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There's a reason referral marketing ROI is such a big talking point for e-commerce brands. E-commerce teams can use referral programs to quickly grow their customer base, drive sales, and achieve positive return on investment (ROI) shortly after the program’s launch.
But how do you know that your customer referral program is "working"? And how does it compare to other customer referral programs?
That's what I'll walk you through here. I'll show you exactly how to calculate the ROI here and then I'll show you some metrics you should be aiming for.
If you're new to referral marketing and launching your first customer referral program, then stick around because I'll also teach you how to set your referral rewards cost for maximum ROI right from the start.
How To Calculate Referral Program ROI
The general concept of "return on investment" is pretty straightforward: we want to make sure that referral revenue exceeds the customer acquisition cost by a lot. Aside from watching your revenue increase month over month, it can be hard to tell exactly how much new revenue your customer referral program has generated.
To get a clear picture of the revenue generated, we'll need to calculate a few other things first:
- Customer lifetime value
- Value of your referral rewards
- Cost per referral reward
Let's look at how Byte, an ecommerce brand in the teledentistry industry, approached this process.
Step 1: Calculate the ROI of the Referral Program
To calculate the ROI of your referral program, divide the revenue it generates by its total cost. This formula applies whether you're just starting out or have an established program.
ROI = Revenue Generate / Total Cost
If you're starting a new referral program, estimate your potential revenue based on your current sales and growth projections. Suppose you anticipate your referral program to bring in $150,000 in the first year and you plan to spend $15,000 on it. Your estimated ROI would be $150,000/$15,000, which equals 10.
If you have an existing program, use your actual revenue and cost figures. For instance, Byte's referral program, powered by Friendbuy, turned out to be their highest converting channel with a conversion rate of approximately 50%. They managed to double their referral transactions year over year, which directly contributes to their revenue.
Step 2: Calculate the Total Value Generated
The total value generated by your referral program is calculated using the formula:
LTV (Total Referrals x Conversion Rate)
For new programs, use your average customer lifetime value, your estimated number of referrals, and your expected conversion rate. If your average lifetime LTV is $5,000, and you're aiming for 6,000 referrals with a conversion rate of 20%, your total value would be $5,000 (6,000 0.20) = $6,000,000.
For existing programs, use your actual data. For example, Byte's referral program has a stellar conversion rate of 50%. If they received 10,000 referrals in a year, and each customer's LTV was $2,500, their total value would be $2,500 (10,000 0.50) = $12,500,000.
Step 3: Calculate the Referral Cost
The referral cost is the maximum you're willing to spend on your referral program to achieve your desired ROI. The formula is:
Revenue / Desired ROI
For new programs, determine your maximum cost based on your desired ROI. If your target revenue is $150,000 and your target ROI is 8x, your maximum annual cost would be $150,000/8 = $18,750.
For established programs, you can adjust your costs based on your actual ROI and your new ROI goals. Byte, for instance, had the goal of driving growth without increasing marketing spend. They managed to achieve this by turning loyal customers into brand advocates through their referral program.
Remember, the referral cost includes the combined cost of rewards for the Advocate and their Friends, and administrative costs. Make sure your reward structure is sustainable and doesn't exceed your maximum referral program cost.
For instance, Byte offers Advocates a $100 gift card for every Friend they refer, and referred Friends get 75% off their first impression kit and $100 off aligners.
By calculating and optimizing these key metrics, you can ensure your referral program delivers strong returns, just like Byte's program, which turned out to be more ROI-driven than any other channel they utilized.
Choosing the Right Referral Reward Cost
Once you have calculated your program's potential ROI and the maximum annual referral program cost, you can then determine the cost of your referral rewards. This cost should align with your program's objectives and be financially sustainable, as it is key to incentivizing customer referrals.
Here’s how to set your referral program costs based on the revenue you’re currently generating:
Example 1: Setting Up a New Referral Program
Let's say you're starting a new program and your calculations indicate a maximum annual cost of $18,750. You expect to generate about 1,500 successful referrals in the first year. This means that you could allocate a referral reward cost of $18,750/1,500 = $12.50 per successful referral.
This could be split between both the referrer and the referred customer, for instance, $7.50 for the referrer and $5 for the friend. Adjust this split based on what makes sense for your customer base and what will incentivize them the most.
