May
29

Are kickbacks and referral fees ethical?

Over the weekend I received a call from a relatively new business in my area. Earlier this year, this business referred two different customers to me whom I was able to serve. However, this time the business owner was calling to send me more new business only if I would agree to give them a referral fee in return.  This business owner said that by not asking for a fee she was “leaving money on the table.” According to her, it was “not a good business practice” to not require a referral fee be paid and foolish on her part to refer business to me again if I would not pay one.

What do you think? Are kickbacks and referrals ethical?

Referral fees are most commonly understood through the real estate business. The Real Estate Settlement Procedures Act (RESPA) and Code of Ethics made it legal to pay referral fees to Real Estate Brokers but not to other individuals in the industry. With the purchase of a home being one of, if not, the most risk filled, expensive purchase of our lives, RESPA was created back in the 70′s because realtors, lenders, construction companies, and title insurance companies were often engaged in providing undisclosed kickbacks to each other, thereby inflating the costs of real estate transactions. RESPA made it illegal for anyone other than Real Estate Brokers to pay or receive a fee or kickback for a referral. And yet, this practice is not illegal in other business segments so why not use it as a new business development tool?

Pro’s

Certainly building your business through paying for referrals could be a lot cheaper than advertising or cold calling. Word of mouth referrals are the best way to hear about a service or product. There is, after all, nothing like having your clients think so much of your service that they are willing to recommend you to others.

And think of it from the perspective of the referrer. Given the current economic climate, the referral fee you might pay, might be the difference between the referrer being able to pay a bill or two, or go out and enjoy an evening with their friends or significant other. Through offering a referral fee, you clearly have an opportunity to not only build good will but encourage repeat business.

And if a customer has no resources or knowledge to be able to find a reputable vendor, and no way to discover what people really think about a vendor and their work, then a referral fee might make really good sense; especially to less-established players in the market.

If paying a referral fee makes sense to you, then the questions you will have to answer include:

  • How much of a fee should I pay?
  • Should the fee be a fixed amount of a percentage based on total spent by the client?
  • What about future sales to the client referred? How will referral fees be handled in the future?

Con’s

So what is the down side to offering kickbacks and referral fees?

Kickbacks and referral fees are essentially a hidden markup on the product or service. If they are not disclosed, they have the great potential of violating trust between the referrer and the individual being referred. Things have a way of  “leaking out”. And when they do, what will the customer think of the referrer who, at the time, they though of as having their best interests at heart?  On some level, by agreeing to pay a referral fee, a business is encouraging referrer’s to limit the free exchange of information to the potential new customer; which had they not been financially motivated to do so might instead have lead them to reveal more options to the customer that might truly have better served their needs and interests.

And how do you think a customer will react if they find out you’re paying for referrals unnecessarily? What if they actually knew about your business already or had done research on their own and identified you as a qualified supplier? Can you imagine the customer feeling very good about the fact that a referral fee is being paid?  The customer would absolutely know the price of the product or service you are selling to them is being inflated to cover the additional expense. In an attempt to avoid this conflict, referrers and referral fee payers rarely disclose a referral fee is being paid to the customer. The consequence is that, psychologically, it seems almost like an illegal act- kind of like a bribe.

And yet, some businesses have chosen to take a very public approach to disclosing referral fees.

How many times have you gone somewhere or been shopping online and been offered a discount if you refer a new customer?  I don’t know about you, but I never want to sign up for those programs. If I as the customer had a great experience with a business why would they need to try and buy my loyalty? It always leaves me suspicious of their motives and wondering what I don’t know about them that would make them feel compelled to do this.  And why would I want my friends to think the only reason I am referring them somewhere is because of what’s in it for me? Personally, I would much rather my friends feel that I truly value the service delivered to me by that vendor and just simply want them to know about it. I am honoring a social contract with my friends by freely offering great products and service to them, and breaking it if I get something for doing so.

When you disclose you pay referral fees or accept them, some may also see your business the way many online affiliate programs came to be viewed; as something to be avoided. Internet users have gotten very savvy to affiliate program links and often will remove the affiliate coding from the link before going to the sales site to buy a product. Not only in this instance has the referral fee been denied but the business asking for the fee viewed as completely unnecessary and irrelevant. ( What a great impression not to make!)

If you are working with the government sector or corporations, you may also run into trouble with customers who are forbidden from accepting any sort of gift. Is paying or taking a referral fee worth potentially being removed from a preferred supplier list as a result?

So under what circumstance, if any, is a kickback or referral fee acceptable?  In my opinion, only if the customer is receiving something of greater value as a result of the referral being made. Period. If you are not adding significant value why would a customer ever want to pay it? Otherwise all you are doing is inflate the price to the customer by doing so. I love Suze Orman’s rule here too: People first, then money, then things. And certainly, if you do pay or ask for a referral fee, respect your client first by fully disclosing that fees are being paid.

