Affiliate Programs: Glue for Distribution Networks

Fastwater Rapids vol. 1.4, 20Sep98

Traditionally, distribution chains have been linear: a line stretching from the vendor through resellers and distributors to the end customer. Value, in the form of products or services, moves along this chain from vendor to end customer. Revenue moves the other way eventually reaching from the customer to the vendor . As the internet impacts all aspects of business, it is inevitably affecting distribution chains too. We are starting to see these chains take on more of a network character -- rather than being simple linear chains, distribution now takes place through a complicated network of relationships between a vendor, its partners, and the customers.

A recent development in these distribution networks is affiliate programs. These programs, also called associate programs and revenue sharing programs, offer a website payments for referring users to a vendor. The affiliate website embeds a link to the vendor in the content of the website. Often, the links are integrated with the surrounding content, instead of standing out the way a banner ad does. When a visitor follows the link to the vendor site and then registers or purchases a product, the affiliate site receives a payment. An early example is the associate program started by internet high-flyer Amazon.com in 1996. Site operators who join Amazon.com's associate program place links directly to the order pages on Amazon.com for books that may be of interest to the site's visitors. If visitors follow the link and place an order for the book, Amazon.com shares up to 15% of the purchase price with the site operator. Recently, Amazon.com announced that it had signed up its 100,000^th affiliate site.

Since Amazon.com's initial efforts, many other players have begun such programs. Included among these are toy sales (FAO Schwartz), computer hardware and software sales (Cyberian Outpost and BuyDirect.com), consumer loyalty programs (MyPoints), and food (Omaha Steak and The Lobster Net).

This week's issue of Rapids describes these programs, looks into what is and what isn't working, and asks how these programs are different from traditional activities such as advertising and using reseller networks.

Who's using affiliate programs?

James Marciano was building a community website for alumni of Ivy League schools. He decided to look into affiliate programs as a way to fund the website, paying for ISP bills and other expenses. Connecting with vendors that offered affiliate programs was hard. And once he found a vendor, it was difficult to evaluate the vendor and to understand the myriad of program options. Sensing an opportunity, Marciano began Refer-It: a clearinghouse for vendors and site operators looking to form affiliate relationships.

Refer-It currently lists approximately 450 affiliate opportunities and provides descriptions and ratings for each vendor. The ratings include a description of the program, the payment levels, and pointers to affiliates of the vendor. Refer-It has 650 registered site owners, and Marciano estimates has played a part in establishing over 10000 affiliate relationships.

Heidi Messer, President of LinkShare describes starting the company with her brother Steve as an attempt to bring all the kinds of business relationships available in the offline world to the online world. Looking at the offline franchise model, LinkShare decided to focus on affiliate relationships. LinkShare provides tools and software for implementing these relationships and uses its website to provide a meeting place for vendors and site operators.

The LinkShare site allows vendors to post "offers" detailing the type of affiliate program they support. Site operators can then peruse these offers and decide to enter into a relationship with a vendor. Site operators can also conduct private negotiations with vendors -- this is often the case when the relationship is bigger and more complicated. Once the terms are worked out, LinkShare handles all the tracking and reporting functions, delivering regular reports to the site operators and vendors covering numbers of visits, purchases etc.

LinkShare currently has over 15,000 site operators signed up who have entered into affiliate programs and over 100 vendors offering programs. Many site operators sign up with multiple vendors. For example, a community site may have ongoing relationships with Cyberian Outpost or BuyDirect to offer computer products to its members. In addition, during the holiday season, the site might sign up with FAO Schwartz to offer specials on toys for children. Or for father's day, the site might refer members to Brookstone for gift purchases.

PCWorld Online runs a variety of electronic publications and forums. Among these are the online version of PCWorld, TipWorld, Games.net. Together, these draw a audience of great interest to vendors: college educated, well paid techies -- exactly the sort of people who are already willing to buy online. And the audience is large: Kimberly Lyons, Manager of E-Commerce for PCWorld Online, reports that TipWorld has 750k unique subscribers. To put this in perspective, Lyons points out that if these were daily newspapers, PCWorld Online would be ranked number 5 in overall circulation in the US.

The PCWorld online publications share a shopping zone populated with a set of vendors with which PCWorld Online has established affiliate relationships. Along with the expected computer hardware and software, visitors can find steaks, flowers, travel, and sunglasses. The vendors that do well in the shopping zone, Lyons explained, offer impulse buys that fit PCWorld Online audience. For example, compact discs and books do well. As do flowers. But health and beauty products don't do well with the high tech crowd.

PCWorld set up and manages many of the relationships itself. Recently, it started working with LinkShare to find affiliate partners and manage the affiliate relationship. Currently, Lyons prefers to work with vendors in ways that are closer to traditional advertising relationships. She does work with vendors on a revenue-sharing basis, but prefers to get 6 month fixed fee payments for giving the vendors access to the PCWorld Online readership. At this point, the barriers to successful revenue sharing are large enough that a more traditional model is easier for PCWorld Online to manage. In any case, Lyons reports that these relationships are a significant source of revenue for PCWorld Online.

