As you build your online business, you may consider implementing an affiliate program. At best, such a program will encourage others (your affiliates) to promote your product or service, directing new leads to your website. The more leads that take action - such as signing up for a service or purchasing a product - on your website, the more benefits for your affiliate, and ultimately for you.
If you plan to implement an affiliate program and find yourself asking what compensation structure would be best for your program, here are some tips that will help you to make an educated decision.
By making a smart decision, you save yourself the later trouble of having gotten it "all wrong." Getting it wrong is a worst case scenario, because changing commission structures will, with absolute certainty, upset a bunch of your best affiliates.
Determining the right compensation structure for your program is only one of many decisions you will have to make as you prepare to launch your affiliate program - including decisions about which network to use or whether to do it in-house, to have it managed by an OPM ("outsourced affiliate program management") or not and other things you must take care of before you get your program off the ground. There are many choices for compensation structures, and some can be combined with others. In this article, I will cover some of the basic considerations in choosing a compensation structure that helps you to achieve your specific goals.
Looking at the commission structure of a competitor is always a good idea, but does not always provide the answer to the question about what the right commission structure is for you.
You must consider things like how your prices compare to the prices of your competitor. A competitor whose products are usually more expensive probably has room for a higher commission due to higher margins. (A 20% markup on a $1,000 watch will, of course, be more than a 20% markup on a $10 toy.)
Be sure to keep in mind that conversion, customer retention, lifetime value and overall satisfaction are usually specific to every website. You don't have that information about your competitor in most cases, even though it would be nice information to have. Higher conversion makes your program more attractive to affiliates than simply paying a higher commission. Why? Higher commission might get you new affiliates quickly, but high bottom line commission paid per referred visitor ensures affiliate loyalty.
What is the goal of your program? Is your goal instant profit with the first sale a new customer makes or customer acquisition? Both, of course, but depending on the competitiveness of your industry, achieving these goals right away will not always be realistic. Different commission structures - depending on the actions performed by the visitor - should always be considered.
You could, for example, categorize your products by margins and pay lower commission for low-margin items and higher commission for high-margin items. You could also pay a flat commission amount (CPA or cost-per-action) for newly acquired customers as a bonus, in addition to or independent from commission on the actual purchase that a referred customer made.
For general merchandise paying a percentage per order subtotal (excluding shipping and tax, etc.) is one way to go, but again, it depends on your overall, long-term goals.
If customer acquisition is the foremost or even only goal of your affiliate program, revenue share or a commission that is a percentage per sale would not be the way to go. CPA, a flat commission for newly acquired customers, would be the better option in this instance. In most cases the CPA should be higher than the commission would be if you were paying a percentage per order amount.
If you don't do that, then you risk losing affiliates to competitor programs. The best approach to coming up with a fair CPA is to determine the average lifetime value of a customer and pay a percentage of that amount as "bounty" to affiliates who send you new customers.
Let's look at an example. You are a retailer and you decide on revenue share (percentage per sale) only and pay a higher or smaller percentage based on the volume the affiliate produces (bonus/performance incentives). If your main goal is actually customer acquisition, you have no real way of reflecting this goal via your commission structure.
For your affiliates, it does not make a difference if the customer who was referred by them is already a customer of yours or not - the commission will be the same.
If you then partner with coupon site affiliates or rewards/incentive affiliates (like Upromise, FatWallet, eBates, etc.), chances are that your goal of customer acquisition will not be reached because you will be attracting people looking for the best deal on a particular product or brand.
In our example, the reason that customer acquisition is an important factor in your case is that you know that you have an unusually high retention rate and customer loyalty is high once a customer has purchased from you. Converting first-time visitors to your site is something that your company has spent a lot of time and money on, and conversion rates are far above the industry average.
Your margins are lower than your competitors, but your prices are lower too. Right off the bat there is no need to advertise a 100% low price guarantee. You have it, but that guarantee is almost never exercised by your customers. Your competitor also has an affiliate program and is also paying commission based on revenue share. He offers a percentage per sale as commission that you are unable to beat.
Your conversion is higher so affiliates might eventually figure out that their bottom line will be better if they promote you instead of your competitor, but getting them to realize that will take a lot of time and effort on your part.
You could offer a flat amount commission for every customer signup for example or - if you want to lower the risk of fraudulent signups by rogue affiliates - pay with the first order by a customer.
This is only one example, but it illustrates the things you should consider to build a successful program.
If you are not sure about a number - or "amount" would be more precise - due to a lack of metrics and stats available and/or lack of knowledge of what your competition is doing, always start with a lower commission first.
The number or amount that you choose depends on the type of commission you plan to pay: flat amounts per "action" (CPA) or revenue share (percentage per transaction).
Revenue share is a form of commission, but not every commission is "revenue share." CPA for example is not revenue share; it's more along the lines of "I pay you $50 for everybody who completes the loan request form." The affiliate gets paid $50 regardless of whether the loan application gets approved or not, so many months down the road. It also does not matter how high the loan amount is. So the affiliate does not care if the person he refers to you is someone who wants to get a loan for a million dollar home or a $250,000 home, because the commission will be the same.
Revenue share, on the other hand is a cut (percentage) of the actual transaction the referred customer completes. This is common in retail.
Because the affiliate is getting a share of the revenue generated by it, is it in the interest of the affiliate to up-sell or cross-sell. The commission earned if the customer buys a $3,000 big screen TV is much higher than if the customer buys a $200 rear projection TV, for example.
You could also pay a flat dollar amount per order in commission. In that case the affiliate would not care what the customer is buying, but simply that the customer is buying something.
If you don't know things like your average margins, then you will have a hard time figuring out the percentage you can pay before you lose money on the sale. This does not mean that you should never go over that percentage, but again that depends on the goals for your affiliate program. If you want to make profit with every sale, regardless of whether affiliate commission is due, you should not pay higher commission that is higher than your margins.
However, if customer acquisition, customer retention or branding are important goals, losing money on a sale might be okay - just be sure to consider numbers like average lifetime of a customer and customer lifetime value. These numbers are especially important for CPA, because you may lose money on some or all transactions that involve an affiliate commission.
In short, the better you know your numbers, the better you will be able to come up with a commission structure that makes the whole thing work for you and for your affiliates.
Affiliates will be happy about an increase in commission. A decrease in commission if you realize that you have been paying too much is always bad and hurts your program and your reputation. Some affiliates will abandon you and maybe even post negative comments about you in industry forums and other communities.
Always leave room to be able to provide high performing affiliates with a bonus or incentive beyond the commission that is available to all affiliates. Special arrangements with performers require special (higher) commission that acts as incentive for the affiliate to do his or her best.
Don't forget to include in your calculation the hidden cost of running an affiliate program. The management (salary), infrastructure (affiliate network fees or in-house IT cost), material (creatives, sales copies, special promotions), accounting (cutting commission checks for affiliates) and other aspects of running an affiliate program all cost money - additional money that you would not have to spend if you did not have the affiliate program.
I hope that this will help you to determine the commission structure that is right for your program's long-term success and growth.
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©2006-2007 Carsten Cumbrowski
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