Someday, Your Godfather Will Call Upon You for a Favour

Ironically, that isn't the actual line from one of the greatest films ever produced. It is actually, "Someday, and that day may never come, I'll call upon you to do a service for me."

In business, there really are only two kinds of transactions. ACID is not one of them, unless you are either in the SQL database business, or your name is Harvey Dent, which, in one of those strange coincidences, a colleague recently called me, since on side of me is deep engineer, still contributing to projects and open source, and another is deep business consultant, designing strategy and fixing operations.

1. Exchange: I give you something, you give me something immediately in return. I give you product or service, you give me compensation in return. It can be cash, it can be a debt, it can be a different product or service (barter). 
2. Referral: I send you a customer, one who will do an exchange with you.

There are variants on these; for example, I can give you something that appears to be for free, in exchange for which you give me something that appears to be intangible. The classic example is Facebook or Google, where they give me a consumer Web service and I give them my attention. But in truth those are also exchanges. That which I give them, my attention (in the late 90s we called them "eyeballs"), is worth quite a bit to advertisers with whom Google and Facebook have lined up arrangements. I have given them a barterable or exchangeable asset, which they then use in an exchange with a separate provider.

Similarly, you can give your product away for free, perhaps as a sample, but once again you are trading your product for the customer's focus, which you will use to "purchase" further commitments from them.

Referral, on the other hand, is one in which I cannot or will not transact a particular piece of business with my customer, but instead will send them to a peer, partner or even competitor. Transaction lawyers refer customer to litigators; operations consultants refer CEOs to marketing specialists; etc.

The interesting question becomes: how does one get compensated for that referral. Let's say that I, as a consultant, work with a company who could really use some help with their marketing collateral. I am not a designer or marketing communications expert, but I know several such people. So I refer my customer to one of these people. Thanks to my referral, Ms. Marketer just received $20,000 in unexpected business! How should I be compensated for it?

There are two accepted methods for compensating people for referrals. I like to call them the "thank you gift" and the "godfather method."

Thank You Gift

Or, if you prefer, the commission. I send you a referral, but I fully expect to receive some compensation for it. Usually the compensation is a percentage of the size of the deal, or, more rarely, a flat fee per referral. In the consulting business, the most common commission I have seen is 10% of the first 6 or 12 months of service. There are two important principles in the "Thank You Gift." First, the expectations must be set up front, well before the referral. Second, the duration must be agreed. Let's say you run an electronics store, and I send you a customer who buys a $400 iPad, with the agreed expectation that you will send me 10% of the deal, or, in this case, $40. What happens if the customer is so impressed with your service that he returns a month later and buys a $600 iPhone? What if he buys a $1,500 laptop? A $10,000 business phone system? What if he buys them after 2 months? 6 months? A year? At a certain point, the customer is returning to you because of your service, ongoing marketing and upsells, and not because of my referral. It is crucial to agree up front on the length of time attributable to my referral, or we are likely to have rather unpleasant disagreements - and all disagreements about unpaid compensation are unpleasant. 

The "Thank You Gift" is an excellent way to compensate for referrals, and often to incentivize potential partners to bring you business. But there are challenges that come along with it.

1. It commercializes the relationship. While all business is, by definition, commercial, referral relationships are very personal. Sometimes the commercializing of the relationship can reduce the probability of referrals. People like to help each other; when they are getting paid for doing so, they feel less of a sense of "being a mentsch", and more of being a paid partner, reducing the intrinsic motivation. No services business ever survived on the 10% commission on referrals; it is icing on the cake, but they won't work too hard for it. On the other hand, when you feel you are helping your colleague out of your own goodness, sometimes you will work harder and keep your eyes open longer to send them business.
2. It complicates the deal. As mentioned earlier, you can almost never determine all of the potential parameters upfront: how long should the referral fee last? What if your referee services them from a different business which they own? What if it isn't the service for which you referred them but another one entirely, e.g. you send your customer to our electronics store because he needed an iPad, but he really needed a new office, and the owner of the electronics store is also 50% owner of an Intelligent Office?

For these reasons, sometimes the preferred method is the "Godfather" method.

Godfather

Late one evening, driving back with an attorney friend of mine - one of the few litigators who is a member of the bar and comfortable with the business cultures in the United States and Israel - he mentioned that most of his business comes from deals or litigation attorneys in the United States who need a litigator who can work both sides of the ocean. Without exception, his method is the godfather method. There are unique ethical and payment constraints when it comes to attorneys, and I do not know if attorneys are permitted to receive referral fees in most jurisdictions. But his point was that it is far better to have another attorney "in your debt" than to pay them off. As long as the attorney knows that the $20,000 or $50,000 or $100,000 in business that s/he received came from someone, they will feel a tug to send more business their way. That "tug" will be a far stronger incentive towards driving referrals, and will be more lucrative for the receiver, than the $2,000, $5,000 or $10,000 paid off right now.

Referral compensation is just another form of pricing for a service, in this case a referral service. Sometimes you get paid right away, sometimes you give something away for free, knowing you will get paid back much better later. Like any pricing service, understanding the dynamics of the market, and especially the cultural expectations, is important in order to get the maximum benefit.

As Don Corleone said to Bonasero, "Some day, and that day may never come, I'll call upon you to do a service for me."