate the referral by an action the referred user has to take such as creating a product, uploading their files, connecting with friends, or inviting a teammate to join them.
  • Payment gated. You might require that your referred customer makes a payment on their account.
  • Capping rewards and referrals. You can cap how many people any one person can get rewarded for referring. For example, you might only allow your customers to refer 5 people during a 12 month period.

Retail

Let's say you're running a Give/Get program where both people will get a $15 credit. You don't want to give that out just for sending someone a referral email. You want to position it in a way that sets you up best to at least earn back your money. Here are some ways to gate it:

  • Minimum purchase requirement. You could decide that the $15 credit can only be used on purchases over $30.
  • Purchase requirement. You could stipulate that person who is referred has to make their purchase first.
  • Time gated. You might decide to delay the payout of the referral until the return window has closed for the referred purchase.
  • Sign-up requirement. You might require that the referred customer also signs up for email or text updates. This will ensure that you'll be able to market to this customer in the future and generate higher customer lifetime value from the acquisition.

2. Strategically choose incentives

Choosing your incentives correctly is half the battle in a referral program. If they aren't attractive enough then you won't get enough people interested in making referrals. If they're too generous, it will take too long for you to pay back the customer acquisition costs. Customers might end up churning before you do. Or be interested only to get the incentive and not because they want or need your services.

Incentives don't have to be monetary. While many companies offer monetary incentives some of the best referral programs don't.

For example, a successful video game referral program gave out free characters skins when people referred a friend. Players could only get the skins through referrals and suddenly everyone wanted to make a referral. The referral incentive cost the company nothing. People responded to it because it was based on scarcity and exclusivity.

Dropbox also ran a successful referral program where they gave out extra storage to anyone who referred friends to their service. People excitedly rushed to refer their friends. The company's secret was that most people who received extra storage didn't actually use it so it cost them nothing.

Here are some other things you can use to incentivize referrals

  • Store/Purchase credits
  • Free months
  • A longer trial period
  • Discounts
  • Status as a top referrer
  • Gifts
  • Charitable donations

Some companies have a competition to see who can refer the most people and give the winner a prize. A wine subscription company in Australia gave out progressively nicer and more expensive and exclusive gifts to people who referred multiple people. The more friends you referred, the better your gift would be.

3. Carefully calculate value

Whether you're giving out a free month's subscription or paying someone $500 for an enterprise referral, it's important that you carefully calculate the value of the referrals to your business.

Here are some things to consider:

  • Customer lifetime value. What's the average lifetime value of a new customer to your business? You should understand how much you're likely to make from that customer before deciding how much you'll spend to acquire them. Make sure to track this metric post-referral. You'll want to know what your referral program's customer lifetime value is as it might be less than the lifetime value of customers acquired through other channels.
  • Payback period. Before you decide on how much you are going to invest in your referral incentive, you should know how many months a customer will have to subscribe or how much they'll have to spend to pay back the customer acquisition costs of that incentive.
  • Churn. Churn is just a fact of life. A percentage of your newly acquired customers will never order from you again or will soon cancel their subscription. You need to build the costs of this into your program and your customer acquisition costs.
  • Difficulty of getting referrals. For some companies, it can be hard to get referrals but lucrative when they do. For that reason, they offer large incentives but gate them to ensure they're able to get the value they need from them. For example, Uber often offers driver referrals. These can be extremely lucrative. One such referral was a $1000 get referral if the driver you referred completed 50 trips in no more than 3 weeks. This may seem like a lot but they crunched the numbers and realized that if someone did 50 trips within that time period they would likely continue.
  • Gating. It's important that companies match their gating to the value of the program. If you strictly gate low value incentives people will be less likely to take advantage of them. But high value incentives will be abused if they aren't heavily gated.

4. Use incentives to breed loyalty and improve retention

The goal of a referral program is to create customers that will stick around. So, how do you make sure your referral program will accomplish that?

  • Create a habit. The goal of referral programs is to create a habit. Whether it's to use your program or shop at your store, you want them to continue spending money at your business. You therefore want to follow up with them and make sure they're getting value from your company or considering their next purchase. In retail, you might include a time-limited coupon for their next purchase in the packaging with their item. Or you might offer them a deal via email. For services, you could give them a discount or free months if they achieve certain product use milestones or refer people themselves. You should also have a drip campaign of emails designed to help them get the most out of your product or easily access support if they need it.
  • Create a community. One of the benefits of referral programs is that suddenly your user and all their friends are using your products. This often creates a stickier community around your product. For example, if your product is a subscription box, friends might swap items they like or talk about what they got in their box together. You could also allow friends to connect with each other on your site or host customer meet-ups or virtual events.

5. Safeguard against abuse

This part is perhaps the most important one. In order to guard against the most common ways referral programs are abused, you have to be able to identify when they're being abused. That's where Upollo can help. We provide companies with the data they need to identify things like self-referrals, repeat referrals, account abuse, and account cycling.

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That means you can stop people from benefiting from referral programs when they aren't also providing you with that new customer your referral program is designed to acquire. That could save you tens of thousands -- or even millions of dollars. And make sure you actually acquire NEW customers the next time you pay out a referral incentive. By ensuring you're not paying out referral bonuses to users already using your platform, you can reinvest those saved funds to create even more lucrative referrals to grow even faster -- at no extra cost.