Referrals Per Customer (RPC) - A key business metric that will allow you to learn more about your business's virality and ability to generate organic growth
Referrals Per Customer (RPC) is the correlated rate of referrals per customers over a given period of time. Stated more simply, Referrals Per Customer tells you "how much of an additional customer" each customer brings in.
Understanding that both the above definitions still might be a bit opaque and obscure to business owners and managers, let's go a bit deeper with an example. A Referrals Per Customer (RPC) rate of 0.25 means that for each unique customer over a given period of time, 0.25 (or one-quarter) of an additional customer is going to come into your business - which means that for every 4 customers, you can expect one additional customer to come in via a referral.
We measure the Referrals Per Customer (RPC) rate in terms of a single customer because it will be easier to use downstream - although it might be easier to say "you get 1 referral for every 4 customers" saying instead that "each customer brings in an additional 1/4 of a customer" is the best ay to approach and to understand RPC because it will allow you to apply an understanding of RPC to each customer and because it will be easier to use the RPC concept downstream in the calculation of things such as the Lifetime Customer Value (LCV).
To calculate your business's Referrals Per Customer (RPC) metric you simply need two numbers:
Using these two numbers, you can simply divide the number of referrals by the number of non-referrals to get your RPC metric. For example, if in 2016 you had 800 non-referral customers and 200 referrals, you would simply divide 200 by 800 to get 1/4 OR 0.25 - your RPC would be 0.25, meaning it's as if each customer brings in an additional one-quarter of a customer with him/her every time they come in.
Now that we've given you a brief overview, we'll discuss why this is an important thing to know, then we'll dive into some important conceptual pieces of Referrals Per Customer (RPC) and then follow up with an example of how to implement this new and valuable understanding.
Why should you care about Revenue Per Customer (RPC)?
Any small or medium size business owner or manager worth anything will understand the importance of referrals. From antiquity to the most modern businesses around the world today, referrals are a critical part of growing any businesses sales base - this understanding is so fundamental that it almost needs no explanation.
Humans, being social creatures, value the opinions of other humans they trust and respect. Humans intuitively understand that a referral from a respected individual is a valuable thing because it both
If referrals are so important to businesses, and if most businesses understand this, why is so little effort put into properly understanding referrals by small and medium-sized business owners and managers? In conversations with small and medium sized business owner sand managers, this usually occurs because a misconception that it is either costly or difficult to go beyond the basic "please refer us" statement to understand the nature of particular business's referrals.
If the nature of referrals can be properly understood, however, various benefits will immediately flow to the business owner or manager. These benefits include:
Correlation vs. Causation - A key distinction to know in business and in life
Now that we've covered the basics, we'll dive deeper into RPC in order to flush out some of the important details and get a good understand fo the concepts and it's potential weaknesses. First, we'll note that the way we calculate RPC is a bit flawed - RPC looks at how referrals are correlated with overall customer volume and NOT at the actual amount of referrals that a certain number of customers bring.
What this flaw means is better illustrated via a generic expamle using the same numbers we used in the brief example above. Let's say you have an ice cream shop and 800 new customer visit in 2016 with 200 referrals. Per our RPC calculation, you would look at be looking only at numbers in 2016. That means a referral could have come in on the very morning of January 1, 2016, but you would still count it as part of your RPC. This doesn't make sense because clearly, no customer in 2016 referred that customer - it was almost surely someone in 2015. So, you're not really looking at the causes of the referrals, but only at how your referrals are correlated with (eg. compare with) your non-referrals.
This is a flaw, but it should remain a minor flaw for the vast majority of businesses. You should be aware of it, but that is all - you can safely assume the flaw away because the error that will be introduced will be very small and due to the fact that the greatest error occurs in the first year. In subsequent years, although the very small error will persist within each year, the error will be normalized away via a comparison of years with each other - 2016 and 2017 could be compared with each other and both will have that error in it.
For calculating RPC, count customers, NOT Transactions
It is important when calculating your RPC metric, as stated above, to use customers and not transactions - customers might engage in multiple transactions but you only want to track the individual customers in order to accurately calculate RPC.