The goal of your business is to deliver your art, service or product at a price point you consider to be a fair value.  If what you are delivering is at an inflated price, because you had to bury the referral fee into the price, your brand in the end will somehow suffer. Customers have a “sixth sense” when it comes to knowing if they get what they pay for.  And when they don’t? They are certainly not shy at all about telling everyone on the planet about you and how they felt “ripped off”.

So how did I handle my call in the end?

I said, “of course I would be grateful to you for your referral. And the way I will show it is by going above and beyond for the customer you refer to me in the same way I do for all my customers. In the end this will serve us both better than my paying you a referral fee.” I wish I could tell you this had a happy ending. It did not. The referrer was really annoyed with me and hung up angry for having referred business to me in the past they were not paid for. Oh well. Remember: the value generated by the quality of what you deliver to a customer will be far more reputation enhancing to you and a referrer than any referral fee ever. It takes a seasoned entrepreneur to understand that customers can’t really ever be bought, exchanged or traded; they have minds of their own!  But potential customers can become friends, repeat customers and the best source of referrals to you ever if you focus on their needs exclusively first by offering them high quality free referrals.

 

 

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  • o.k.

    why don’t you pay a referral fee from your OWN money earned from this referred to you customer (not inflating the price for a customer at all)? as marketing expences that you didn’t really have to get this customer for free? fair enough?

  • http://www.entrepreneurthearts.com Lisa Canning

    Nice suggestion. I have just found it is not necessary in my business model to do- my business continues to grow utilizing the strength of free referrals. If that were to stop or change I would consider this option. How about you?

  • Nate

    What about the person refering a new customer to YOU for your stellar customer service saying I know of a great realtor that would look out for your best interest and by the way he has a referral fee that he takes from his own commission at no extra cost to you that we can SHARE !!!!

  • sore forehead

    No offensive but I would have to classify that as horrible advise. Generally speaking if you were to make a commision of $1000 from a sale and had to pay 10% referal fee ($100) inturn making $900 instead of $1000, you would prefer to make $0, nothing then to make less on your commision then usual??? and she was bringing 2 more people. I can see exactly why the customer was annoyed did you even ask how much they wanted? lets compare both circumstance paying a 10% percent referal fee you make $900 not paying you make ZERO watching another happy agent collect money from commision PRICELESS. (unless your counting your potential loss.) There are many things to take into cosideration when entering a referal market and from your reasoning I am left with a sore forehead from smacking myself. Just imagine you would of had 3 happy customers and maybe even more if you put aside your own greed lol my suggestion do more research. 1 customer is better then none Coma. Good promotion better then bad Period

    I wish you well
    check out amazon, groupon, apple affliate markets is a pretty big thing

  • http://www.entrepreneurthearts.com Lisa Canning

    James you missed my point entirely. I am talking about building trust with customers and why it matters here. All the same thanks for sharing your point of view. lisa

  • Christi Pemberton

    First, I am both an artist and entrepreneur. If the referral agent has proven that he/she can bring you customers, then a referral fee is only fair. We live in a time where we “expect” everything for free or everything at minimum cost…and that’s not the real world. You get what you pay for. If you don’t think a referral fee is fair, then don’t use a referral agent…just get the customer yourself…or go to Facebook or Twitter to connect with others for free. When you devalue a person’s service like that, you are gaining a bad reputation on you. In business, you need to keep a good rapport with others in the business community, others who may have a strong roster of customers who they can send your way. Providing good customer service is great, but it doesn’t help the referral agent who brought the person to you in the first place. It only helps you..and that is definitely not how you do good business. That referral agent can also mention to the customers who he/she brought to you in the first place that there is a better organization/business who can serve their needs….which could mean your loss of those customers. I personally get my own customers, but if I had to find a particular type of customer that I know will be hard for me to get…then I may consider a referral agent and just pay the money. No one is making us using a referral person, its our choice. If you can’t afford it, don’t buy it.

  • Jimjiminyjimjim

    If you are being paid to refer clients to a particular firm, aren’t you in fact biased? It is then in your best interest, financially, to send clients to a company paying you a split or commission above sending a client to a company that does not pay a commission but may do a better job for the client. If you are networked, doesn’t that then lessen your credibility when referring someone to a provider, based on your expertise, because you are incentivised to do so regardless of the client’s best interest? Doesn’t that take away credibility? If you don’t disclose that you are paid to refer clients, does that make the transaction even less honest? For instance, I am providing consultation to an interested party who is trusting my knowledge in a particular market, I refer them to a specific provider in their area of need and am being paid to do so through commissions. I would jeopardize my credibility if the potential clients knew I was being paid to refer that client to the agency I referred them to, correct? Let’s hear your take on this angle.

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