A loyalty program deepens the relationship with the customers you already have. A referral offer is the only common mechanic that adds new ones.
It is also the one most likely to be set up wrong, because the obvious design has a hole in it.
The basic shape
An existing customer shares a code or link. Someone new uses it. Both get something.
Everything worth deciding sits in three questions: who gets rewarded, when they get it, and what it is worth.
Reward both sides
Single sided referral offers underperform, and for different reasons depending on which side you leave out.
If only the referrer is rewarded, sharing feels like asking a friend for a favour so you can get a free coffee. Most people will not do it, and the ones who do it a lot are not the ones you want.
If only the friend is rewarded, there is nothing in it for the person doing the sharing, so almost nobody shares.
Two sided offers work because the referrer can frame it as a gift. "Here, use my link, you get a free drink" is an easy thing to send. "Use my link so I get a free drink" is not.
Pay out on first purchase, not signup
This is the design hole.
If the reward triggers on signup, you are paying for email addresses. Some of them will be real people who never come in. Some of them will be the same person with three addresses.
Triggering on the new customer's first purchase costs you nothing until there is revenue attached, and it filters out everything that was never going to become a customer. The referrer waits slightly longer, which is a fair trade for a mechanic that pays for itself.
What it should be worth
Work backwards from what a customer is worth to you.
If a typical new customer spends £60 with you over a year at 65 percent margin, that is £39 of gross margin. A referral reward that costs you £3 on each side, £6 total, is a good trade even if only a third of referred customers stick around.
The reward needs to be worth mentioning to a friend and no more than that. Doubling it rarely doubles referrals, because the constraint is usually that people forget to share rather than that the reward is too small.
Make the ask at the right moment
Referral offers fail on timing more than on economics.
The right moment is just after something good happened. A customer redeeming a reward is the single best moment there is: they have just received something free, they are pleased, and they are standing in front of you.
The wrong moment is at signup, when they have no experience of you yet and no reason to recommend anything.
If your program can trigger the referral prompt at redemption, do that. If it cannot, tell staff to mention it when they hand over a reward.
Close the abuse cases first
Small businesses tend to skip this and then discover the problem after it has cost real money.
Self referral. Someone refers themselves with a second email address. Fix: pay out on first purchase, and check that the referred account is not the same phone number.
Referral chains between friends. Two people refer each other repeatedly. Fix: one reward per referred person, ever, not per referral event.
Volume abuse. Someone shares the code publicly on a deals site. This is not always bad, but it should be a decision rather than a surprise. Fix: cap the number of referral rewards one member can earn in a month.
Staff referring customers. Decide in advance. Usually it should be excluded, because staff have access customers do not.
None of these need sophisticated fraud detection. A payout trigger on first purchase and a monthly cap closes most of it.
What to measure
Share rate. What proportion of members ever send a referral. If this is very low, the ask is happening at the wrong moment, not the reward being too small.
Conversion rate. Of the people who receive a referral, how many make a first purchase. Low conversion usually means the friend side of the reward is too weak or too complicated to claim.
Retention of referred customers. Whether people who arrived through a referral come back. Referred customers usually retain better than customers acquired through discounting, and if yours do not, the reward is attracting the wrong people.
Where it fits
A referral offer works best bolted onto a program that already runs, rather than as your only mechanic. The referrer needs somewhere to put their reward and a reason to care about it.
If you have not built the underlying program yet, start with how to create a loyalty program. For the other mechanics that sit alongside it, loyalty program ideas has the full list.