It's easy to see why we want to focus on customers and not transactions. Imagine a customer who refers one friend but comes to your coffee shop every single day for a year. Intuitively, how do we understand the relationship between the customer and the referrals that come from him/her? We clearly would say that the one customer refers one person - we wouldn't say 365 customers refer one person. If we count transactions, we would in effect be saying that it takes 365 of this customer to get a preferred customer - a meaningless and inaccurate statement. Clearly, we can see that it only took us one customer to get that referral - the more accurate approach is to count only customers.
Does the same apply to referrals? Do we count transactions or customers when counting the number of referrals? Clearly, we also count the number of customers - counting transactions would possibly overstate a number of referrals and thereby overstate the RPC metric incorrectly. Again, image one customer refers another and that referred customer comes into your coffees spot every day for a year. Would it be more appropriate to say that one customer was referred or would we say that 365 customers were referred? Clearly, it is more meaningful and correct to note that one customer refers another, not that one customer referred 365 customers.
Digging deeper into the calculation of Revenue Per Customer (RPC)
We touched on the actual calculation above, but let's dig a bit deeper into it in order to really flush out the details. As we said above, there are only two things you'll need in order to calculate Referrals Per Customer (RPC):
Then you simply divided:
(# referrals)/(# non-referrals) = RPC
Make sure to keep in mind that you're dividng referrals by non-referrals (not the other way around). Additionally, it is key that the two numbers your dividing are for the same time period - if you use different time periods for counting the number of referrals and non-referrals, your RPC will inaccurate and incorrect.
Hopefully, you already have the data to be able to get the above numbers. However, if you don't, you'll have to set up a system for collecting customer data and wait a bit (at least 3 months) before you do the calculation. You'll want to wait so that the data is sufficiently representative of what's going on and so the short-term kinks and gyrations are evened out. One year is an even better timeframe - if you start at a shorter timeframe, move to a longer one as more data becomes available. One year is particularly excellent because for most businesses it will allow for a full yearly business cycle (eg. holidays, special sales, varying weather, etc.) to be represented within the dataset you are using.
It's not difficult to start collecting the necessary data to calculate RPC if you currently don't have it - you really only need to tag each customer with whether or not they are a referral and be able to separate out customers from transctions. Separating referrals vs. non-referrals is relatively easy - you or an associate can simply ask at the time of purchase verbally or via a registration form if your business uses them. Making sure transction are separate from unique customers will be a bit more complicated, but is still relatively simple - you'll need to someone keep track of your customers (eg. an MS Excel file) and be able to search within your customer list (eg. Ctrl-F within MS Excel) for the customer when a new transaction occurs. This MS Excel - Ctrl-F is the most basic and primitive approach - far more sophisticated and elegant approaches are possible using both MS Excel or a piece of Customer Relationship Management (CRM) software.
Benefits of knowing your business's ability to generate revenue from customer referrals
Once you know your businesses RPC, you'll have a far better picture of how referrals factor into your business. You will literally be able to understand what percentage of customers are referrals and, thereby, understand what each customer (on average) brings into your business in terms of referrals.
You'll effectively be able to both understand and quantify the additional benefit that is derived from each customer above just the transaction - you'll knw that the transaction amount is only one part of the gain your business receives from each customer. By knowing this, you'll be able to better evaluate marketing - both towards new customers and to existing customers. You'll also be able to better evaluate different approaches to growing sales and revenue - a common dilemma many business owners and managers face is whether to market towards new customers or to focus on getting more referrals.
Additionally, by knowing your RPC, you'll now be able to track your RPC over time - this is incredibly valuable and will allow you to monitor the performance of different strategies and tactics. For example, if you implement a referral bonus where customers get a certain discount for each referral, you'll actually know how effective that program was. You might think that you would already know how effective that program was without knowing you RPC - wouldn't tracking sales and revenue be sufficient? The answer is NO - revenue clearly depends on many thigns (eg. season, tastes, unemployment rate, economic growth, randomness, better salespeople, etc.). By knowing your RPC, you'll be easily able to measure one time period's RPC against another and really know how a new strategy affected the level of referrals derived from each customer.
Most importantly, you'll be able to use your RPC metric in important downstream uses that will further create business intelligence for you - critically useful metrics such as Lifetime Customer Value (LCV) rely on the RCP metric as an input.
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