Referral marketing is sometimes considered one of the simplest and least glamorous types of marketing. However, when utilized correctly it can result in remarkably high close rates with an extraordinarily high return on investments. The internet and social media outlets, where communication travels freely (and instantly), is forcing companies to re-think how they utilize this tried and true strategy of referral marketing. World-renowned sales trainer Tom Hopkins recently completed a study demonstrating the closing ratio for non-qualified leads is 10 percent versus a 60 percent close ratio with referred leads.

An equally compelling 2010 study on referral programs and customer value conducted by the Goethe University Frankfurt and the University of Pennsylvania tracked the customer referral program of a German bank paying its customers 25 euro for referring a new customer. According to the author of the study, Van Den Bulte, the two principal objectives of the study were: (1) to determine if customer referral programs can turn social capital into economic capital; and (2) to develop an easy-to-implement methodology to assess the effectiveness of customer referral programs with data and tools available to business managers. The study found referred customers were more profitable (as measured by contribution margin) and loyal (as measured by retention rates) than the bank’s traditional customers.

Referral marketing does not have a role at every company, which is why our CEOs determine which method(s) of marketing will produce the best results (and the highest ROI) for their respective portfolio companies. ESSCO, a MCM portfolio company selling floor care equipment to 7,000 independent dealers and on-line retailers nationwide, has determined the best use of its marketing dollars is to maintain a first class outbound and inbound call center and a highly interactive website with product schematics.

Alternatively, Cole Information Services, a portfolio company providing lead generation and direct marketing solutions to small business owners has implemented a web-based approach to marketing. Their marketing strategy involves selective use of pay-per-click advertising, an extensive social media program, weekly webinars, and most recently, a new online referral marketing program launched via its Cole Community on-line marketplace. Leveraging their social media and online presence, Cole offers pre-paid credit cards for any lead culminating in a sale. Given the adoption of social media and advances in observing customer behavior online through the use of web browser cookies, online referral marketing provides a high degree of tracking and accountability for possible leads. Within thirty days, the Company converted over 50% of the referred leads into new high-margin business (a 270% increase in contribution margin) at a cost that was substantially less than what it otherwise would have cost the company to secure these new customers.

According to Darrell Zahorsky, a business expert, author, speaker and consultant, the following are several benefits of a well-founded referral marketing strategy:

1. People feel more comfortable when a product or service is recommended by someone they know and trust. This is especially true if the product or service is expensive. Referrals do not involve direct selling. Instead a satisfied customer sells the products and services for you. If a satisfied customer tells a close friend about a certain business, then their trust is immediately transferred to the company, irrespective of if he has heard about it or not

2. Referred customers are typically less price sensitive. Most referrals can be sold at full price because they’ve been presold on your client’s trust and credibility.

3. A good referral marketing system can quickly multiply, giving you plenty of interested prospects. This will provide you with the luxury of selecting who you want to work with instead of having to take everything that comes your way. You’ll be able to focus on high-quality customers that are highly profitable for your business.

4. Referral marketing reduces your sales expenses and sales cycle.

5. Referrals can build your level of satisfied customers. The cycle self-perpetuates with more satisfied customers referring others to your company.

Referral marketing is one of the most cost effective means of advertising and will provide you with rewards beyond your expectations. In a future blog, I will provide you with some tips on how to build an effective referral marketing program.