Paying commissions for referrals pt.2

As I imagined, my previous entry was a topic of great debate. Before we can sort through it, it is important to separate commissions generated via recognized sales functions from relationship referrals. For example, any agent is clearly off the table. Of course agents get referral fees or commissions, how else could one presume they are paid? Indirectly, this most clearly indicates that transparency is central to the debate.

For his research in The Market for Lemons, George Akerlof won a Nobel Prize in Economics for describing how in the used car market, lemons reduce the price of good used cars because a seller is strongly motivated to sell all cars as good ones to make the most money. As a buyer of a used car, you want to pay as little as possible because the car could be a lemon (there is no transparency). For this reason, high quality used cars are difficult to sell at fair value because there is no way to prove they are worth the money (some dealers now offer warranties on used cars as a strategy to reduce uncertainty). This indirectly explains why you should offer warranties on your sewn products because consumers have no way of knowing whether your stuff is any better than anyone else’s in the marketplace.

That the bad stuff can push out the good (Gresham’s law) is due to the mechanisms of asymmetrical information. Asymmetrical information refers to a power imbalance in a transaction because one party has more or better information (power) than the other. How is that partnering? Returning to the issue of secretive referral fees, the party generating the referral has information the receiver does not because there is no transparency. If the party seeking a referral were to know the first party is accepting fees, the receiver should weigh the risks of being party to the arrangement because there is the likelihood of their buying a lemon.

If transparency is the key then there is no problem whatsoever if one party refers another to a preferred partner as long as the first party has disclosed their arrangement prior to making a referral. The second party is then free to take it or leave it. There is nothing wrong with this. However, if the first party does not routinely disclose their financial interests in the matter, they’ve said more than words ever could that their business arrangements aren’t above board. If they truly believe there is nothing wrong with it, then why would they need to keep it a secret?

Gate keeping
Another issue to consider is the matter of gate keeping. Like it or hate it, gate keeping in the needle trades is more democratic because you can progress based on what you know (searching for a contractor instead of a manufacturer) as opposed to who you know. Paying for referrals contributes to a system of financial elitism. If we all had to pay for a name no matter how much we know, you can’t get in if you’re too poor to pay. That seems patently unfair. Conversely, it is not unfair if the issue of referral fees is transparent because you agree to the arrangement through disclosure. If you have a bad result after that, it is a separate matter of whether one performed the duties they agreed to provide.

It is not coincidental that my forum is set up like this. You gain access to people who have names by knowing whats (buying my book). That someone buys it doesn’t guarantee they’ve read it and know but the culture is such that members will vett you before providing information. They will make sure as well as they can that you are prepared to undertake what you propose to do. Collectively they do this because they also have an interest, that of their own reputations and that of the community. More on that is below under the sub sub heading of reputation.

And sure, celebs and rich people pay for a lot of services (usually too much) to produce their lines but they have transparency. The phrase “money to burn” is literal, money is a fire accelerant. Both money and gas are volatile and have to be used in measured safe delivery systems. If you trot off on the wrong path full speed with a full tank, you might not have enough gas to return to the fork in the road to end up where you should have been to refuel. That also explains why most DEs are killed by growth rather than the lack of it.

Yes, everyone has an interest in providing referrals whether they are paid or not and you would do well to consider what those may be. Quid pro quo is traditional among non-agent practitioners (like pattern makers, contractors etc). This means I do for you and you do for me. The benefits and mechanisms of these kinds of referrals are indirect, based on reputation and related to lowering costs, not increasing them.

Lowering costs: A contractor has a vested interest in pointing you to a given pattern maker because they know their work quality. They won’t send you to a pattern maker who makes such crappy patterns they can’t be sewn because that would increase the job costs and hassle once they got the patterns in house. A contractor is going to send you to a pattern maker whose patterns they like. The reverse is also true. A pattern maker will send you to a contractor that will sew their patterns error free. That your transaction was smooth start to finish, is why you will become a repeat customer.

Increasing costs: You have no idea of the veracity of someone who accepts fees under the table. Like a used car salesman, they push lemons (to both parties) alongside the good ones meaning a contractor in the arrangement may not value the referral as much as you think. The contractor may be rolling their eyes at yet another referral from Harry, that based on the poor quality of candidates he’s sent before, your job may be marked up 20% to 40% or maybe more. That you may know more than Harry’s average referral won’t get you a discount because you’ve become part of the profit and loss mix of Harry and the contractor’s business arrangement.

Reputation: In my case (and many many others I know) none of my referrals involve fees either way. My role in the marketplace is to be an unimpeachable source of information. Unimpeachable is my stock in trade. Whether someone likes me or not or whether I make an error in judgment have nothing to do with my integrity. Since I have worked a lifetime in the trade, I have too much to lose if I make a bad referral. I’m very cautious and centrist. If I make a bad referral to you, I lose value because you won’t tell anyone else about the services I provide. If I send a bad customer to a contractor, he will lose respect for my judgment at having failed to vett you thoroughly and he will be very reluctant to take on anyone else I send him. If he won’t take any more of my clients, then I’m less valuable to my customers. So yes, I do have an interest albeit indirect and based on reputation. This is why I will not give a referral to just anyone. [You should thank me now for not ranting over stupid pig-headed people who find my name on the internet and insult me for not giving them a name upon demand.]

In upcoming entries, I will be writing about trust -as in, who can you trust? Trust is something we all face but I think it’s affected me (and people like me) more than is typical. Accordingly, I’ve read a lot about it and have written a lot of (unpublished) material too. That and about trust and asymmetrical information. And trust and intuition (I believe there is no such thing, at least in terms we typically describe it). It was difficult for me to write this entry because all of those things are connected and with no less than 10 separate entries on my hard drive, it was hard to edit and parcel out my thoughts without going off topic. I hope this has been helpful and clarified some issues for you.

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  1. This entire discussion is fascinating to me. I have been approached by bloggers who want me to pay them a kickback for recommending my site (I’m not a DE – I own an online store). I’ve gently refused, saying that I’m simply not set up for referral fees at this time, which is true. One of them immediately removed all references to my business from her blog. It left a bad taste in my mouth. It highlights the difference between the professionals and the dilettantes.

  2. Kathleen says:

    The FTC cracked down on blogging referrals because it was becoming such a problem. Bloggers have to disclose their relationships. You should mention that the next time it comes up, are they willing to do that?

    For the record, my policy is to pay for anything I’d use in the normal course of my business. I don’t take advertising from anyone except those I’ve used myself personally (and paid for their products). I only accept free stuff upon certain conditions. One, I don’t guarantee a review, much less a good one. Two, they have to ask me first, some stuff I just won’t take (clothes, perfume, jewelry etc because it’s not business related). I should revise that, the only stuff I’ve accepted are books. lol. And if I review them it’s because I like them. I think I’ve only reviewed one or two books I didn’t buy personally.

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