• by Sarah Mahoney  @mahoney_sarah, July 28, 2010

While marketers have long believed that customers acquired through word-of-mouth referrals are more valuable, a new study from Wharton University has even put a number on it: WOM clients are about 16% more profitable than those generated by conventional advertising.

These customers initially generated a higher profitability than others with the same demographics. And while that difference eroded over a three-year period, they remained more loyal -- a trait that did not degrade with time. Combined, that resulted in a 16% difference. "In the short run, these word-of-mouth clients are more valuable because of higher margins," Christophe Van den Bulte, a professor of marketing at the Wharton School* at the University of Pennsylvania and one of the authors, tells Marketing Daily. "And in the long run, they are more valuable because there is less churn."

The study looked at about 10,000 customers of a large German bank over several years, with about half coming from a WOM program, which paid existing customers about $30 for each referral, and half coming from such conventional ad methods as direct mail. "We wanted to see how well these referral programs turn social capital into economic capital," he says. "But we also wanted to measure how effective they were -- this was the first study of its kind to assess the financial impact of these programs."

That's good news for marketers right now, he says, as they continue to become more skeptical of the impact of traditional media, and are increasingly relying on social and viral methods. "With very basic analysis, marketers can see exactly how much they spend on referral programs, and how much they get in return," he says.

Referrals work so well because the person making the recommendation acts as a matchmaker, in effect screening potential customers on behalf of the service or product. But there is also the benefit of emotional attachment. "It is easier for people to remain with a dental practice or a bank or even a law firm because you know other people who are there, too," he says.

"It's the idea that friends of my friends are also my friends, which is why we think these customers are more loyal. It's different than online message boards, for example, where you are essentially relying on the kindness of strangers."

WOM tends to be less effective for products or services that have many search attributes, where people can go online to compare prices, interest rates, or product features. "But for those that are experience intensive -- what kind of cell phone reception people in your area get from a certain carrier, for instance -- you do want to talk to people you know."

Van den Bulte says that preference for using acquaintances over experts is increasingly applicable in such industries as pharmaceuticals. "The effectiveness of sales calls has been eroding, so pharma companies have been targeting opinion leaders. But they are discovering many doctors don't want to hear what national experts think -- they want to hear from doctors with practices and patients similar to their own. That experience is more compelling than what experts say."

But like any relatively new media, WOM's effectiveness may be short-lived. Recently, Cone, a Boston-based cause related agency, released new data showing that while 77% of American consumers say they are more likely to buy a product or service recommended by someone they know, they are also taking those recommendations with a bigger hunk of salt than they used to: 81% go online to verify those recommendations before actually making a purchase.

"That's why it's important for marketers to think of the power of WOM not just to generate customers, but to perform other functions, like generating customer excitement, retention and even maintenance," Van den Bulte says.

One of his favorite examples is a colleague who participates in ALS fundraisers, riding a tandem bicycle with his wife all over the world to raise money for research: "His enthusiasm makes me much more likely to be involved. A direct mail campaign or sassy ads could never do that."

*Editor's note: The article was amended post-publication.