How Much Should You Pay Your Affiliates?

Determining how much to pay your affiliates is one of the most important decisions you can make as a merchant. For one thing affiliate commissions are easily the biggest cost in any affiliate marketing program. Moreover, payout rates are one of the most significant factors evaluated by affiliates in choosing which merchants to promote. Fortunately, determining payout rates and methods is entirely up to the merchant.

So, how much should you pay your affiliates? Should you pay per click, per lead or per sale? Is it better to compensate affiliates for incremental traffic, each transaction or the entire lifetime value of a new customer? What's your average order size? Are you a retailer with razor thin margins or a service provider with low marginal costs? Do your customers have an acute need or do they instead generate on-going demand? Do you think of affiliates as long-term partners, or a source of cheap traffic? Regardless of the particulars, the importance of properly structuring affiliate payouts can't be overstated.

Click, Lead, Sale

With over 3,000 merchants now offering affiliate programs, payouts vary tremendously from merchant to merchant. Many merchants seem to trade originality for low risk. As a result pay per sale programs are easily the most common. If you pay too little, your program will never really get off the ground. Likewise, if you offer a pay per sale program when your true goal is to drive awareness, affiliates may drop your program as quickly as they first joined it due to poor earnings. Similarly more and more merchants are shying away from per click programs, in many cases due to improper planning and implementation, which leads to affiliate fraud. Pay too much or for the wrong clicks and your program runs the risk of self-destructing. Financial services are particularly prone to use per lead programs, but why? Don't pay per lead if you really want to encourage repeat usage.

Who Pays? What? How?

Perhaps the best way to answer these questions for your affiliate program is to look at how other merchants have solved them. A direct link to an affiliate's favorite book at Amazon pays a 15 percent commission. Would-be competitor BN.com pays just seven percent. In the textbook category, VarsityBooks pays a slim five percent. The commission rate is the same five percent at Textbooks.com. Over at Half.com affiliates earn a healthy $5 for each new customer sent. A&E offers a solid 10 percent commission on its collection of videos and other related merchandise.

Clothing at Gen Y fave American Eagle Outfitters brings $.02 a click, while lifestyle retailer Atomic Living pays $5 per sale. The latest Big Dog apparel comes with a 10 percent commission. Dirt world retailer J.C. Penney pays four percent, while long-time mail order cataloger Lands' End offers affiliates a six percent commission.

Looking at Margins

Clearly commission rates vary tremendously. For many companies, margins wield the greatest influence in determining commission rates. Margins on consumer goods are often relatively low, leading to equally low commissions on products like computers, electronics, CDs and so forth.

Tower Records pays only a three percent commission on the latest CDs, while consumer electronics retailer hifi.com and competitor 800.com both pay a five percent sales commission. In the case of these merchants, there is very little gross margin on which to pay affiliates. Even within this space you see differences, though. While Dell and IBM both pay a one percent commission on the sale of computer hardware, IBM pays four percent on software. However, Dell holds the line at one percent even for software and accessories, despite the obviously higher margins on software and peripherals. Despite low commission rates IBM, Dell and hifi.com all sell relatively expensive items. One percent of a $2,000 computer can still be a meaningful commission to an affiliate. Three percent on a $15 CD probably isn't as attractive.

Less is sometimes more: Henry and June's collection of lingerie pays 12 percent. Why? It has the margins to support a higher commission rate. Ditto for other higher margin discretionary items. For example, Wine.com offers eight percent commissions. Sending your significant other flowers via either an FTD or 1-800-Flowers affiliate results in a six percent commission. Brighter walls courtesy of Art.com yields a 10 percent commission. Lesser-known 123posters.com offers a huge 18 percent.

Low COGS

Services often have a different model, frequently offering significant payouts to affiliates. These commission rates are supported by a combination of low marginal costs for each incremental customer and relatively high selling prices. Essentially, these service providers have almost no cost of goods sold. For example, SinglesNet, a dating site, pays a 20 percent to affiliates for referring a new listing. Competitor We Meet pays 30 percent. Kiss.com goes even farther, paying affiliates 40 percent of all monthly fees to affiliates - on a recurring basis. Considering subscriptions to the online personals service run $15 per month or $80 per year, the payout can be meaningful. Other services like Career.com offer $45 to affiliates for referring new job listings.

