Affiliate Marketing in 2009 is primarily pay-per-sale (PPS), so it can be argued that this should be part of a merchant`s sales budget, and therefore uncapped since it is performance based.

However, there is an alternative view that affiliate marketing essentially involves advertising on hundreds or even thousands of different websites, with a combination of performance-based and set-fees, and should therefore be part of the marketing budget, which in most cases is capped. The question here is which view is right?

A win-win
The structure of much of today’s affiliate marketing sector makes it a win-win for all parties. The merchant gains enhanced exposure though a highly competent sales channel. On a PPS basis this is with minimal financial risk other than any network or affiliate programme set-up and management costs. Equally, the affiliate gains access to high quality goods and services, often from recognised and respected brands, without the risks or complexity of carrying inventory, fulfilment and long term product or service strategic planning.

Even in pay-per-click scenarios, the depth of the available data and the sophistication of today’s analytical tools ensure that a merchant can gain raid and in-depth insight into the performance of all elements of such a channel and can adjust the channel mixture accordingly, pretty much in real time, thus limiting any exposure and closely controlling profitability.

Value chain and capital exposure
Exploring this question requires an understanding of the value chain. Simplistically, the merchant is the one making the sale and gross profit margin and is therefore the determinant as to the available margin when accounting for cost of sale. The timing of commission payments from the merchant to the network and from the network to the affiliate (or indeed directly to the affiliate if a direct programme) is then a major determinant in identifying operating capital requirements. In the vast majority of cases, the timings are designed to minimise financial exposure for the merchant — and necessarily so, particularly in the current climate of economic instability.

We must, however, factor in the exposure for any potential commission reversals. Given the Distance Selling Directive and ever growing consumer awareness as to the right of return, this can be a significant factor, particularly in some high touch sectors where return rates are at their highest. In the worst case scenario, a merchant may be exposed to ‘bridging’ the commission costs of reversed sales pending their replacement with fresh sales through the channel concerned. All of these arguments could reasonably be used in suggesting that the affiliate channel must fall within a capped marketing cost, albeit perhaps a rolling framework accounted over a given period as opposed to a fixed annual budget.

Unconstrained potential
In the majority of cases, the merchant is happy to get as many orders or referrals possible, so it seems reasonable not to impose a limit as to the value of commission the affiliate can potentially earn. Recognition must also be given to the fact that the income generated by the affiliate is almost never cost free. In fact, the more effort the affiliate puts into attracting customers, the more likely it is that serious skill, search-engine optimisation and potentially even paid advertising has been added into the mix.

On a pure play performance basis, it is the affiliate that is taking the capital risk here. Clearly this risk must be acknowledged and supported by the merchants in question. In the absence of financial support, imposing artificial constraints as to potential earnings may see the more professional (and effective) affiliates looking for alternative merchants.

Marketing or sales cost?
The thrust of the argument here is that both the merchant and the affiliate each have a significant part to play in the value chain. To expect only one or the other to carry the full responsibility and / or the financial cost and risk would be unrealistic. Whilst we are not privy to the internal accounting mechanisms of individual merchants, it is reasonable to assume that the truth, as always, lies somewhere in between the two. For merchants in sectors with a high returns rate exposure, there will be carefully managed financial controls to protect trading capital and to ensure stability. These may take the form of periodically controlled marketing spend caps.

Similarly neither party wants to artificially constrain sales volumes, any such limits will be adjusted in real time in accordance with the profitability identified in the affiliate channel. Since affiliate commissions are sales volume-driven and are quantifiable only per sale, it is reasonable for the merchant to account these within the cost of sale itself.

The fixed costs of affiliate channel management must also be accommodated, including programme set-up costs, marketing and communication, the use of specialist AM firms and monthly fees from the networks. In all likelihood, these will be accounted within the annual marketing budget as they are quantifiable and predictable.

In the same way that the merchant recognises the value of products being professionally promoted on highly ranked and professionally managed affiliate sites, the affiliate recognises the value the merchant brings in their brand, products or services and the time, effort and expense incurred to develop them. In science, this is referred to as a symbiotic relationship where each animal depends upon the other. As with the Shark and the Remora no one gets eaten if both work collaboratively!

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