January 24, 2008

Customers Who Refer Profitable New Business to a Company Can Be Worth as Much as the Big Spenders

Research by Dr. Robert Leone

"Most companies with statistical models for customer valuation focus only on customer spending and don't factor in a customer's word-of-mouth value," says Dr. Leone. "We demonstrated that when companies try to ascertain how valuable individual customers are, it's not just about how much the customer spends but whether that individual can bring in new business."

Knowing which customers can potentially add the most to the bottom line is vital to the firm, he says. While broad-based marketing is expensive and inefficient, detailed customer data can guide the content and timing of marketing pieces to specific segments of the customer base and thus achieve the greatest return on marketing investment.

"But if a company creates a priority list of customers based solely on how much those customers spend, they risk focusing on the wrong individuals," says Dr. Leone. This is because high-volume spenders and good referrers are not generally the same people, and the value of the best referrers can far exceed that of the good spenders.

The study looked at the purchasing and referral history of 9,900 customers of a large telecommunications firm and 6,700 customers of a large financial services firm. Individuals were randomly chosen from among the companies' many millions of clients.

For each of the two samples, participants were divided into four classifications roughly equal in numbers: those who both spent a lot and regularly referred others ("champions"), those who spent a lot but seldom referred others ("affluents"), those who spent little but regularly referred others ("advocates"), and those who neither spent much nor referred others ("misers").

Then a year-long marketing campaign was directed at the affluents, advocates, and misers, offering incentives carefully tailored to each of those three groups (but not to the champions). The goal was to encourage affluents to increase their referrals and thus become champions, advocates to increase spending to likewise become champions, and misers to become affluents, advocates, or champions by increasing spending or referrals or both.

The results were dramatic. Hundreds of affluents and advocates became champions, and throngs of misers upgraded into affluents, advocates, or champions.

The marketing campaign for the telecommunications sample cost approximately $31,500, or $4 per customer in the three targeted groups, and reaped gains totaling $486,090, or $62 per customer. Simply speaking, each dollar spent on the campaign returned about $15.40 in revenue.

Results for the financial services sample were similar, with a return on investment of $13.60 for each dollar spent on the marketing campaign.

The two companies' standard return on marketing investments had previously been $4 to $6 for each dollar spent.

However, the real return on investment is even higher than that reported in this study because the researchers did not include indirect referrals, which occur when referred new customers make referrals of their own.

If similar targeted marketing campaigns were to be directed at the telecommunication firm's 40 million other customers and the financial firm's 15 million customers, the profit potential could be staggering.

And, says Dr. Leone, future returns on marketing investments may be able to be improved even more.

"A new study we are conducting involves profiling customers who make a lot of referrals. We're looking for distinguishing characteristics such as demographics, profession, geographic area, and large social networks. Then we'll select other customers with similar profiles for targeted marketing with referral incentives," he says.

Dr. Leone concludes that companies with marketing efforts well-designed toward eliciting referrals should see much greater returns from their advertising expenditures than do companies relying on mass marketing.

"Mass marketing is very costly and inefficient, with low rates of response from prospective customers. But referrals from existing customers are personalized, so the odds of response are much greater," he explains. "The more targeted a company's marketing is, the more efficiently they can spend their marketing dollars."


Elaine Cole
PR Manager
Neeley School of Business at TCU
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