- Affiliate marketing is a process where one company promotes another company's product and earns a commission for sales made.
- Affiliate programs can be a great way to earn profits, but to do this effectively, you need to do some calculations.
- Conversion rates, profit margins, and overhead costs should be considered before starting an affiliate marketing program.
- Use our Affiliate Marketing Calculator (make a copy) to calculate your affiliate profitability.
Affiliate marketing programs are a great way to drive sales and generate online revenue.
By promoting products you already love, you can earn commission and improve your profitability in a simple and effective way.
According to Forrester, affiliate marketing spend shows an annual growth rate of 10% with around 81% of publishers using these programs.
Of participating affiliates, 35% make at least $20,000 annually from their affiliate programs.
While affiliate marketing is a powerful channel, there are some important business calculations to be considered before jumping in.
Below, we’ll show you how to calculate profits, conversion rates, and overhead costs to set your affiliate marketing program up for success.
What is affiliate marketing?
Affiliate marketing is a process in which one company earns a commission for marketing another company’s products or services.
Affiliate programs are a great way to promote a product you enjoy while also getting paid for it. For example, if you love a certain desktop software and constantly recommend it to your clients, it may be worth setting up an affiliate partnership so that those recommendations result in a commission.
For the affiliate, they benefit from widespread, cost-effective marketing. On the seller’s side, they get to benefit from recommending a product they already love.
How to use affiliate marketing successfully
Creating a successful affiliate marketing strategy means that you are driving profits for your affiliate and for your company.
To do this effectively, you need to understand the basic math that goes into calculating these profits.
Here are some of the questions that you might have:
- How many affiliates do I need?
- When do we start making money?
To answer these questions, we can employ some simple math. There are a few things to consider
- Conversion Rates
- Profit Margins
- Overhead Costs
Let’s take a look conceptually at how an affiliate marketing channel works for an eCommerce scenario.
Affiliates generate impressions through promotional content (posts, blogs, videos) which generates awareness and leads to your website.
Those leads are driven to your website and become prospects. A certain percentage of those prospects make a purchase and convert to sales.
Impressions----Conversion Rate #1---> Leads ----Conversion Rate #2---> Prospects ----Conversion Rate #3---> Sales
At each of the above steps, there is a conversion rate. A common mistake that marketers make when assessing the viability of an affiliate marketing model is to underestimate the number of impressions required to generate a sale. Using a generous conversion rate of 10% for each step above implies that you need 1000 impressions in order to generate a sale. (1000 impressions -> 100 leads -> 10 prospects -> 1 sale)
*Note: This is where it is important to understand your conversion funnel. The more steps in your funnel, the more opportunities for a sale to drop off and the more conversion rates you need to account for in your model.
It is also important to understand the type of affiliates you are working with to understand their reach. Say each affiliate generates 100 impressions per month, then you now need 10 affiliates to generate enough impressions for one sale.
Profit margins refer to the leftover after deducting all variable costs from your sale. Assuming you already know the profit margin on a direct sale, you now need to consider the added cost of paying your affiliates.
Depending on your chosen compensation method (pay per impression, pay per click/lead, pay per sale) the profit margin of each sale can drastically decrease.
You now need to consider the average value of a sale and the compensation (Fixed? Percentage based?) per sale. For our example, let’s use the following assumptions:
- Average sale value is $100
- Profit margin is 30% (after materials, processing fees, etc.) OR $30
- Affiliates are compensated 10% of the sale value
Your affiliate profit margin is now 20% or $20.
Ok, so now we know that we need:
- 10 affiliates to generate 1000 impressions which create 100 leads which lead to 10 prospects that convert to 1 sale brings us $20 in profit
Now let’s consider our overhead costs to implement an affiliate marketing strategy.
Staffing Costs: Who is running our affiliate program? Are we paying a contractor? Bringing in a salaried employee? Either way, this is a new expense that we need to consider in order to execute our affiliate marketing strategy.
Collateral Creation: Are we creating media/assets etc. to provide to our affiliates? This comes at a cost that must also be factored in.
Software: How are we managing or paying the affiliates? Affiliate management software exists, however, you guessed it… it comes at a cost! Additionally, are we incurring a cost per transaction in order to pay out the affiliates?
Affiliate Acquisition Costs: This is a fun one, in order to attract affiliates, we need to promote our affiliate program. We will need things like an affiliate landing page on our website and advertising/promotional costs to get those affiliates. Yes, this is yet another place we need to consider conversion rates and ROI/ ROAS. Add this one to the budget!
All in, we have determined that it will cost us $120, 000 in yearly overhead to initialize, support, and execute our affiliate program. To breakeven:
- We need to generate $120, 000 in profit from affiliate sales.
- At $20 profit per sale, we need 6000 sales per year OR 500 per month
- To get 500 sales per month we will need 500, 000 impressions (see above)
- We need to attract 5000 affiliates in order to cover our overhead costs
Seems simple enough? Well we aren’t quite done yet, here are some additional considerations:
- Based on the total addressable market, are the volumes of impressions and affiliates feasible?
- How long will it take us to ramp up to our breakeven level of affiliates?
- What is the repayment period to compensate for the losses over the months (years?) leading up to the breakeven level?
Ready to get started with affiliate marketing?
To reiterate, an affiliate marketing strategy can be an effective way of generating sales. However, if you don’t take the time to consider the numbers, you can be setting your business up for failure or a very expensive lesson.
Interested in starting an affiliate marketing program of your own? Our team would love to help you get your project started. Reach out to us.
Don’t forget to make a copy of our Affiliate Marketing Calculator before starting your program.