Rewards or Upgrades? Incentive Designs in Referral Programs

Abstract

Referral programs are a popular strategy to enhance public awareness and drive sales of new products. These programs offer incentives to invite purchasing customers to refer their friends. These incentives are made in the form of monetary rewards in traditional referral programs. In this paper, we introduce a referralupgrade strategy, allowing incentives to be made in the quality dimension. Specifically, the firm sells a basic product and offers a free upgrade to a high-quality version if the referral generates new purchases. We first demonstrate the limitations of offering upgrades exclusively through referrals and then explore scenarios in which customers can return to purchasing the upgrade if their referrals are unsuccessful. Allowing customers to make multiple referrals, we introduce a referral reachability metric to measure potential overlaps in customer networks. We show that our proposed referral-upgrade program can be more profitable than the traditional referral-reward programs under a high referral reachability, a low referral cost, and a low referral cap. Moreover, the relative difference between these two referral programs is non-monotone in the referral cap, suggesting firms can achieve the most gains from offering quality incentives under intermediate values of the referral cap.

Keywords: referral-upgrade, referral-reward, product design, pricing