Referrals vs. Discounting: The Long-Term Value of Word of Mouth

by Sean Ogino |

Referrals vs. Discounting: The Long-Term Value of Word of Mouth

referrals vs. discounting

While certain marketing tactics will give you quick wins, they fail to give your business long-term value and growth. Extreme discounting often falls into this category, and it’s become a pervasive trend. One way to incentivize shoppers to spend–as well as share your business with friends–is through a referral program. Let’s take a look at referrals vs. discounting, and how to optimize your referrals ROI.
The ideological difference between referrals vs. discounting is all about value. If we look from the top level, it may appear that discounts bring a sudden spike in sales and it pulls lots of customers. The inner look will reveal that even though that’s true, it’s a swell. Apart from cheapening the brand value and brand status, extreme discounts carry with them a slew of factors that may prove detrimental for the brands in the long term.

Referrals vs. Discounting: Bad Economics

In an era where profit margins, at large, are rapidly shrinking due to intense competition, discounting can be a dangerous game. Think in numbers now. When you give 50% discount, what does that do to your sales It directly means that to fulfill your revenue goals, you will have to sell twice as much. The question then begins to squirm is this: Do you have the time or the manpower to do that?
If a product has a profit margin of 30% and you are giving a 10% discount to make the sale, you lose a massive one-third (33.33%) of the available profit. If we go on dismantling it, it also means that your company has to work 33.33% harder to earn the company the same amount of money, which can be highly demotivating for staff members. By not giving discounts, in essence, the company can work 33.33% less and earn the same income.

In contrast to discounts, the economics of referrals are much more logical and gives a breathing space to your sales funnel. Instead of broad price cuts that can create chaotic demand, referrals only reward new customers or those or brought a new customer in. It’s an even pace of incentives, only discounting purchases when your business grows.

Basically, there are two main ways through which the entire referral process can be rationally incentivized. First is the optimal payment mode, a.k.a. the linear mode, where the customer gets rewarded for each number of successful referrals that he makes. In other words, if you refer one friend, you get $10 off. If you refer two, you get $20 off, and so on.

Known as the threshold mode, the second way is to reward a customer if he makes a specific number of referrals. In either case, the rewards are given for an act which will create a possibility of more purchases. In fact, threshold mode has been proved as a revenue booster.

Living Social, a daily deal website, is a living example of the success of the threshold mose. Whenever someone buys a deal from them, Living Social encourages the customer to send a referral to their friends. If at least three friends subsequently purchase based on this post, Living Social provides the customer with a full refund of the purchase price. It has been done by keeping in mind that two referrals may not bring a profit, but three referrals push Living Social to a tangible profit.

Meanwhile, a Annex Cloud client in the fashion industry is using the linear mode of referrals, and is offering the referral incentive in terms of points in their loyalty program. On average, they are awarding customers with $25 worth of loyalty points a week for their friend referrals. However, those friend referrals are averaging $5500+ in revenue a week, which creates a referral ROI of 219:1 for incentives and purchases.

Referrals vs. Discounting: The Risks of a Price War

Bruce Kasanoff, co-author of Smart Customers, Stupid Companies, is right when he says that when you sell products based on price, you are always at the mercy of your dumbest competitor.

If competitors lower prices, it forces price-slashing companies to do the same. Obviously, there is a point below which you cannot offer discounts. Suddenly such companies find themselves caught off guard, as apart from price, they have nothing substantial that might give them a competitive edge. As such companies have been relying heavily on price sensitive customers, they fail to retain them. As soon as their customers see a better deal from the competitor’s side, they switch without even a second thought. Due to this price game, they aren’t missing just the repeat purchases, but also the entire spectrum of benefits that customer retention process brings.

Of course, it will be foolish to believe that there is no competition in the referral segment, as so many businesses capitalize on referral marketing. But its intensity is much lower when it comes to pure price war.

As per the University of Chicago, non-cash incentives are 24% more effective at boosting performance than cash incentives. A referral program is perfectly placed in exploiting this insight in order to be more profitable. Cash rewards can be easily replaced with experiential rewards like giving an early/exclusive access to your products or service, or making things simpler for them at the front of customer service. There are innumerable ways to offer the absolute best customer experience for your most powerful advocates.

What’s best is, these experiential rewards can be altered according to the theme and need of your business. If you are in a hotel industry, you can offer a deluxe room as a reward. Even compared to your competitors’ offers, it can be a unique experience. If you are in a home decor industry, you can reward your top referrers by giving them free consultations. As you can see, it is taking the price factor completely out of the equation. Consequentially, businesses can be free from the rat race of cutting down the prices.

Referrals vs. Discounting: Virality

When comparing referrals vs. discounting, it seems like the latter have a disorganized nature. The reason for this is that discounts are a one-to-many type of communication.

A store will have a placard announcing the discounted prices. The online store will do the same by putting discounted prices on its website. Those who get to see it will think about these prices. Those who remain out of the store’s sphere will not even get to know that such discounts exist. Even when the company’s team uses ads, social posts, marketing emails, and so on to circulate the news, these will still be one-to-many communications. As the buyer is getting a discount after every purchase, he has no motivation to spread it to others, except out of an altruistic attempt to let a friend know about a good deal. In short, advocacy is not the area of concern for core discount givers. 

Referrals, on the other hand, are by nature social. A referral program is not there to reward only a purchase behavior. It is there to reward sharing, and emphasizes advocacy. Many types of referrals are one-to-one and come with a personal appeal that regular promotions just can’t achieve.

Sharing and referring often happens on social media which comes with an enormous potential of “sharability.” When a buyer shares his purchase or a referral link on social media, the entire sphere of his social media networks gets exposed to his shares. When referral programs pick up steam like this, they reach mass audiences but still operate on a personal level.

Referrals vs. Discounting: Making It Work

You can only achieve the cost-effective growth that a referral program brings if you implement it properly. We have many resources about referral best practices, including a white paper, tips on A/B testing for referrals, referral marketing FAQs, refer a friend 2017 best practices, and much more.

That said, here’s a summary of some necessities for your program:

  • Test and customize your referral discounts.
  • Ensure that your referral offer is one of the most enticing incentives your business has. For example, if you offer 15% off to shoppers who sign up for your email list, but only 10% off for referring a friend, they won’t be motivated to share your brand. Read more about the frustration that this causes here.
  • Promote your program! Make it noticeable on your site, and mention it in your email, social media, and advertising campaigns.

In looking at referrals vs. discounting, the former offer reach, trackability, and unbridled possibilities of conversions. In its opposition, discounting appears as a temporary means to get into the market. But the strain that such discounts put on the economic backbone of the company can paralyze it in the long run. 

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