Referral-based sales: How much are they really worth?
Builders intuitively understand the importance of buyer referrals. But turning a feeling into figures has often been far less intuitive.
The place many builders start is simply estimating what happens to cash flow. A builder selling $500,000 homes who can make 12 additional sales per year by way of referrals generates $6 million in additional cash. While the impact of added cash flow on the bottom line is uncertain, it is almost certainly a positive event.
A second, more meaningful, consideration is the impact referrals have on a builder's absorption rate. Although absorption rates vary widely, a typical project of 100 homes may have six closings per month, or six percent absorption, which means the project would take about 17 months to sell out.
Most builders look at three main sources in finding qualified buyers: One is sales by outside realtors, which typically generate 40 percent of sales leads; a second is sales by the builder's own sales and marketing efforts, which generate another 40 percent; and the balance comes through referrals.
The challenge to builders becomes one of increasing the number and/or the percentage of referral-based sales and determining the value of selling out a project in a shorter period of time. If they can accomplish this, what are the resulting financial savings? More specifically, what is the dollar advantage for a builder who can increase his referral sales rate by one sale per month?
Given a project of 100 homes and a baseline total sales rate of six homes per month, an increase of one additional referral sale per month reduces the close-out from 16.7 months to 14.3 months, a savings of 2.4 months.
During the sales cycle, certain variable costs occur every month in which the project is actively selling homes. Those include costs for advertising and media; landscaping, security, and model maintenance; sales and support staff salaries and benefits; property management; and interest on finished but unsold homes.
The dollar cost of these expenses varies widely, depending on the total cost of the homes being built, current interest rates, and a variety of other factors.
Estimates from several major builders indicate the variable costs for a typical 100-unit community of homes in the $200,000, $500,000, and $800,000 price ranges (excluding head office overhead) typically run to $30,000, $60,000, and $80,000 per month, respectively, but can easily hit $110,000 depending on the market and other circumstances.
For a 100-unit project selling six homes a month, those monthly charges add up fast over 17 months: At $30,000 per month, variable operating charges would reach $500,100; at $80,000, they climb to $1,333,600.
If a builder can generate one incremental referral-based sale per month, he can reduce the close-out period in this example by 2.38 months. The builder spending $30,000 per month on a 100-unit project of $200,000 homes would save $71,400. The builder selling $500,000 homes would save $142,800. That same builder with 10, 100-unit projects would have corresponding savings of $1,428,000.
Looked at from a different perspective, that makes the value of each incremental referral-based sale worth approximately $5,100 per house at the low end ($71,400 divided by 14 net months of selling one extra referral house a month) and $13,600 per house at the high end.
Increasing referrals involves doing a lot of things right. And doing them all won't be cost-free. There are bound to be offsetting expenses in trying to exceed customer expectations at every phase of the purchase.
But industry satisfaction surveys indicate that customers with high satisfaction levels will refer an average of six potential buyers to a builder, while those with low satisfaction scores will produce none; or could actually reduce referrals.
Clearly, if builders are to realize the cost savings that come from referrals, they need to begin by tracking their referral rates and communicating the results. Like many initiatives, the effort to boost referrals will only succeed if everyone throughout the builder organization understands its overall importance and hears about it consistently.
And builders will continually need to identify the most effective ways to improve customer satisfaction. Most builders already measure how satisfied home buyers are with the quality of their new homes, and as importantly, their buying experience. Many builders also tie the bonus compensation of their sales, design center, construction, and customer service personnel directly to home buyers' satisfaction scores and referrals.
Most customers want to be pleased. Focusing on key quality concerns and improving service responsiveness will cultivate customers who are more motivated and more willing to provide referrals that lead to greater financial success for the builder.