How do affiliate programs really work online?

What a great question! There are indeed many different ways that you can make money from a Web site, ranging from how your local newspaper sells classified advertising to how Amazon.com sells books, but I’ll start right out by saying that in my opinion, at least, the most important element of any successful online business is to start out by making a commitment to being ethical.
That means that tactics like ripping people off with deceptive photos, fake testimonials, false endorsements, bait and switch and unsolicited email offers are all bad and should be avoided like the proverbial plague.
Now that we agree on ethical business practices, let’s talk about affiliate programs. (see, you didn’t think we’d inject philosophy into this, did you?)
When a vendor sells a product, there are number of factors that go into whether the sale is profitable or not. There’s the sale price (the “income”), the cost of goods (the “cost”) and the transaction costs (exemplified by the transaction fee charged by credit card companies, but let’s add shipping and handling here too).
Let’s suppose you have a custom candle business and sell your candles for $25 each. The candle actually costs you $6 to make, but then there are all the additional fixed costs: the jar it’s in is $3, the label is $1, the box is $2, the packing material is another $1 and shipping is $4. Each time you sell one you have to pay an additional $1 to the credit card company. Add that all up and your candle costs $16 to ship. Your profit is $7 per candle.
That’s not bad, actually, for a commodity item like a candle. The difference between your selling price and your total transactional and fixed costs is called your profit margin (in this case 28%) and that’s exactly where an affiliate program springs from.
If you wanted to sell more candles, would it be good business to decide that you would pay a middleman $2 for each candle sold if they stocked it in their store? Of course it would. If you could double your sales, you’d be doing great. What if you told the middleman that you’d pay them 50% of your profits (in other words, $3.50/sale), is that still a good deal? Yes. Every two candles they sell garner you that same $7 profit.
In Internet marketing terms, the middleman, the store merchant, is an affiliate of yours, and the money you pay on a per-transaction basis is their affiliate commission.
We do need to slightly recast this when it’s an affiliate relationship, however, because, for example, their percentage of the transaction wouldn’t be based on your profit (which generally isn’t something they’d know) but on the selling price of the product. So if you offered a $3.50 commission payment for each candle sold, that would be referred to as a 14% commission rate, which is quite high.
Mechanically, affiliate programs work where you give the affiliate a special code to use that uniquely identifies them in the program. Your product shows up on their site and then when someone clicks on it to buy it, they’re directed to your Web site with that code in place to help you track the sale. At the end of each month, typically, you tally up the sales by affiliate and pay out their commission.
One of the most popular affiliate programs is Amazon.com, actually, and it not only accounts for a significant percentage of their overall sales, but it’s also quite easy to work with too. The logic is simple: if you’re going to write about a book, a movie or a mountain bike, say, why not have a link to that very product at Amazon and hopefully make a few bucks if someone who read what you wrote decides to buy it?
You can learn more about Amazon’s affiliate program at amazon.com/associates and if you want to set up your own, two great places to investigate further are Commission Junction (cj.com) and Colorado-based CPA Empire (cpaempire.com).
Good luck with your affiliate efforts!