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Ideas for Leaders #745

When Customer Referral Programs Backfire

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Key Concept

A new study reveals that customer referral programs can sometimes backfire: customers are less likely to recommend innovative products when they are rewarded for finding new customers. The study explores the reasons for this surprising negative impact.

Idea Summary

The typical customer referral program offers a monetary reward for customers of a product or service who find other customers to buy that product or service. In most cases, the referral program is public: that is, the recipient of the referral knows that the person who recommended the product is being compensated for the referral. This happens, for example, when new customers must provide the names of the customers who referred them in order for that referring customer to receive the compensation. Some customer referral programs are private, however: the new customer does not know that the person who recommended a product or service will get compensated for the referral.

With new product failure rates ranging from 30% to 60%, any marketing initiative that can attract new customers to a new product would seem to be recommended. However, are customer referral programs always effective in getting customers to recommend products to others? 

New research has revealed that customer referral programs can have dramatic unintended consequences: they can, in fact, decrease the likelihood that a customer would recommend a product, especially innovative products, to other potential customers. 

Specifically, the research showed that:

  • The more innovative the product or service, the greater the likelihood that customers would refer the product without encouragement from a customer referral program (also known as ‘natural’ referrals).
  • The reason innovative products elicit natural referrals is self-enhancement — that is, the belief that sharing information about innovative products or services enhances your image with others.
  • Public customer referral programs reduce the positive impact of innovativeness on the likelihood of a referral, and reduce the effect of self-enhancement in sparking referrals for innovative products. The reason is that sharing information about innovative products or services does not enhance your image if people know you are being compensated for the referral.
  • Private customer referral programs take away the negative impact that public referral programs have on referrals of innovative products. That is, when private referral programs are involved, innovative products are more likely than non-innovative products to be recommended to others, and these recommendations are driven by a desire for self-enhancement,
  • The size of the compensation can overcome the negative impact of public referral programs. Customers will recommend innovative products or services if the reward is large enough. 
  • Having both the referring customer and new customer get rewarded for the referral also overcomes the negative impact of public referral programs.

The research was based on a field study in which a survey was emailed to 450 customers of an online store who recently purchased a product. The survey included questions about the innovativeness of the product and the chances the buyers would recommend the product. The survey also included questions designed to measure the participants’ desire for self-enhancement.

In addition to the field study, the researchers conducted controlled laboratory studies using participants from a marketing research firm’s online panel. These studies offered various hypothetical products or services, and manipulated the innovativeness of the product or service, as well as different details about the promotion: public, private or no reward at all; size of compensation; and whether or not both referring customers and recipients of the referral are rewarded. As in the field study, the laboratory survey questions measured the participants’ likelihood of recommending the product or service and their desire for self-enhancement.

Business Application

The study has several important implications for marketers concerning customer referral programs:

  • Marketers should not implement public CRPs for more innovative products. Customers will recommend innovative products without the incentive of a CRP — and in fact the CRP will discourage recommendations.
  • If marketers implement CRPs, they should not disclose the reward to recipients. If the CRP is private, the negative impact of CRPs on the recommendation of innovative products is attenuated.
  • If marketers implement public CRPs, they should offer large referral rewards. The size of the reward disarms the negative impact of public CRPs.
  • If marketers implement public CRPs, they should use ‘reward-both’ schemes. Offering both the referring customer and the recipient of the referral rewards also disarms the negative impact of public CRPs.
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