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Beyond Word-Of-Mouth: Advantages And Disadvantages Of Referral Programs

beyond-word-of-mouth:-advantages-and-disadvantages-of-referral-programs
Beyond Word-Of-Mouth: Advantages And Disadvantages Of Referral Programs

Nuud is on a mission to help combat the effects of climate change and save the planet, one armpit at a time — that might sound strange, but they manufacture and sell a clean and effective alternative to regular deodorant that uses no canisters, vague chemical ingredients, and no animal testing. 

To achieve their audacious goals, the folks at Nuud created a loyalty program with an embedded referral initiative to reward customers for recommending friends and family members. 

The Nuud website uses onsite popup prompts to tease customers with free products and discounts for referring others, alongside its social media and email marketing promotion for the program. 

So how has this referral program fared? Nuud has seen program members spend 153% more than regular customers — returning to the store to use reward points on larger purchases. 

Nuud’s referral program success isn’t an isolated case, but it does sit on the backdrop of a challenging time in terms of acquisition.

Customer acquisition costs have risen 222% over the last eight years; advertising is also becoming more expensive, and the demise of third-party cookies by the end of 2024 will significantly reduce targeting capabilities.

In this guide, we’ll review the advantages and disadvantages of referral programs to help your Shopify store combat these industry issues. We’ll also show you how to craft the perfect referral program and talk through examples of stores excelling with this strategy.

But just to be clear, this is how we define a referral program:

A referral program is a system that allows your business to incentivize customers with rewards for recommending your brand to friends and family.

Customers receive a unique referral URL, which they send to their friends and family via SMS, social media, Whatsapp, email, etc. The referee (or referrer, or both) can then claim the reward once the new customer meets the terms of the referral (e.g., purchasing a product).

The advantages and disadvantages of referral programs

In this section, we’ll show you the benefits of a referral program and advise you on what to consider when you explore them:

Screenshot 2024 01 29 At 17.35.07

Advantage 1: Increased customer acquisition at a reduced cost

Since acquisition costs have risen by 222%, you’ll need to do everything possible to combat them. A referral program can help you acquire new customers without spending money on ads, and they’re also more likely to convert since over half of customers trust brand recommendations from friends or partners more than any other source of advertising.

Advantage 2: Referrals help boost brand loyalty

A little over half (52%) of customers show their loyalty to a brand by recommending it to family and friends. Happy customers are likely to talk about your brand, whether in passing to family and friends or posting about it on social media. But what helps boost brand loyalty in this scenario is rewarding them for this behavior, turning happy customers into brand ambassadors or advocates.

Advantage 3: Referrals drive sales and revenue

Of course, a person referred to your brand and converted into a customer will improve sales and revenue compared to never having the referral. Tracking your referral sales can provide interesting insights — for example, Ofra Cosmetics generated an additional $183k in revenue by implementing a referral program.

Advantage 4: You’ll find improved CLV

Since a referred customer likely has similar interests and tastes to the person who referred them, they’re likelier to stick around than someone who discovered your brand by chance. In fact, the value of a referred customer is 16-25% higher than that of a non-referred customer, according to research from the American Marketing Association.

Advantage 5: Referrals help build a community around your brand

Word-of-mouth recommendations spread and create a community of customers engaging with your brand. Julian Patrick, CEO of Stovefitter’s Warehouse, a wood-burning stove specialist store, says this about his referral program:

This [referral program] not only brought us new customers, but it also made our business look better in the eyes of the public. Our reputation got stronger, and we became known for more than just selling high-quality wood stoves. We were also known for giving our customers the best experiences possible.

Disadvantage 1: You’ll need to balance incentives and profit margins

If not set up wisely, referral rewards can eat into your profit margins, so it’s essential to consider the balance between them. Katie Devoe, Owner and Co-Founder of CBD Nationwide, faced this issue and came up with a clever solution:

Striking a balance with referral incentives was another puzzle. We wanted to reward referrals without slashing our profit margins. Our solution offered exclusive early access to new products or priority customer support, adding value without financial strain.

Disadvantage 2: Look out for potential misuse

Potential misuse and fraud are problems for referral programs that were highlighted to us by Ilia Mundut, Founder and CEO of HeftyBerry. He said:

Some referral programs can be susceptible to abuse or fraud if not properly managed. Implement safeguards and monitor referrals to prevent misuse.

Some of these safeguards include putting a cap on the number of referrals each customer can make, using non-monetary rewards, and keeping track of similar email addresses and patterns.

Disadvantage 3: Don’t rely solely on referrals for acquisition

Ilia also highlighted this disadvantage, suggesting that:

Relying solely on referrals for customer acquisition might limit the diversity of your customer base. It’s crucial to have a well-rounded marketing strategy.

So, while there are great referral program benefits, it’s important to have other methods of acquisition and retention in place. You can still use paid ads to promote your brand, but we suggest a referral program can be part of a broader loyalty marketing strategy for even more benefits.

Crafting the perfect referral program: A step-by-step guide

Given how advantageous a referral program can be for your business, you’ll probably want to set one up. Here’s how to do it.

Step 1: Set clear goals and objectives

Many business owners have a simple goal, “to make more money.” While this is a fine goal to remember in passing, the bar is too low, the goalposts aren’t clear, and you won’t be able to measure what works and doesn’t.

On the other hand, “improve our customer lifetime value by 10% by the end of Q2 to increase our overall revenue” is an example of a SMART goal (you probably know what that is, but just in case, Specific, Measurable, Attainable, Relevant, and Time-Bound).

