#4: When referrals are overrated

Why service companies can't leverage word of mouth the way product companies do.


There’s no doubt that referrals help companies thrive. Sometimes, we love them to the extent we want to make it our core distribution strategy.

However, It’s crucial to understand that referrals don’t yield the same results for all types of companies.

Free sales and marketing channel for products

Products usually have marginal costs of production, which is the change in total production cost that comes from making or producing one additional unit. In other words, the more you sell, the more profitable every unit gets up to some point.

This is particularly true for software where distribution and reproduction costs are negligible.

Build something people love, and they will be very likely to recommend it to their friends.

If your product is widely available (an app on the App Store or a new soft drink on supermarket shelves), word of mouth will be your free sales and marketing channel. You can go really far this way.

Referrals have no downsides for product companies.

Let's see why things are slightly different for services.


Why we all love referrals?

Imagine you run a service company (or maybe you already do), say web development agency.

Relying on referrals is tempting and gives lots of (apparent) comfort:

  • You don't have to introduce yourself, pitch your service, or trying hard to convince the potential client that you are the right business partner.

  • You feel personally appreciated by the one who referred your agency, it makes you proud of the quality your company produces.

  • The client jumps straight to the end of your sales funnel and is usually ready to buy because they’ve been told that your company is the right fit for him

Having all these merits in mind, how come referrals are not the best way to grow a business? After all, it guarantees good sales conversion, and you are feeling happy and proud.

Lack of control

You have literally zero control over the process. Some people may know other entrepreneurs who might need your service/product. Noticed in the last sentence "may know" and "might be"?

These are all highly uncertain events, and there's no way you can increase the odds that someone knows another person who needs your business (at least in a direct way).

To illustrate the difference between products and services in terms of word of mouth distribution probability:

When an individual downloads a new mobile game and falls in love with it, it's likely they will share it with friends, and some fraction of them will give it a shot. Considering a scenario with the service business, when someone needed to hire a dev shop to develop a web application in Ruby on Rails - the likelihood of replicating this need among this person's social circles is significantly lower.

Client segment lock-in

The second issue pertains to the segment of clients. Most likely, the leads you get aligns horizontally with referrers in terms of status, wealth, and needs.

To be more brutal, a client with a project budget of $1,000 is more likely to refer you to a person with a similar budget than to someone who is looking to invest $500,000 in your service.

It makes it difficult to jump up the ladder and land higher profile clients. On the other hand, once you get a few clients that belong to your dream segment, the value of referral goes up accordingly.


It’s harder to say “no”

Last but not least, it’s way more challenging to say “no“ if the person inquiring about your services has been sent your way by one of your past clients or friends. The situation when saying “no” is less comfortable may cause bias that results in bad judgment, and eventually to working for clients you normally wouldn’t want to work with.


Summary

For product-oriented companies, happy users are a robust, self-propelling sales & marketing machine. Word of mouth significantly increases the chances of the product's market success.

It's always better to deliver outstanding results and receive shout-outs from your clients than not.

As a service-based business, you should strive to get referred but never rely on it. Working with clients who come from referrals has certain downsides related to client segment lock-in or the feeling of obligation.

Final words

Regardless of whether you are a product or service company, referrals might come as sirens that lure to get you to rest on laurels. 

It’s better to focus on building durable, repeatable sales and marketing strategy and treat referrals as a supplement to your core tactical actions. 

And, of course, always deliver the best quality possible. Without this fundamental value, marketing and sales are just growth hacks that will never get you to the point you want to be.


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