MotivationNet provides a variety of internet marketing and relationship building services, including an online loyalty program called MyPoints. Similar to other loyalty programs, MyPoints allows web users to accumulate points and then exchange those for products or services from participating vendors. Currently, MotivationNet has signed up over 50 "redemption partners" including Barnes and Noble, Disney, and Sony. Jeff Montgomery, Director of Marketing for MotivationNet, explained that the current challenge facing MotivationNet is signing up more members -- users who interact with the redemption partners and obtain loyalty points.

In order to find these members, MotivationNet has begun an affiliate program. Initially, they managed their own program, but recently signed up with LinkShare in an effort to increase the rate of member acquisition. In the first month after partnering with LinkShare, MotivationNet signed up an additional 2000 new affiliate sites and had 50,000 new visitors at the MyPoints site.

The rate at which visitors actually become MyPoints members varies depending on the nature of the referring affiliate site -- predictably, sites focusing on shopping or online coupons deliver visitors with high sign-up rates. To increase the rates, MotivationNet keeps the member sign-up easy and lightweight and provides bonus points at sign-up time. Since MotivationNet doesn't directly sell a product, a revenue sharing model isn't appropriate. Instead, MotivationNet makes payments to affiliate sites based on the number of visitors who do sign up.

How the programs work

As you can see from the examples above, there is a wide variety in the activities falling under the rubric of affiliate programs. These cover a range roughly corresponding to traditional advertising through reseller networks. Different programs are appropriate for different kinds of products and business goals on the parts of the vendors -- we look into this below. At the same time, we ask if these affiliate programs are actually different from their traditional counterparts, and if different, how?

The main way to distinguish the programs is based on their payment programs: what does a visitor have to do in order for the affiliate site to get a payment? Among the payment options are:

Impressions and Click-throughs: Similar to traditional advertising, these programs pay affiliates when a visitor is presented a banner ad or other content about the vendor, or actually follows a link to the vendor site.
Lead Generation: These programs focus on the next step after a visitor clicks through to a site. They pay when that visitor registers or signs up with the vendor.
Revenue Sharing: These programs tie payment to an actual purchase and usually involve sharing a percentage of the purchase price with the affiliate site that referred the customer.

Impressions and Click-throughs

Affiliate programs aimed at consumer impressions or visitor click-throughs parallel traditional advertising programs and share their benefits and drawbacks. At this time, the primary differences between such affiliate programs and traditional advertising campaigns involves the size of the affiliate sites and the integration of the referring link with the site's content. Most small web sites would never attract advertising dollars, but they may be able to use one of the affiliate networks such as LinkShare or Refer-It to attract affiliate-based advertising.

And as opposed to a typical banner ad, the referral links are often integrated with the site content. Jeff Montgomery of MotivationNet emphasized the importance of this integration. While MotivationNet does provide banner ad content for sites to use, they have seen poor results from sites that simply run banner ads. User just don't respond to these ads, resulting in click through rates of only one or two percent. Montgomery says he believes users have become desensitized to the ads. Instead, he sees much better results if the site incorporates a reference to MotivationNet's MyPoints program directly in the site content.

Payments for impressions are typically done by CPM, or per each thousand impressions. Just as with any website banner ads, accurately calculating impressions is difficult and error prone. Click-through payments typically range from 25 cents to one dollar. As a vendor, you need to look at these payment rates and incorporate them into your calculations about cost of customer acquisition. For example, Marciano of Refer-It told us that between 10 and 20% of users who click-through from his site to a vendor offering an affiliate program then sign up for the program. This means that, given a 25 cent payment to Refer-It for such a click-through, this program is contributing between $1.25 and $2.50 to the vendor's cost of acquiring a new affiliate site.

Lead Generation

Impressions and click-throughs are primarily for branding. Any actual sale happens as the result of follow-on activities. The first step is those activities is finding prospects. Once a visitor clicks through to a site, if the vendor can convince the visitor to register or provide other personal information, then that visitor has become a prospect. Some affiliate programs focus on producing such prospects, by paying when a user registers. MotivationNet's program is an example of this: affiliates are paid whenever a referred user registers and becomes a MyPoints member.

Building an affiliate program around lead generation allows the vendor and site operator to each focus on different and coordinated goals. The site can direct users to vendors of potential interest and thereby offer new value to those users. At the same time, the site can remain editorially independent of the vendors, not confusing its content with sales activities. Once a visitor arrives at the vendor site and registers, the vendor can now focus on those sales activities. The site has delivered a qualified lead and now the burden is on the vendor to do the actual selling.

Revenue Sharing

Revenue sharing ties the affiliate program to actual sales: affiliates typically get a percentage of the purchase price when a referred makes a purchase. This is straightforward for vendors: affiliates are only paid when the vendor also gets revenue, and the vendor knows that the affiliate's motivations align with the vendor's own.

This works well when the product is an impulse buy or a low-consideration product. Even with a low-consideration product, difficulties can arise if the purchase involves the visitor making multiple visits to the vendor site. In these cases, an affiliate site can deliver a legitimate prospect who does eventually make a purchase without the affiliate getting credit for that purchase. LinkShare provides a partial answer to this problem by tracking visitors who make a purchase within a specified time period. For example, if an affiliate refers a visitor who then returns within the week and finalizes the purchase, the affiliate still receives credit.