SMART goals are hugely beneficial because they give you the following:

– A realistic result to aim for;
– A metric to measure and track your progress towards the goal;
– A check to see if the goal is relevant and if you’re not going to waste resources and
– A time frame to work backward from.

In making SMART goals, you can align your referral program with wider business goals and strategies.

Step 2: Choose the right program type

It’s easy to think there’s only one type of referral program (especially if you’ve used them as a customer), e.g., “Give $10, get $10.”

However, behind the scenes, there are two main referral programs: standalone and loyalty-hybrid.

Standalone referral programs

A standalone referral program is precisely that — it’s a simple approach where you can set up a widget and/or popups that promote your referral offer, which in these cases is usually a discount or money-off coupon code.

The benefit of this approach is its simplicity. There’s little to think about in the design, though you’d be wise to experiment with your offers to see what type produces the best results.

The downside of this approach is that it’s much harder to balance rewards against your profit margins, and it’s also harder to stand out from your competition.

Loyalty and referral programs

This approach embeds a referral program in a wider loyalty program, typically using a points-based system where customers can accumulate points and earn rewards.

The benefit of this approach is that it’s a lot easier to balance rewards and profit because you can offer non-monetary referral rewards and reduce reliance on discounts. 

Having a loyalty program that’s thoughtfully on-brand will also help to foster a brand community — the program Astrid & Miyu built is an excellent example of this, its program led to over 50K signups within nine months and has led to a 40% increase in overall revenue for the brand.

The downside to this approach is that it takes more thoughtful consideration and measurement on the top of the referrals, e.g., will you build a simple or tiered program? Will you give it a creative name? How many points are your rewards worth? How will they earn them?

While there’s more to think about with a loyalty and referral hybrid option, as you’ll see in the case studies below, it can have a more meaningful impact on your business.

Step 3: Design irresistible rewards and incentives

A simple discount code in a standalone referral program will convert some customers, but compelling and meaningful rewards will have a much more lasting effect on retention and CLV.

This is where you consider using experiential rewards, such as early access to new products or priority support alongside financial rewards (such as earned discounts), within a hybrid-loyalty solution to create a more well-rounded customer experience.

Step 4: Promote your program effectively

The modern customer journey is a wild ride, so it takes multiple touchpoints to reach and convince people to use your program. Consider the following areas where you can promote your program:

– Popups at various website touchpoints — entering the website and post-purchase.
– Post-purchase email or within a regular email marketing sequence.
– Across social media channels where your audience hangs out.
– On forum sites such as Reddit or Quora where people may be asking questions about your product (though be mindful and provide value in your response beyond promoting the program).

Step 5: Track and measure your success

Remember those SMART goals? After implementing your program, you’ll need to use your provider’s analytics to track and measure your progress towards them.

At first, you’ll need a measurement period to figure out what your baseline is. From there, you can work on optimizing your program to reach your goals faster or more effectively.

For example, suppose you find that your referral offers aren’t converting as many customers as you hoped (or that conversions are declining over time). In that case, you can conduct customer research and experiment to find out what offers appeal most to your audience.

Real-world success stories: Case studies in referral marketing excellence

Here, we’ll give you more details on two stores mentioned in this article that successfully implemented a referral program: Manuka Doctor and Ofra Cosmetics.

Manuka Doctor

Manuka Doctor has a lot of competition as a store operating in the beauty and personal care industry. So they decided one way to stand out was to build a referral program with a great offer:

Manuka Doctor’s approach was to give the referee a small discount and the referrer points to spend in their loyalty program. This program resulted in a 53% increase in repeat purchases, and now 47% of Manuka Doctor’s revenue comes from loyal customers. Importantly, they found that almost 100% of referees convert into customers with this unique offer.

This approach achieves two things other than increased revenue:

1. While they give the referee a discount, they reduce financial strain by giving the referer points to use for rewards if they meet specific criteria.
2. They minimize the possibility of referral fraud by not giving the referee a financial reward.

Ofra Cosmetics

Another store in the highly competitive beauty niche, Ofra Cosmetics, takes a similar approach with its referral program:

Ofra Cosmetics loyalty tiers

In this case, Ofra Cosmetics offers referees a fixed $10 off and referers 1,500 points if the referee spends over $20.

This program resulted in a 59% increase in customer spend, a 56% increase in repeat purchase rates, and an additional $183k in referral revenue.

Both of these cases are similar in what they achieve — increased revenue and retention and minimized fraud prevention. But notice how the offers are slightly different?

Actionable takeaway: use a unique referral offer that your existing customers will get good value from to incentivize the recommendation. You’ll need to tailor the offer and rewards in a way that makes sense for customers and your business.

While Ofra Cosmetics offers more points and lower criteria, this is likely because their loyalty rewards for earned points could be lower in financial value than Manuka Doctor’s.

Build a referral program for your Shopify store today

As you’ve seen above, there are several advantages of referral marketing:

– Increased customer acquisition in a more cost-effective way
– Higher sales and revenue
– Greater levels of CLV
– A chance to foster a brand community

However, you’ll need to think about:

– Balancing your rewards and profit margins
– Monitoring attempts at referral fraud
– Over-relying on the referral program to do all the work

You can easily address these referral program disadvantages by using a hybrid loyalty approach and embedding your referrals as part of a loyalty program and strategy.

To learn more about mastering customer referral strategies, check out our free-to-use LoyaltyLion Academy.

However, if you’re ready to start your journey and build a referral loyalty program for your store, book a call with one of our loyalty analysts today

Special thanks to our friends at LoyaltyLion for their insights on this topic.
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