Customer referral programs: turning your customers into an acquisition channel for a restaurant or local business

What a referral program means for a local business

A referral program rewards an existing customer, the referrer, when they bring in a new customer. It turns spontaneous word of mouth into an organized process, with a traceable invitation, a validation condition and a reward granted only after the new customer’s first visit.

Every neighbourhood business already lives on word of mouth. What separates a spontaneous recommendation from a referral program comes down to three elements: the invitation can be identified, the conversion is verified at checkout and the reward is conditional. Without these three elements, the owner knows neither how many customers their regulars bring in nor what each of those customers is worth.

Local businesses are particularly well suited to this mechanism. Their customers live within a few blocks, visit the same places and often share similar consumption habits. Research shows that this closeness between the referrer and the new customer is one of the mechanisms that make referred customers more profitable, as detailed below.

Trust also works in favour of this channel. According to Nielsen’s global survey on trust in advertising, 88% of respondents trust recommendations from people they know more than any other channel. A referral program does not create that trust: it organizes how it circulates.

What research shows about the value of referred customers

Field studies published in the leading marketing journals conclude that a referred customer is worth 16% to 25% more than a comparable customer acquired through other means, leaves less often, and that word of mouth has a far more lasting effect on acquisition than advertising.

Four studies set the benchmark on this question. They were conducted in banking, web hosting and social networking, not in food service, so their figures cannot be applied as is to a neighbourhood business. Their mechanisms, however, apply directly.

The study by Schmitt and his co-authors clarifies the nature of the advantage. The margin generated by a referred customer is initially about 25% higher, and this gap fades after a little more than two years. The better retention, on the other hand, persists throughout the period observed. With a reward of 25 euros per referral, the authors estimate the program’s return on investment at about 60% over six years.

Van den Bulte and his co-authors explain why. The referrer knows both the business and their own circle, so they recommend it to people it will suit, which improves the quality of the match. The new customer then benefits from a social tie with an existing customer, which keeps them around. The flip side is telling: when the referrer leaves the company, the risk that their referred customers leave becomes about 280% higher than for non-referred customers. For a business owner, the conclusion is simple: referrals depend on active regulars, and keeping referrers loyal protects the value of the customers they bring in.

The profitability calculation to run before launch

A referral program is profitable when the additional gross margin generated by referred customers exceeds the cost of rewards, valued at cost price. In a restaurant with a $25 average bill, a referred customer’s first visit usually covers the cost of both rewards.

The calculation relies on four figures every owner knows: the average bill, the gross margin after cost of goods, the number of visits a new customer makes in a year and the cost price of the rewards. The table below applies this calculation to a neighbourhood restaurant, using deliberately conservative assumptions.

Even after removing half of the visits, on the grounds that some referred customers would have come anyway, each activated referral brings in about four times the cost of its rewards. Break-even is reached on the first visit: its $16.25 margin alone covers the $7.80 in rewards.

Two precautions apply. First, rewards must be valued at cost price rather than menu price; otherwise the program looks two to three times more expensive than it is. Second, the temptation to raise the reward to accelerate volume deserves careful scrutiny. Wolters, Schulze and Gedenk (2020) analyzed a field experiment involving more than 160,000 bank customers, then data on about 270,000 customers of a telecommunications provider: larger rewards bring in more new customers, but considerably less profitable ones. The size of the reward is therefore a trade-off between volume and quality, not a simple growth lever.

To run this calculation with your own figures, the profitability calculator on our home page and our French-language guide on calculating the ROI of a loyalty program provide the full method.

Choosing the reward: type, size and recipients

Research points to three principles: reward both the referrer and the new customer rather than the referrer alone, prefer in-kind rewards to cash, and keep the amount modest. These choices increase the number of recommendations while preserving their credibility.

The first principle stems from how the new customer perceives the recommendation. Verlegh and his co-authors (2013) show that when a recommendation is rewarded, the person receiving it suspects an ulterior motive and gives it less credit. The effect is stronger when the recommendation was unsolicited or comes from a distant acquaintance. Rewarding both parties, or offering a symbolic reward, eliminates this negative effect.

The second principle concerns the type of reward. Across four experiments, Jin and Huang (2014) establish that cash rewards generate fewer recommendations and fewer acceptances than in-kind rewards, especially for lesser-known brands. Money carries a social cost: the referrer worries about looking like a salesperson. Cash becomes effective again when the amount is large or when the new customer is rewarded as well. For a neighbourhood business, a free house product therefore does the job better than a dollar discount.

The third principle follows from the work of Ryu and Feick (2007): rewards increase the likelihood of referral, particularly towards distant acquaintances and for less established brands. That describes most independent businesses, which therefore benefit from rewarding recommendations, provided they keep the amount under control for the reasons set out above.

In a restaurant, the typical combination is a free dessert or drink for the new customer on their first visit, followed by a free dish for the referrer once that visit is confirmed. In a retail shop, an entry-level item or a complimentary service plays the same role.

Designing the journey, from invitation to first visit

An effective referral journey takes five steps: the referrer shares an invitation, the new customer signs up on their own, their first visit is recorded at checkout, the rewards are triggered automatically and the referrer is thanked. Each step must be verifiable.

The first step is the invitation. The referrer shares it with whomever they choose, through a link or a QR code, from their phone. The business plays no part in that choice, which keeps the recommendation personal.

The second step is the new customer’s sign-up. They add the card to their own phone and provide their own information. This point is central for compliance reasons, detailed below, but also for commercial reasons: a new customer who signs up on their own has already shown an intention to visit.

The third step is validation. The reward should only be triggered by an action the business can verify, typically the new customer’s first visit, recorded when their card is scanned at checkout. A sign-up alone is not enough, since it generates no revenue.

