I’m going to be honest. In many cases, paid referral programs are a waste of money.

What’s a paid referral program? It’s a program where you incentivize customers to refer other customers to your company. You can incentivize the customer who refers, the customer who is referred, or both. The incentive can come in the form of a free product, a discount on the next order, or even cash.

What’s not to like? Usually referral incentives are smaller than your normal acquisition cost so it seems like you’re getting customers inexpensively. And if you’re giving a discount to the referrer, you’re incentivizing another purchase.

The issue, of course, is that your referral program may not be sufficiently incremental. In other words, you could be paying customers to make referrals they would have made anyway.

I see this happen all the time. A company starts a paid referral program and is excited that the number of customers coming from referral has increased. But the company’s referral rate before starting the paid program wasn’t 0! What matters is how many additional customers are referred because of the paid incentives.

Why is this so important? Because a paid referral program not only causes the company to pay for incremental referrals, it adds a cost–the referral incentive cost–to referrals that were previously free. If your referral rate goes up that’s great–but if you’re paying for a large number of referrals that would have happened otherwise, the referral program is much more incrementally expensive than you think.

This isn’t to say that paid referral programs are never worth it. They often can be. But you shouldn’t just assume they are. This requires real analysis and work.

Measuring incrementality is always hard but to determine a paid referral program’s effectiveness you should review your referral rate–probably with post checkout surveys–before and after implementing a paid program. You also need to establish how many of these referrals you’re paying for and actually nail down the incentive cost–discounts have a different cost than free product.

Finally, this is a more qualitative point but paid referral programs can also impact customer perception of your brand. One intuition here is you would never try to pay a friend $20 because they did you a favor. They’d be offended because your friendship isn’t meant to be transactional.

Obviously your relationship with your customers is fundamentally transactional but you don’t necessarily want it to always feel that way. Incentivizing referrals can cheapen a brand to me.

In general, paid referral programs can be helpful but users beware: they can be way more expensive–both quantitatively and qualitatively–than they look.