An essential part of running marketing campaigns is determining return on investment. In this section we show you how to calculate ROI and determine the benefit of a referral program.
Hi, welcome to another session on customer referral programs. Today, we’re going to talk about if a customer referral program makes financial sense for my business. This is one of the hardest things for people to figure out. They’re looking at who do I reward, what do I give them, and all we’ve been looking at to this point is will it work, will they actually refer friends, and will they actually sign up. It’s also important to go back and double check the numbers to make sure that this is actually a worthwhile acquisition for you channel for you. It’s more than likely it is, but it would be irresponsible if we didn’t know how to determine if it was. For those of you on the business side, you’re going to know ROI quite well, but we’re just going to explain it for those who don’t. ROI stands for Return on Investment, and it’s actually quite a simple concept.
Doing the Math
What we look at is how much money did we make, subtracted by the cost of us to make that money, divided by the cost for us to make that money. The whole idea here is to figure out a really simple idea, if we spend $1 on this, we make $3, which would be an ROI of 3. You want to figure out what that is, 1 for 3, 1 for 5, whatever you can get away with, or whatever your ROI works out to is what we’re trying to determine here. Now, before we go into the math of figuring out the ROI of your specific customer referral program, first I want to touch on what a good return on investment for a customer referral program is. If you’re a young company, you might actually be OK with an ROI of under 1, that would mean that you’re spending $1 on a customer referral program, and only getting $0.5 back and you think, “that’s crazy, I’m losing money”, the reality is, in early stage startups, what we’re often looking to do is prove that there’s a customer base interested, and our small amounts of revenue are getting multiplied to create evaluations. If you imagine you can get a 5x multiplier, so your revenue multiplied by 5 times equals the value of your company, actually, an ROI where you’re spending $1 to make $0.5, is going to leave you in a company where you just spent $1 and you just increased the value of your company by $2.5, so all of a sudden, it’s very worthwhile.
Looking for ROI
Now, most of us aren’t in that early stage, most of us are more in that mid stage. Now, the mid stage when you’re looking for a customer referral program, you’re looking for an ROI that’s much closer to 1. Higher than one is obviously better, but 1 is actually okay, and the reason for that is because if you’re just growing and continuing to increase your revenue dollar for dollar, then your business is still growing, and you’re able to cement that you have a valid company and a valued product proposition. Now, if you’re a little more late stage, all the way up to being a public company now, you’re obviously going to be looking for an ROI that is higher than one, profitable. If you’re at that stage, you’re going to know internally what your ROI is. I’ve worked with major retailers in the past that have said when they can get an ROI of 5, they will borrow the money to make that possible, but internal to your company, you’ll know what that target ROI is. Just to recap that, if you’re really early stage, it’s probably OK if your return is less than 1, if you’re mid stage, you’ll probably want 1, or a little better, and if you’re late stage, you’ll be looking for profitability, and you probably know what that needed ROI is. So, how do we actually figure this out for our customer referral program? If you were with us earlier for the session on the goals of your customer referral program, you would have learned about the viral coefficient, if you haven’t, I recommend you find that session and give it a watch first, but let’s assume everyone has.
Figuring out LTV
To figure out the return of your customer referral program, we’re going to look at what’s called the LTV, which is the lifetime value of your customer. If you don’t know what your LTV is, the secret trick here to figuring this out by estimate is to take your average monthly bill and multiply it by 18, it’s not scientific, but it’s going to work for this. Then what we do, is we include this viral growth coefficient, which, if you remember, is telling us how many extra users each user is bringing to the system. So, if we imagine one customer brings .2 customers, we’ve effectively increased the value of one customer here. You take your LTV, multiply that by 1 plus the viral coefficient, then you subtract the cost of your rewards (R), if you’re doing a credit system, lets say your credit is $1000 and you’re rewarding both parties, R will be $2000, if you’re only rewarding one party, obviously it will only be $1000 and if it’s swag, it’s the cost of printing, shipping, distributing and everything with your swag. Then, you’re going to subtract the cost of running your program (P), now, this number can be a little tough to figure out, but you have to remember that at some point you had to either put customer development time in, or you’re using a 3rd party service for your solution, and you want to make sure you don’t leave out their cost, as that is important to you as a business. Finally, you divide that by the rewards cost and the cost of the program added together.
This is going to let us know if the customer referral program makes sense for us. If you haven’t launched your customer referral program yet, it is okay to estimate the numbers and figure out what you need, and then speak to vendors or your own team about what you think you can actually achieve and play it a little more as an estimate, and that really wraps up our session on whether a customer referral program makes economic sense for you business.