The fourth step is delivering the rewards, which works best when automated: the new customer sees their benefit appear on their card and the referrer receives a notification that their reward is waiting. Manual handling leads to oversights, and a forgotten referrer stops recommending.

The fifth step is recognition. A thank-you message to the referrer, stating how many people they have brought in, sustains the relationship. Van den Bulte’s work shows that referred customers stay loyal when their referrer does, so looking after referrers also protects the value of the customers they bring.

Three safeguards limit abuse. A referred customer must be truly new, with no existing card. Each referred customer triggers only one reward. Finally, a monthly cap on rewards per referrer helps detect unusual behaviour without penalizing the best ambassadors.

The legal framework in Quebec: personal information, CASL and contests

In Quebec, a compliant referral program rests on three choices: the new customer provides their own information, the business only writes to them in compliance with Canada’s Anti-Spam Legislation, and the reward is guaranteed rather than drawn by lot. This section is general information, not legal advice.

Personal information. Quebec’s Act respecting the protection of personal information in the private sector, as modernized by Law 25, provides that information about a person is collected from that person, unless they consent to its collection from a third party. A form in which the referrer enters a friend’s name and phone number amounts to collecting information from a third party. The simplest solution is to let the referrer pass on a link and let the new customer sign up on their own. The Act also requires businesses to determine the purposes of collection beforehand and to collect only the information that is necessary.

Electronic messages. Canada’s Anti-Spam Legislation (CASL) generally requires consent before a commercial electronic message is sent. The Electronic Commerce Protection Regulations provide an exemption for the first message sent following a referral, under several conditions: the referrer must have a relationship with both the sender and the recipient, and the message must disclose the referrer’s full name and state that it is sent as a result of the referral. When the referrer shares the invitation themselves, the business does not need to rely on this exemption. The rules for sending notifications are covered in our French-language guide on push notifications.

Contests. A program that awards rewards through a draw among referrers generally falls under the publicity contest regime, overseen in Quebec by the Régie des alcools, des courses et des jeux. A guaranteed reward for each validated referral avoids this complexity.

Language. The Charter of the French language applies to commercial communications. The invitation, the sign-up page and the messages must be available in French; an English version can be added for English-speaking customers.

Before launch, having a lawyer review the program’s terms remains advisable, particularly for businesses that sell alcohol.

The indicators to track and the most common mistakes

A referral program is managed with five indicators: customer participation rate, invitation conversion rate, cost per activated referral, 90-day retention of referred customers and the share of revenue coming from referred customers. Volume alone is not enough to judge the program.

The most common mistakes fall into four categories. The first is an invisible program: if staff do not mention it at checkout, most customers never learn it exists. The second is paying the reward at sign-up rather than at the first visit, which rewards referrals who never show up. The third is an oversized reward, which inflates volume at the expense of profitability. The fourth is judging the program solely on the number of referrals, without looking at their retention.

Running a referral program with ARSOM

ARSOM includes referrals between cardholders in its Pro and Network plans. The loyalty card lives in Apple Wallet and Google Wallet, with no app to install, and every visit is recorded at checkout, which makes it possible to validate referrals and measure their value.

A referral program relies on a base of active cardholders and on reliable visit records. That is what a digital loyalty card provides: the referrer carries their card on their phone, the new customer adds theirs without installing an app, and the scan at checkout confirms the first visit. The owner then tracks visit frequency, regularity and average bill for each customer.

Referrals are included in the Pro plan, at CA$119 per month with a tablet lent and installed, and in the Network plan, at CA$99 per month per location. Onboarding takes place in person, and we help each business calibrate its rewards using the method set out above.

Frequently asked questions

Sources

1. Philipp Schmitt, Bernd Skiera, Christophe Van den Bulte (2011). Referral Programs and Customer Value. Journal of Marketing, 75(1), 46-59.
2. Christophe Van den Bulte, Emanuel Bayer, Bernd Skiera, Philipp Schmitt (2018). How Customer Referral Programs Turn Social Capital into Economic Capital. Journal of Marketing Research, 55(1), 132-146.
3. Julian Villanueva, Shijin Yoo, Dominique M. Hanssens (2008). The Impact of Marketing-Induced Versus Word-of-Mouth Customer Acquisition on Customer Equity Growth. Journal of Marketing Research, 45(1), 48-59.
4. Michael Trusov, Randolph E. Bucklin, Koen Pauwels (2009). Effects of Word-of-Mouth Versus Traditional Marketing: Findings from an Internet Social Networking Site. Journal of Marketing, 73(5), 90-102.
5. Gangseog Ryu, Lawrence Feick (2007). A Penny for Your Thoughts: Referral Reward Programs and Referral Likelihood. Journal of Marketing, 71(1), 84-94.
6. Liyin Jin, Yunhui Huang (2014). When Giving Money Does Not Work: The Differential Effects of Monetary Versus In-Kind Rewards in Referral Reward Programs. International Journal of Research in Marketing, 31(1), 107-116.
7. Peeter W. J. Verlegh, Gangseog Ryu, Mirjam A. Tuk, Lawrence Feick (2013). Receiver Responses to Rewarded Referrals: The Motive Inferences Framework. Journal of the Academy of Marketing Science, 41(6), 669-682.
8. Heiko M. Wolters, Christian Schulze, Karen Gedenk (2020). Referral Reward Size and New Customer Profitability. Marketing Science, 39(6), 1166-1180.
9. Nielsen (2021). Beyond martech: building trust with consumers and engaging where sentiment is high. Nielsen Insights.
10. Government of Canada (2013). Electronic Commerce Protection Regulations (SOR/2013-221), section 4. Justice Laws Website.
11. Government of Quebec. Act respecting the protection of personal information in the private sector (CQLR, c. P-39.1), sections 4 to 6. LégisQuébec.