Are referred customers more valuable than non-referred customers?

This is the question that researchers from Goethe University Frankfurt and University of Pennsylvania set out to answer in their paper "Referral Programs and Customer Value" (pdf here).

The researchers tracked 5,000 customers that a leading German bank acquired through its referral program.

• Reward: A 25 Euro reward was given to existing customers for each new customer brought in.
• Duration: The profitability and loyalty of these new customers were tracked for 33 months
• Control: These referred customers were compared against a random sample of about 4,600 customers acquired through other methods in the same period.

Profit margins, retention rates and lifetime customer value were significantly higher for referred customers.

Here are some of the key insights:

A. Referred customers had 25% higher profit margins, presumably due to referred customers being a better fit

Referred customers started out with profit margins that were more than 25% higher than non-referred customers. The researches had two hypotheses as to why:

1. Referred customers were a better fit for the bank. Referrers would likely select friends that he or she thought would be a good match for the firm.
2. Referred customers would have needs and values similar to their friends. The bank could use these similarities to better serve the new customer and get higher margins.

These advantages did gradually diminish over time as the bank accumulated the same amount of information about both referred and non-referred customers. More importantly, non-referred customers who weren't a good match for the bank were more likely to leave as time went by.

Even though profit margins became equal over time, the study still found that the average lifetime customer value of referred customers was 16% higher than that of non-referred customers.

B. Referred customers were 18% less likely to leave

The research showed that the probability of remaining a customer by the end of the study was 82% for referred customers and 79.2% for their non-referred counterparts. Analyzing this data, researchers found that customers acquired through the referral program were 18% less likely to defect than non-referred customers.

Conclusion: Referral programs don't just bring you more customers, they bring you better customers.

• They're more profitable.
• They're less likely to leave.
• They have higher lifetime value.

If you're hungry for more details, you should definitely check the full paper here.