The 2 most popular scaled growth channels for unicorn consumer companies - Part 2 (Referrals)
About the author
Jeff Chang (@JeffChang30) is a growth technical leader at Pinterest and angel investor. If your startup is looking for an angel investor who can help with all things growth, please send over an email!
The basics of effective referral programs are simple: if you invite another user, both you and the user get a monetary reward. Below, I’ve listed some sample implementations, but note that these are constantly being iterated on so the exact details may change over time or by A/B test group.
As you can see, referral programs follow a pattern: Give both the user and your friend some monetary value. These types of referral programs are effective because users are now incentivized to help your company acquire new users. One Uber driver made $90,000 in 6 months by just referring other drivers. Sometimes, referral programs create large arbitrage opportunities that people build entire businesses off of. For example, before it was banned by most referral programs, some users realized they could be profitable by running Google Ads for their referral codes. People even put out small billboard ads with their referral code. Since advertising on Google to get referrals is now mostly banned, a lot of people have resorted to using SEO to drive traffic to their websites advertising their referral codes. Taken to the extreme, there are relatively large businesses like The Points Guy that are centered around helping consumers pick the best credit card, which they get large referral bonuses for. The Points Guy writes articles about the pros and cons of each card, which in a way is free advertising for the credit card companies. So, by having an effective referral program, you can incentive others to work on acquiring users for you.
Product-channel fit for referrals
Referrals has been effective mostly for products that users directly pay for. Determining product-channel fit for referrals is done by figuring out if there is a discount rate that is high enough that users are encouraged to refer, but low enough that the effective CAC (customer acquisition cost) isn’t too high.
There are three metrics that you should consider though when determining your discount rate: LTV, payback period, and CAC through paid channels. Obviously, you don’t want to be giving away more value than your LTV or you will never make back your money. Then, the payback period, or time it takes to recover the cost of the discount should be low. The best referral programs have close to 0 payback periods because the action required by the friend being referred to get the bonus generates more revenue than the discount. Let’s take a look at the payback period of a specific referral program.
Referral payback period case study: Coinbase
The requirement to get a $10 referral bonus for you and a friend that you refer is that your friend must by 100$ worth of digital currency. If we only consider the users who sign up and buy more than 100$ of digital currency (since the ones that don’t are acquired for “free”), the average buy amount is probably significantly over $100, since there will be users that buy $1,000 or even $10,000. The Coinbase fee on a 500$ buy with credit card is $19.18, which already covers a large part of the $10 referral bonus to both of the users taking into account credit card fees and money made on the spread. So, the payback period for referrals buying over this amount is close to 0, which is great.
The third metric consider when determining discount rate is CAC through paid channels. If your CAC through paid channels is significantly lower than your discount rate, you may want to lower your discount rate. After considering these three metrics, if there is a discount rate high enough to entice users, below LTV, low payback period, and below paid CAC, it’s a strong indicator that referrals as a growth channel is worth pursuing.
SEO and referrals are the two core channels that consumer unicorn companies use to grow today, so your growth team should heavily invest in these channels if there is product channel fit! To recap, if your product has a growing base of quality user generated text content, SEO has good product channel fit. If your product has an existing discount rate that is high enough to entice users, below LTV, low payback period, and below paid CAC, referrals has good product channel fit.
Want to chat about building a referrals or SEO growth channel? Email me at firstname.lastname@example.org