Traffic's the Thing

Merchants focused on driving traffic would do well to compensate based on the incremental value of each visitor. On one hand, per click is the cleanest approach to measuring results: every click has a predictable cost. But are all clicks created equal? The downside is that per click programs often fail to recognize the long-term value of new visitors. In some ways per click programs are a tacit admission of poor visitor retention, low lifetime value, or a general lack of insight into visitor dynamics. Still, for some sites per click programs are just the thing. Auction meta search site AuctionWatch pays $0.03 per click and human advice site Expertcity offers $0.02 per click. NameBoy, an incredibly useful domain name suggestion site, pays $0.05.

Per click programs can also be particularly powerful during the launch phase of a new web site. First, the program generates velocity and awareness. Second, per click programs are probably the easiest to implement. Third, and most importantly, per click programs generate a meaningful base of early affiliates and visitors around which to start building metrics and benchmarks. Business.com used exactly this approach to launching its affiliate program with a huge $0.10 per click affiliate commission, while at the same time messaging to affiliates that the commission rate would later drop to a more sustainable $0.04 per click. As a merchant, challenge yourself to use a per click program not because of intellectual laziness, but because it matches your objectives.

Understanding Lifetime Value

Some merchants choose to recognize the entire lifetime value of a new customer right away. For example, Half.com pays a flat fee of $5 for each new customer affiliates refer. Considering Half.com earns a mere 15 percent cut on each order, its affiliate payouts on the first order likely exceed its entire gross margin. Clearly Half.com is counting on retaining these new customers and earning more fees in the future. The story at Amazon is similar, considering its 15 percent payout versus seven percent at BN.com. While the margins on any given book are basically the same, Amazon can afford the higher payout because of other factors, including the number of other product categories it can cross-sell and its greater retention rate.

The story is similar at Capital One. It recognizes the entire customer value at day one, rewarding affiliates $25. Other direct marketers and newsletter marketers operate similarly. SportsSleuth and Backwire.com pay $0.50 for email subscribers. GetAQuoteNow offers $8 per completed application. AOL pays affiliates for each new subscriber. Hosting firm Verio pays $50 per domain name registered and $60 for each new hosting account. If you know your business well, compensating affiliates on the basis of a customer's lifetime value can be a powerful proposition.

Second Class Citizens?

Another facet to setting affiliate payouts is more philosophical in nature. A number of otherwise promising merchants mistakenly treat affiliates like second tier partners. The logic is that small affiliates don't deserve the same payouts as other strategic partners. Some merchants seem to ignore Adam Smith's invisible hand. In the short-term merchants can get away with under-compensating affiliates, but ultimately market forces prevail - forcing merchants to adjust or perish. For example, pricey Birkenstocks offers only a meager two percent commission, while trendy Teva offers seven percent. Odds are these two merchants have similar margins, but Teva is generous, while Birkenstocks appears to hold back.

A recent conversation with an about-to-launch merchant is telling. After developing a schedule of allowable acquisition costs for his business development team to use with portals and other partners, he cut it by nearly 80 percent when it came to paying affiliates. When pressed, he protested, "We just don't think affiliates can generate as much business [as other partners]." Affiliate marketing is all about paying for performance. If the performance of your affiliates matches the performance of your other partners, your affiliates should be eligible for comparable payouts. If you shortchange your affiliate payouts, many affiliates will never join. As a result, you'll never know just how much traffic your affiliate program could have generated.

So, how much should you pay your affiliates? Should you pay per click, per lead or per sale? Is it better to compensate affiliates for incremental traffic, each transaction or the entire lifetime value of a new customer? When you pay based on performance, you're not solving for quantity. You're solving for price. But if you fail to develop an appropriate affiliate payout, your affiliate program will never realize its full potential. Perhaps the key to affiliate payouts is to treat affiliates the same way you would want to be treated.

Courtesy of Joel Gehman.