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The power of word-of-mouth marketing is the subject of the Forbes article “Straight Talk About Word-of-Mouth Marketing” from Knowledge@Wharton, and it briefly shows referred customers spend more and stay longer:
“Using information from a database of 10,000 customers acquired by the bank in 2006–about half of them through the institution’s referral program and the other half through traditional marketing efforts such as direct mail and advertising–the study tackled three questions:
–Do referred customers have higher margins than other customers?
–Do referred customers stay longer with the firm than other customers?
–Do referred customers have a higher customer lifetime value, the net present value of all the profits a customer generates over his or her entire association with the firm?
The answers, according to the study, are all positive.”
Also, the article describes a study about customer retention and its high ROI with regards to a customer referral program at a bank:
“Christophe Van den Bulte, a professor of marketing at Wharton, describes customer referral programs as an effective way to attract higher quality customers. “They are an old idea that’s getting more traction these days,” he notes, “and we now have solid evidence of their financial benefits.”
According to a new study titled “Referral Programs and Customer Value” customer referral programs are indeed a financially attractive way for firms to acquire new customers. The study–authored by Van den Bulte, Bernd Skiera and Philipp Schmitt, a professor and doctoral student, respectively, at Goethe University in Frankfurt, Germany–was conducted over a period of three years and followed the customer referral program of a leading German bank (which remained anonymous) that paid customers 25 euros for each new customer they brought in.
Van den Bulte says it is no coincidence that the study was conducted with colleagues based in Frankfurt, a city considered the eurozone’s financial capital, and the home not only of the European Central Bank, the Bundesbank and the Eurex, but also of the headquarters for several large banks, including Deutsche Bank , Commerzbank and KfW.
The objective of the study was two-fold, Van den Bulte states. “There’s a lot of talk about word-of-mouth-marketing, and about making money out of social connections. Our first objective was to see if customer referral programs can indeed turn social capital into economic capital. Second, we wanted to come up with a methodology to assess the effectiveness of customer referral programs that was easy to implement with data and tools available to many managers.”
An analysis of customer activity from January 2006 until September 2008, a total of 33 months, showed that referred customers indeed generated higher margins than other customers. This difference was quite sizable at first, but eroded over time and came down to zero after about 1,000 days.
This pattern, Van den Bulte notes, is consistent with what is known as the “better-matching mechanism,” which has been documented in studies by economic sociologists at MIT on employee referral programs. The practice involves employees getting paid for bringing in new hires and is especially popular in high-tech industries.
“As a customer, I know my bank better than non-customers do. I also know my friends better than my bank does,” Van den Bulte points out. “I have a better idea than my bank about which of my friends would be a good match for the bank, and vice versa. This is the better-matching argument: The existing customer knows both the bank and the prospect, and so has superior information to assess to what extent there is a good fit between the two. Using that information, I only refer prospects who I feel will match well with my bank.”
This “superior match” phenomenon explains why the margins documented at the beginning of the study were higher for the referred customer than for the customer acquired through traditional marketing efforts. Well-matched customers simply generate more revenue at a lower cost to the firm.
As the bank worked with the new customers, however, the two parties learned about each other from their own interactions and no longer needed to rely on having a third party in common (the customer who made the referral). The initial information advantage from superior matching eroded as the relationships between the bank and new customers developed, and so did the margin advantage. Thus, the better-matching effect also explains why the difference in margin eroded over time.
The second key finding was about customer retention. Referred customers were about 18% more likely to stay with the bank than other customers, and that gap did not fade over time. This pattern, Van den Bulte suggests, is consistent with another mechanism documented in previous studies on employee referral programs. People tend to have a stronger attachment to an organization if their friends or acquaintances share a bond to the same establishment.
The researchers also concluded that the difference in margin combined with the difference in customer retention amounted to a disparity in long-term customer value of 16% to 25%. “That’s not only a sizable chunk of money,” Van den Bulte says, “it also amounts to a 60% ROI over six years on the 25 euros that the bank paid for every referral.””
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