Read our guide if you need help choosing referral rewards and incentives.
Example 2: Adjusting an Existing Referral Program
Suppose you have an established referral program like Byte. You've noticed that your referral program's ROI is higher than expected, and you want to incentivize more referrals without exceeding your calculated maximum annual cost.
Byte's referral program gives Advocates a $100 gift card for every Friend they refer. If Byte's calculations showed they could afford to increase this reward by 10% while still maintaining a healthy referral program ROI, they could increase the gift card value to $110.
Alternatively, they could add an extra perk for the referred Friend, such as an additional discount on their first purchase. This could help increase the program's conversion rate, leading to even more successful referrals and a higher total value generated.
In each scenario, the key is to strike a balance between incentivizing referrals and maintaining a healthy ROI. Regularly review your program's performance and adjust your referral reward costs accordingly to ensure your program continues to drive growth for your business.
5 Referral Marketing ROI Metrics That You Can Look Forward To
Successful referral programs can make a noticeable impact on total revenue. Don’t take our word for it. Here is how a few of our customers are enjoying a positive ROI:
- Thinx has their CPA (cost per acquisition) down to less than $1
- Tonal's referral program drives 4-7% of total revenue (growing month over month)
- Flaviar's referral program generates 9.2% of total revenue and 6.2% of Flaviar’s total new subscription revenue
Sounds nice, right? It's not all that uncommon with the right referral marketing software. Friendbuy allows brands to actively A/B test every aspect of the referral process, from the referral incentives and rewards offered to the copy used in the referral widgets.
The highest referral program ROI possible.
Here are five metrics you should know that showcase the ROI of referral marketing.
1. Businesses can drive at least 5-15 percent of total revenues through a referral marketing program.
Friendbuy’s top-performing customers have achieved up to 30 percent of revenues by A/B testing referral offers and optimizing the creative elements of their referral marketing campaigns. These customers have also used Friendbuy to implement targeting and segmentation to further enhance referral marketing performance.
2. Customers referred by a friend convert 5 times faster.
Referred friends are highly qualified because they’ve been introduced to your brand by someone they trust. As a result, referred customers tend to convert much faster—5x faster—than those acquired through other channels.
Faster conversions means fewer dollars spent hitting your customer acquisition goals, which allows you to put newly freed-up funds toward other acquisition initiatives or to invest in other areas of your business.
3. Referral marketing should be one of your most efficient channels in terms of cost per acquisition (CPA).
Leveraging existing customers to refer new customers is a highly efficient method of acquisition relative to paid channels. By increasing conversion rates and accelerating time to conversion, referral marketing can consistently deliver your business’s best CPA.
By category, here are the CPAs that Friendbuy’s customers are achieving:
- Apparel and Accessories: $1-10
- Essentials: $1-9
- Health and Beauty: $1-6
- Subscription: $1-11
- High Consideration: $1-14
4. Referral marketing achieves a 5x greater lifetime value (LTV) than other channels.
Referred customers are much more highly qualified than other customers, which itself achieves a significantly higher LTV. But acquiring a new customer is just the first step in building your brand. To achieve sustainable growth, you need to turn your new customers into repeat buyers. Referral programs facilitate strong customer relationships by rewarding your existing customers to promote your brand to their friends, which results in repeat purchases from these existing customers and higher average customer lifetime values.
5. Referral marketing can offer a 25x return on spend.
Investing in a best-in-class referral marketing platform and services vendor allows your marketing team to own the referral channel without requiring additional resources across your organization from engineering, finance, and product management.
Take a look at some of the average ROI seen across different verticals:
- Apparel and Accessories, CPG/Essentials: 25x
- Health and Beauty: 22x
- Subscription: 18x
- High Consideration/Luxury: 47x
A top-performing referral program can deliver unmatched value for your brand.
Demand More from Your Marketing Investments
Eighty-three percent of consumers trust recommendations from their friends, and 80 percent of consumers are likely to purchase an item based on friends' suggestions. If your current marketing strategy can benefit from the value achieved by referral marketing, it’s time to invest in the technology and tools—and a referral marketing partner—that offers these new efficiencies and unparalleled value as you grow your brand.
Find out more about what it takes to build a successful referral program—download Referral Marketing: The Essential Guide today.