In a revenue sharing model, the affiliate is essentially acting as a reseller for the vendor. However, as opposed to a traditional reseller relationship, the affiliate doesn't process the actual transaction -- that happens at the vendor site. And an affiliate might offer a much broader range of products than a traditional reseller. How many resellers offer computer equipment, lobsters, and flowers?

Barriers

Traditional distribution chains face a set of barriers around physical distribution of the product and information flow along the chain. Building a distribution network using affiliate programs runs into a somewhat different set of barriers. Among these are:

Mismatches. One possible mismatch is between the product and the affiliate program payment model. For example, an affiliate program attempting to sell a high-consideration product such as a car and using a revenue sharing model is likely to fail. Another possible mismatch is between the motivations of the vendor and site operator. Consider a revenue sharing program such as Amazon.com's associate program. Amazon.com is interested in acquiring new customers and is willing to pay a percentage of first purchase as a bounty to a site that refers a new customer. However, after that first sale, Amazon would prefer not to pay that bounty and wants the customer to come direct to Amazon rather than going through the original site. At the same time, the site is looking to ongoing payments as a revenue stream. A program based on lead generation fees might address some of the discomfort caused by this mismatch in motivations.
Trust. An affiliate has to rely on the vendor for accurate reporting of purchases, registrations, etc. And even with automated reporting of purchases, there may still be room for disagreement. Lyons of PCWorld Online told us of sites that revise purchase numbers saying that some of the customers gave invalid credit cards and this was discovered only after the fact. While certainly plausible, if this happens very often, it can put strain on the relationship between the affiliate site and the vendor. Lyons identified the emergence of objective third parties such as LinkShare as an important way to address trust issues.
Program Overhead. Setting up and managing an affiliate program can involve significant expense and effort for both the vendor and the affiliate. On the vendor's side, it is now necessary to track which site referred each visitor and the subsequent activities of that visitor. And regular reports and payments must be delivered to the affiliates. For the affiliate, dealing with one vendor isn't too hard. But, in general, each vendor will generate different reports and offer different payment schemes. Since affiliate sites will often chose to deal with multiple vendors, the overhead of managing these relationships can become substantial. The emergence of third parties such as LinkShare that outsource this management overhead and provide a unified view to both vendors and affiliates helps address this barrier.
Appropriateness for Audience. An affiliate site needs to be careful that it is presenting products and vendors that are appropriate for its audience. This is especially important since affiliate references are often embedded directly in site content and don't appear to be advertising -- the choice of referrals thus reflects strongly on the site itself. Inappropriate referrals are sometimes obvious: for example, health and beauty products are unlikely to do well on a model railroad hobby website. Others are less obvious. Omaha Steak has been a successful vendor using affiliate programs. However, Lyons found that the PCWorld Online audience doesn't buy steaks online. However, this audience does buy lobsters when referred to LobsterNet.

Opportunities

Affiliate programs offer different opportunities to each of the players in the value network. For vendors, the obvious opportunity is to open new distribution channels and thus increase sales. Other less obvious opportunities involve making use of the online nature of the network. For example, a vendor could easily offer specials driven by real time inventory, adjusting the onsale item to reflect current inventories. This would be much more difficult using offline technologies. And, vendors can tailor their offers to the audience without having to learn about individual visitors. By knowing which affiliate referred a visitor, the vendor can already understand something about the visitors interests and preferences. As a simple example of this, both The Sharper Image and Preview Travel offer customized entry pages to visitors referred from the PCWorld Online site.

Affiliate programs offer site operators several opportunities. In addition to a new revenue stream from vendors interested in the visitors to the site, the operator can also offer new value to its visitors. This will be particularly important for community and specialized portal sites. These sites provide access to a pre-selected audience with common interests.

And since these programs do present a new set of difficulties and barriers, there is opportunity for players such as LinkShare and Refer-It. These organizations serve as market makers: making it possible for the affiliate relationships to be built. They provide places where vendors and potential affiliates can meet. Then given that market, the market maker can make money from all the players by providing products and services that make it easier to participate in the market. This opportunity is somewhat similar to the opportunity for site operators. The market maker builds a collection of vendors and makes them available to potential affiliates. The market maker also builds a collection of potential affiliates and makes those available to the vendors. The trick for the market maker is to provide real value to both sets of audiences and figure out how appropriate ways to receive revenue from those audiences.

These opportunities still face significant barriers. Program overhead, mismatches of motivation and incentive between vendors and affiliates, and trust issues pose real problems. As we saw in the case of PCWorld Online, these barriers can drive relationships towards more traditional models. For smaller organizations, however, these traditional models don't apply.

The emergence of market makers such as LinkShare and Refer-It is thus an important event. If these groups can sufficiently lower these barriers, then we will see an increased role for affiliate programs. As we watch the market develop, we'll be looking in particular for emerging trends in payment models and in the ways affiliate programs are used by community and niche portal sites. As we uncover these trends, we will continue to report on them to you.