Take It on a Case-by-Case Basis

It is starting. I knew it would happen. The desperate need for aggressive fourth-quarter, year-end deals to boost sales numbers is unfortunately disintegrating with the cool winds of winter. Now that things have begun to calm down, it’s time to carefully consider how we should be putting together deals. This article addresses a more deliberate way of structuring affiliate agreements. It is time to start relating affiliate commission payouts to the price points of the products being offered for sale as well as the lifetime value of each referred customer.

One of the most aggravating problems with affiliate payment models is the insanely irrational desire to “institutionalize” and “standardize” the revenue-sharing structures currently in place. The serious predicament that merchants face is that their product purchase points and the customer’s purchasing patterns do not meet the “strict criteria” of these intrinsically faulty attempts to standardize the affiliate payment structures.

Current Challenging Predicament No. 1: Does it make sense that affiliates want to charge a merchant who sells a product for $100 the same cost-per-click or cost-per-impression as a merchant who offers a product for $20?

Current Challenging Predicament No. 2: Should affiliates think about restructuring their payments based on the merchant’s gross margin (sales price less hard cost of product)? For example, should it matter to the affiliate that the $100 product that only has a 10 percent gross margin produces the same $10 profit as the $20 product that has a 50 percent gross margin?

Current Challenging Predicament No. 3: Should affiliates be rewarded more up front or on the back end for producing customers who have a lifetime value that far exceeds their initial purchase?

For example, X10 pays affiliates a one-time commission of $20 (ingeniously in store credit only) for referring a customer who spends at least $50 on one purchase. The lifetime value of this customer probably far exceeds the original purchase, yet X10.com doesn’t pay the affiliate anything more over the lifetime of this referred customer. Is this fair? It might be.

Let’s try to tackle the three predicaments above by examining the following scenario.

Affiliate Bob offers merchants the opportunity to advertise one time in his 500,000 member newsletter at either a $25 cost-per-thousand (CPM) price or a percentage of the total revenue derived plus some upfront payment for doing the mailing.

Assuming the newsletter has a targeted audience that meets some statistically measurable norms, let’s imagine an average response rate of 2 to 5 percent on both click-throughs and conversions and ask our first question.

1. What kind of traffic will the affiliate generate from one email to the entire list?

  • On the normal end (10,000 clicks, or a 2 percent response), 200-500 people will buy.
  • On the high end (50,000 clicks, or a 5 percent response), 1,000-2,500 people will buy.

2. How much total cash revenue (gross sales) will be generated from this emailing?

Though this question does not take into account the merchant’s actual cost of goods, statistically the gross sales could range anywhere from $2,000 to $250,000. It depends on two factors: the response rate and the product’s price point. Here is a breakdown of the revenues based on these two factors:

  • On the normal end (10,000 clicks), the $20 merchant would generate $4,000-$10,000 of gross sales, and the $100 merchant would generate $20,000-$50,000 of gross sales.
  • On the high end (50,000 clicks), the $20 merchant would generate $20,000-$50,000 of gross sales, and the $100 merchant would generate $100,000-$250,000 of gross sales.

3. When does the merchant break even so that the deal will make sense?

The answer to this question depends on two major factors: the amount of gross margin there is on each product and the affiliate payout structure.

The $20 merchant (with a 50 percent gross margin) breaks even under the $25 CPM model if 1,250 people buy his product. Of the $25,000 in gross revenue, $12,500 covers the sponsorship, and $12,500 covers the $10 cost per product.

The $100 merchant (with a 10 percent gross margin) also breaks even under the $25 CPM if 1,250 people buy her product. Of the $125,000 in gross revenues, $12,500 covers the sponsorship, and $112,500 covers the $90 cost per product.

Just to review, both merchants need 1,250 people to buy their products. That means that even if 10 percent of the subscribers click on the offer, the merchants have to close 2.5 percent of those people. This amounts to a very substantial 0.25 percent total conversion rate on the entire list.

Great. They each need 1,250 people to buy their product in this very narrow scenario. Where is the problem? Shouldn’t they be paying the same cost per click or impression to have their offers delivered to a targeted audience?

I say absolutely not, for the following reasons:

  • The person spending $100 on an item is not the same as a person spending $20 on a different item. The cost to reach each person should not be the same.
  • The gross revenues are so vastly different — that is, $25,000 versus $125,000 — that the standard “fixed share of the gross revenue” models out there can’t be applied to both merchants similarly without drastically incomparable results.
  • The gross margins also influence the deal because if the $100 merchant doubles his margin to 20 percent, he has a lot more money to spend (or make for that matter) on acquiring customers. Whereas the $20 merchant who is already at a 50 percent margin doesn’t have much more room to maneuver. And if his 50 percent margin suddenly becomes a 40 percent margin, or even 30 percent, he’s losing money on the deal.
  • Finally, what about overhead? What about the cost of processing 1,250 orders?

The numbers get very confusing here, as you can very well see. If I haven’t lost your attention by now, then I’m a much better writer than I think I am.

The bottom line is that if you want to strike a deal that is highly profitable with the least amount of risk for both parties, then you need to put aside these absurd attempts at creating universal standards and approach every affiliate relationship individually with as many cards on the table as possible.

These are the types of items that should be discussed (at the very least):

  • How much of the gross sales price is absorbed in hard costs? Knowing this helps the affiliate and the merchant determine how much money there really is to work with, on both the front and back ends.
  • Is there a possibility for sales beyond the initial purchase? If so, how many purchases will the new customer make over the next 12 months (what I call a more measurable lifetime value)? And what is the dollar value of these 12 months’ worth of future purchases?
  • How much money does the affiliate need to open the door to his customer base on good faith?

Here’s wishing you a great end to 2001 and a hearty welcome to 2002 with the hopes that we all live each day in ever-better health and good fortune.

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