Some of the most used mechanisms for promoting products nowadays are cashback promotions and refer-a-friend promotions that merchants use to attract customers looking to save money. Although it might seem similar, the two business models have a few key differences that can impact the revenue and budget of the companies that are looking to leverage these techniques for customer growth.

The cashback business model

The cashback business model was first introduced back in 1986 by credit card companies who wanted to increase the number of people signing up for a credit card and lure them in with cashback promotions every time they shop at certain stores. It implies typically a cash percentage a customer receives back when they purchase at a merchant. This win-win situation is attractive to customers because they feel more comfortable making a large purchase when they know that the company will reimburse them for a percentage back.

On the business side, it can also be a great win at first glance, but it entails building a strategy around it that will give sustainable growth in the long run, as well as returning customers.

The highest risk when offering cashback is the acquisition of customers who are looking for deals and will always need some incentive to make a purchase. Using this promotional technique is less cost-effective if companies are looking for something that will work on a small business budget, because it implies lowering your profit margins with every purchase that your customers make. 

The referral business model

Word of mouth marketing has been around since the beginning of time like we want to say it and has always been a part of conversations between friends and family and an essential topic that gets the conversation going. Ever since they started trading goods for other goods, customers used referrals to get the best products on the market.

With this in mind, using referrals is the most trusted way to get a new customer on board, because they don’t have to research that much before they purchase your business. Since they learned about you from a friend or family member, it will be more likely to make the purchase right away. 

Another advantage of using this business model is that the cost implied in offering an incentive in exchange for a referral can be lower than using a cashback promotional technique because you won’t reward customers every time but only when they make a referral to a friend. This fact makes it more likely that customers will return to refer friends, make more purchases, and eventually become loyal customers.

Below we have an example of how the cashback model compares to the referral model.

In this example above, we can see clearly how the marketing cost is adjusting to the referral business model compared to the cashback business model. Both promotions involve a 10% cash reward, the only difference being that the cashback model rewards that 10% every time a customer makes a purchase, compared to the referral business model, that rewards 10% cash only when a customer makes a referral that converts into a sale. By using the referral business model, the customer can still earn cash rewards even when not purchasing if they refer friends to your company.

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