Customer referral programs are a great way to grow your web app’s customer base. It makes sense that your happy customers would be great advocates. They know your product, how to use it and like your product because they are still customer.
So you, like many others, have decided to jump in and launch a customer referral program!
Now, before you start thinking about the specifics of how you are going to market your customer referral program, where you’re going to place the calls to action, and other important details, lets make sure a referral program is going to work financially for your business.
A large amount of companies never calculate the Return on Investment of their customer referral program. In this article I will show you how to calculate the return on investment of your customer Referral Program.
There will be some math, but don’t worry, it’s not hard.
Lifetime Value of a New Customer
Your customer lifetime value (LTV) is a measure of how much you will earn from an average customer over their lifetime using your product.
You may already know your customer LTV but if you don’t, it’s not a problem. You can calculate LTV by using the formula below.
LTV = (avg customer lifetime * monthly plan) + avg up-sell
- A 24 month average lifetime,
- $50 average up-sell,
- And an average monthly plan of $25.
LTV = (24 * $25) + $50 = $650
Introduce the Referral Program Reward
In any referral program, you are going to give something away to the referring user and probably to the referred user. The specifics of the reward are a topic for another blog post. For now I will assume you have an idea of what rewards might work for you and your customers.
Whatever your rewards are, you need to calculate the dollar value of them.
For example, if:
- Your reward is 20% off to both the referring users and the referred users for 12 months,
- The referring users is on a $25 /mo. plan,
- And the referred user signs up for a $25 /mo. plan
Reward = 12 * ((20% * $25) + (20% * $25)) = $120
Calculating your basic Return on Investment
Once you have calculated the value of your reward, and the lifetime value of a customer, you can calculate your basic Return on Investment (RoI).
If your RoI is greater than 1 that means you referral program is profitable. By playing around with the value of your rewards, you are able to maximize your RoI. However, remember if you provide to small of a reward your users are much less likely to make a referral.
To calculate your basic RoI:
RoI = (LTV - Reward) / Reward = ($650 - $120)/($120) = 4.4
Your Viral Return on Investment
So far, our calculations have assumed that your customer lifetime value is the same before and after you launch your customer referral program. However, the reality is that with a customer referral program each customer becomes more valuable, because they now will also help you find new customers.
To represent how many new customers an average user will bring to you, we use something called a k-factor.
- If an average user sends 1 invite,
- And 25% of those invites convert to new paying customers,
- Your k-factor would be 0.25 and calculated as follows.
K = avg number of invites per user * conversion rate = 1/4 = 0.25
If you don’t know what your k-factor is, you can assume 0.25.
If you add the k-factor as a multiplying factor on customer LTV we transform the basic RoI formula to the Viral Return on Investment (VRoI) formula.
VRoI = ((LTV * (1 + k)) - Reward) / Reward = (($650 * (1 + 0.25)) - $120) / ($120) =5.77
With the above formulas you can now calculate if your customer referral program is profitable.
Feel free to play around with rewards, customer LTV and viral coefficients (k-factor) to understand just how much of an impact a customer referral program could have on your bottom line.
For additional reading, watch our video on how to get started with building a referral marketing program: