Referrals are, and always have been, something of a mystery. On the one hand, most advisors call referrals the one best source of new business. On the other hand, only a small percentage of clients actually provides referrals. And while a majority of clients are satisfied with their advisory relationships, very few take the next step and share that information with friends and family.

To crack the referral code, my firm, Advisor Impact, went to the one true source of insight on the topic: your clients. This month, we are publishing the Economics of Loyalty: Anatomy of the Referral, a comprehensive examination of what drives satisfaction, loyalty and referrals and an in-depth follow-up to a 2008 study on this same topic.

The results push us closer to understanding why most financial planners haven't yet cracked the referral code. We are, it turns out, collectively guilty of applying a simplistic, tactical model to a complex issue. We treat referrals like any other business tactic, focusing on crafting the perfect script, letter or campaign. The reality is that referrals are driven by more than the right 'ask'; they result from a complicated algorithm that goes to the core of how you build relationships, demonstrate trust and drive loyalty among clients.

The Economics of Loyalty was sponsored by Charles Schwab and involved feedback from 1,000 investors, gathered in May 2010. Every respondent worked with a financial advisor, contributed to the financial decision-making in the household and met specific household asset criteria. They reflect the client bases of most advisors and skew to the high net worth.

The data contributed to a new view of referrals, a model we call the Anatomy of the Referral. The model starts with the recognition that there are four parts to the referral equation, each of which gets us closer to the strategies that will work.

* Who provides referrals?;

* Why do those clients refer?;

* When do clients refer?; and

* What impacts how many referrals they provide?

By answering these four questions, you can crack the referral code for your practice. More business is just around the corner.

WHO PROVIDES REFERRALS

As an industry, we are guilty of assuming we understand "who" provides referrals in the first place. Traditional wisdom suggests that clients who are satisfied or loyal will refer. It's simply not the case.

Among all clients surveyed, 29% indicated that they had provided a referral. If we isolate those clients who gave their advisor a 10 out of 10 rating on satisfaction, however, the percentage jumps-but only to 42%. It's a respectable outcome, but not enough to say that satisfaction necessarily drives referrals. Less impressive is the fact that of those clients who provided a high loyalty rating (four or five out of five are likely to continue using the advisor), only 30% provided a referral. So while a majority of clients are both satisfied and loyal, that information isn't helpful in understanding and modeling the ideal client.

Enter the engaged client. Through a process called cluster analysis we grouped clients based on the strength of three factors: satisfaction, loyalty and referrals. The results speak for themselves: Engaged clients had high scores on all three factors, and they were the ones who referred others. We need to set client engagement as the standard because satisfaction and loyalty simply aren't enough. More important, we need to understand what drives client engagement.

WHY CLIENTS REFER

The "why" of referrals is about a client's core motivation. Fifty-eight percent of clients said that they had referred because an advisor had done a good job and they wanted to return the favor by helping him or her build the business; it's the law of reciprocity. There was a steep drop to the 38% who said they had a friend with a financial need and they were able to provide a solution.

The question is, what drives that motivation for engaged clients? We've broken it down into three primary activities, each of which can impact client engagement at a different stage of the relationship:

* Work with the right clients;

* Have the right conversations; and

* Ask the right questions.

Work with the right clients. We believe that client engagement starts when the client is a prospect. Those advisors who choose to work only with those clients for whom they can do their best work are more likely to be rewarded.

"In this industry, we routinely set minimum standards for client relationships, such as household assets, but the best matches run deeper," says Randy Ambrosie, CEO of Accretive Advisor. "Magic happens when the advisor and investor are matched based on their core motivations and needs, including things like investment philosophy, communication style or personality. "