TL; DR
Referrals convert at the highest rate and are an inexpensive way to acquire new customers especially compared to ads
Like any lead source, referrals have a CPL (cost per lead) and a CAC (customer acquisition cost), both CPL and CAC are notably lower for referrals than other lead sources
CAC is lower for referrals because the conversion rate is higher than other lead sources and the hard-cost is mostly the cost of rewarding the referring party and the cost to incentivize the referral
Determining how much you’ll pay each: i) the referring party and ii) the referral, is based on the standard fee of your service, the lifetime value of a new customer and the CAC for other lead sources
TIP: the best way to pay the referring party and referral is with credit towards your service. This incentivizes customers who are most loyal. The credit not only builds their loyalty but also attracts the same type of characteristic in the referral. Plus, a service credit doesn’t increase your hard costs.
BUT WAIT THERE’S MORE → we’ve included a spreadsheet link so you can calculate your reward credits and costs.
Referrals Convert at the Highest Rate, Cheaper than Ads
Bottom-line, people trust people they know more than strangers, referrals taps into this trust so conversion is high, and cost to obtain referrals is low.
Trust is why referrals usually convert at a higher rate than other lead sources. In fact 20-50% of purchasing decisions are made because of WOM (word-of-mouth) and 75% of new business in the green industry is attributed to referrals.
In our past blog, “Referrals are the best way for home service businesses to land new business” we dive deep into the reasons why referrals convert at the highest rate.
The big takeaway should be that referrals convert at a high rate and indirectly this makes them an inexpensive way to acquire new customers, especially if you’re comparing the cost to ads.
Referrals Have The Lowest CPL (Cost Per Lead) And CAC (Customer Acquisition Cost)
Word-of-Mouth (WOM)/referrals have the lowest CPL and CAC. Other lead sources like Google ads and list buying have the highest CPL and CAC.
Low CPL and CAC is great, high CPL and CAC is not great.
We find that home service businesses (painters, residential cleaners, lawn care, landscapers, roofers, etc.) spend most of their marketing dollars on ads and lists, yet these convert poorly. Conversely, WOM drives most of their business.
Referrals have the lowest CAC because the conversion rate is higher than other lead sources and the cost is mostly due to the reward offered to the referring party and referral. So you really only pay if you convert to a customer.
To figure out how much you should pay for referrals you’ll need to first know your CPL and CAC by lead source.
You can quickly calculate the CPL differences with this equation:
Cost spent to obtain the leads
_________________________________
Number of leads by lead source
Lead source is what gets that lead’s information to you, e.g. a list, search, ads, WOM, etc.
You can define a lead based on different factors, but easiest might be filling out a form on your website for more information (includes booking a job).
And you can calculate CAC based on:
Cost spent to obtain the leads
_________________________________
Number of leads converted to customers
So let’s say you spent $1,000 each month on Google ads, and $300 to produce them (e.g. labor, design, etc.). So that would be a total cost of $12,300 for the year to obtain leads through ads and convert them to customers.
Each month you get 10 leads, so you get 120 leads for the year. And 10% of these 120 leads convert, so 12 customers are acquired.
Your CPL would be calculated as follows:*
$12,300 spent
_________________________________
120 leads
Your CAC would be calculated as follows:*
$12,300 spent
_________________________________
12 customers acquired
Your CPL would be $102.5, and your CAC would be $1,025, or said differently, you spent $12,300 to acquire 12 new customers.
*To simplify this example we’re not incorporating the time and effort in costs associated with closing the lead.
Now let’s say you’ve spent $1,000 a year on automating your referral program. And for each new customer referred you pay $50 in credit each to your referring customer and the referral.
Each month you get 10 referrals (120 referrals a year) and the close rate is 70%. So a total of 84 referrals become customers over the year. These customers will cost a total of $8,400 in credit. Add this to the $1,000 spent on the automated referral program, you spent $9,400 for the year to acquire new customers through referrals.
Your CPL would be calculated as follows:*
$9,400
_________________________________
120
Your CAC would be calculated as follows:*
$9,400
_________________________________
84
Your CPL would be $78, and your CAC would be $112
It costs you 10x more to convert customers from Google Ads than it does with referrals.
Although this was an example, the spend and conversion rates are based on industry results. What could you do with 10x more cash in your business?
Let’s compare the two lead sources
Referral Reward, How Much to Give?
The example above pre-emptively considers referral reward (amount you’ll pay the referring party and referral) in calculating the CAC. But you’ll want to test some different referral rewards in your CPL and CAC calculation.
How you set the referral reward (cost to you) is based on a few variables:
Standard service fees
lifetime value of a new customer (LTV)
CAC for other lead sources
Building off the example from the section above, let’s assume your standard service fee is $100 and a customer spends $2,400/yr with you. You calculate that the average customer spends 2-3 years with you. So being conservative, the LTV of your customers is $4,800.
From the example above, the results show you spent $1,025 to acquire customers with your Google Ads spend and $112 to acquire customers with your referral spend. The $112 CAC assumes a total $100 referral credit spent per new customer, $50 to referring customers and $50 to referrals.
Now let’s take a few different examples to help you calculate the referral reward.
*For purposes of this example the reward for the referring customer and referrals were the same, and the CAC is only considering the reward fees, not any software tools or labor associated with getting or closing the referral.
You can see that the reward affects CAC. Your CAC should be considered comparing other lead sources as well as the LTV. In other words, if your client is spending $5,000 with you over their lifetime, and it usually costs you $2,000 to acquire them, decreasing that cost to $500 is attractive to your bottom-line. Better yet, the $500 cost, made up mostly of the reward cost, is attractive and incentivizes your referring customer and their referral.
TIP
The best way to pay the referring party and referral is with credit towards your service. This incentivizes customers who are most loyal and not only builds their loyalty but also attracts the same type of characteristic in the referral. Plus, it doesn’t increase your hard costs, or “cash out the door”.
BUT WAIT THERE’S MORE!!!
Try out this simple spreadsheet to calculate the economics behind your lead sources and what you can set as reward credits/costs. (Make a copy of the spreadsheet to edit and add your data.) to calculate the economics behind your lead sources and what you can set as reward credits/costs. (Make a copy of the spreadsheet to edit and add your data.)
LoyalAs is referral software that gets and tracks referrals automatically for home service businesses.
Signup at loyalas.com, for a free 7-day trial, no credit card required.