Slant Referral Rewards Toward the Referred

How should the incentive be allocated? To get the best from referral programs, what proportion of the reward should you offer to the referring customer and what proportion to the referred?
     Researchers at University of California-San Diego, Washington University in St. Louis, and Harvard University recommend giving most of it, if not all, to the referred customer. This does seem counterintuitive. Classic economic theory says that if you want somebody to take an action, you offer as large a reward as possible to that person. To keep a new customer referral program cost-effective, we must limit the amount of the reward. Shouldn’t we slant as much as possible of that amount to the party we want to initiate the action?
     But this economic reasoning overlooks two considerations. First, becoming a new customer is usually tougher than recommending a new customer. Santa Clara University, University of Maryland, and University of Texas-Austin studies concluded that switching costs exert a stronger influence than does customer satisfaction on whether a consumer will continue to patronize a business. Those researchers identified three sorts of switching costs in retailer-to-consumer and business-to-business sales:

• Procedural. The end consumer asks, “How difficult will it be for me to change my habits if I shop at the other store?” The business consumer asks, “How hard will it be for me to set up new accounts if I change retail suppliers?” 
• Financial. “Will I lose frequent shopper points, quantity purchase discounts, or deposits if I switch now?” “Are there deposits I’ll need to make to do business with a different retailer?” 
• Relational. “I lose a steady identity which comes from association with the business.” Customers of small to midsize retailers enjoy seeing store staff they recognize and who recognize them, or even call them by name. A hindrance to switching is the consumer’s discomfort with having to become acquainted with a new set of store staff. In addition, people often augment their self-identity using the personalities of the stores they frequent. 

     The other consideration overlooked by classic economic reasoning is the social reward given to the referring customer by the referred customer. Appreciation for matchmaking with a competent business. Gratitude for pointing out the referral bonus. Praise for the referrer’s expertise.
     In the field trials, rewarding both parties worked well. However, the highest rates of referred customers and of retained customers occurred when the rewards were slanted toward the referred.

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