Setting a referral program without taking steps to analyze its outcome will be a waste of your money and effort. Both success and failure are results that can be measured.
You can also project the revenue earned by your referral program by consulting industry benchmarks, your volume numbers, and a simple formula.
Calculation of Referral Program Revenue: How You Can Do It
When it comes time to assess your referral program’s success, nothing works better than these two mathematical methods.
Use the Talkable formula
Incremental Revenue = AOV x Online Transactions x Advocacy rate x Share links sent x Clicks per share x On-site Conversions
We use this formula to project our client’s monthly revenue, which is based on:
Number of monthly online transactions
Share links sent
Clicks per share
Picture a middle-sized online shop, which sells seasonal clothes for women. It’s not a world-famous brand, yet it’s quite popular; their high-quality tailoring and smart casual style suits most women’s tastes. This shop runs mostly online, and has a few show-rooms in its home city’s downtown and a small one on the outskirts. They have 4 collections per year and 4 off-season sales. This shop is using a referral program to increase their sales and connect with more customers.
Let’s calculate their expected monthly referral revenue gains.
Incremental Revenue = 200 x 5000 x 6,48% x 1,21 x 1,5 x 0,21 = $24,698
Use a % benchmark
To give you a more accurate estimate, we can use some of Talkable’s benchmarks. Our clients usually see a 2-5% increase in sales from their referral programs. The bigger the sales volume, the bigger the growth percentage from referrals you will get.
When considering projections, think of 3 example cases that fall around those ranges. Your results may also depend on your type of business, so try to examine how similar businesses have performed to help you project more accurately.
The formula is just 2-5% of monthly revenue.
Let’s look back at our online shop. Here are their figures:
Monthly revenue = 5000 x 200 x (2%+5%)/2 = $35,000
* Note: since the increase varies from 2% to 5%, we assumed the mean value, which is 3,5%.
There is a lot which is subject to the factors which influence your inputs for this formula. Why do some stores see an 8% sales increase, while others reach only 2%? How can you know what your advocacy or on-site conversion rates will be? Let’s go through the steps of the referral funnel with the benchmarks you’ll use for your projection.
What determines referral program revenue
Your potential referral advocates and customers go through a series of steps between first learning about your product and making a referred purchase. For each step, there is an average rate at which Talkable clients’ advocates and customers move onto the next one. Those figures are as follows:
First element — Advocacy rate: the share of your pre-existing customers who become advocates for your brand by referring your products to their friends over a given timeframe. The average advocacy rate is 8-10%.
Second element —Share rate: the number of times, on average, that an advocate for your brand shares your brand with a friend via your referral program. The average share rate is 1.2 shares per advocate.
Third element — Clicks per offer: how many recipients of your advocates’ referral offers click on the offers visit your referral page. The average click per offer rate is 2x.
Fourth element — Visit rate: the share of referred friends visit your landing page? The average rate is 30-35%.
Fifth element — Conversion rate: the share of referred friends who visit your referral page who then actually become your customers. The average is 25%.
The narrowing path in which interested customers go through the referral process and others fall away is called the ‘referral funnel.’
Generally, the more you promote your offer and get traffic to it, the more sales it will bring.
For example, if you send an email blast with a referral offer, you will get a 3X increase in advocate impressions, which will result in а 1.5X referral sales boost. Every metric influences program efficiency, so adjusting each stage with A/B testing and optimization will ensure the best results possible.
Calculating Reward Amount — The 6th Element?
Rewards are part of any referral program. It’s critical to determine the right amount to spend on your rewards to make your referral program both attractive to your clientele and profitable enough to be worth your time and effort.
In order to set the right level of referral rewards, you must first calculate your Customer Lifetime Value (CLV), as well as your optimal Customer Acquisition Cost (CAC). In this case, your CAC is your reward amount.
Companies, which are early in the development cycle, say that their biggest expenses are the incentives for their clients. Thus, their CAC is simply the amount of a single reward.
For companies, which have been on the market for more than a year, it is fairly easy to calculate CLV. The simplest way to divide customers into cohorts based on their traits. Then, calculate and add up the average monthly income from clients during their life cycle. The most widely used trait is the date at which the customer started using the product.
The method for calculating the possible award amount involves the planned pay-off period of the client. In fact, this means balancing between CLV and CAC before determining the amount by spending which the user pays for the cost of a client engagement. The right balance here means that your result covers your investment. Otherwise, you will fall like a newbie falls at the first yoga class.
Think of our online shop again. Would it make sense for them to offer a $25 discount reward for their advocate referring a friend who spends $500 on items over the time of customer-shop relationship? Of course!. The discount is much smaller than their CLV, so it’s a reasonable investment.
This case explains why it’s necessary to determine your CLV. Knowing your CLV helps to figure out what kind of incentive is appropriate and worth the investment.
Good client treatment is not a random trend. Every new customer can refer more business to you.
The Money Question: How Much Does it Cost to Set Up a Referral Program?
First things first: the ROI of referral program is usually around 3X-10X (45X on average for Enterprise businesses). The costs are either the referral tool/platform cost or the total cost of developing the program in-house.
Let’s see what the in-house development costs include:
Paying for the copy.
Two heads are better than one. Referral marketing requires well-written copywriting. Emails, banners, ads, offers, and on-site placements require well-chosen words. Who will write your referral copy? If it’s not you, you will need to hire a freelance or in-house copywriter.
Well-crafted copy will fall flat without strong visuals to match. The shading, colors, lines, and fonts in your graphics project the ideas and qualities of your brand and shape your customers’ image of your business.
Systematic testing reveals insights into your customers’ preferences: the copy they most respond to, the visuals they like most, the CTAs they like to click on, and the emails they open to read instead of ignoring or deleting. A/B testing is the best way to learn and understand what is most appealing to your customers. Designing and implementing this testing yourself costs time and money.
Software integration requires precise coding, especially if your store pages have complex or unusual designs. Badly-written code will leave your referral page with bugs, broken links, distorted layouts, or even repeated annoying of pop-ops which site visitors can not close.
Cost of software
The cost of building an in-house referral program depends on your required features and the size of your company. The more you demand from your program, the more it will cost. For instance, if you want to develop additional features, you have to pay extra. Read more on how to choose between an in-house referral program and a referral software provider.
There are still individual factors beyond the ones we’ve discussed here which can make your referral program more profitable. If you want some customized help from us in making revenue projections, contact us here.