Run paid ads and scale lead flow 12 of 23 in this group
SOP 47
Price affiliate commission off acquisition cost
What this page is for. Use it to set what you pay an affiliate, and to check afterwards whether the affiliate channel is earning its keep. The commission is not a number you pick; it is a share of the most you could afford to pay for a customer anyway. This page gives that derivation, the three-tier structure built on it, payment in product, and the returns calculation.
SOP-47-Price-affiliate-commission-off-acquisition-cost.md
A note on wording. The title names the cost of acquiring a customer; the body says the cost to win a customer throughout. They are the same thing.
1. Why the channel is worth paying for at all
An affiliate is one of the most powerful ways to have other people get leads for you, and also the most complex: an independent business that tells its own audience to buy your stuff. On the surface that resembles a referral; underneath it is a business-to-business agreement between two owners, made so both of them gain.
The leverage argument. Selling to a thousand businesses takes the same size of team as selling to a thousand consumers, and the thousand businesses then sell on your behalf. That is the whole trade.
The compounding argument, with the figures offered. Suppose you sign ten affiliates a month and an affiliate is worth ten thousand dollars.
| Month | Selling to ten affiliates a month | Selling to ten customers a month |
|---|---|---|
| 1 | $100,000 | $100,000 |
| 2 | $200,000 | $100,000 |
| 3 | $300,000 | $100,000 |
| 4 | $400,000 | $100,000 |
| 5 | $500,000 | $100,000 |
A context note on that table. The same ten-thousand-dollar figure is used on both sides but treated differently — as income arriving every month thereafter on the affiliate side, and as income arriving once on the customer side. That difference is what makes one column climb and the other flat; it is not stated as an assumption where the comparison is made.
The picture behind it is of each affiliate as a node that throws off new customers every month, so that adding affiliates adds nodes rather than adding sales.
2. Deriving the ceiling
Before you set a commission you need the most you can afford to pay for a customer.
- Take the ratio of lifetime profit to cost that you run the business against. Three to one is the ratio used here.
- Take your gross profit.
- A third of the gross profit is the maximum you are willing to pay to keep the economics working.
That third is the ceiling. Every tier below is a share of it, which is why no tier on this page is expressed as a share of the sale. A second reading, which does pay a share of the sale, is flagged at the end of this section.
The worked ceiling, and the check on it. The example uses a maximum of forty dollars on a hundred-dollar sale, and it is introduced as round numbers for easy arithmetic. Read against the rule above, a forty-dollar ceiling implies a gross profit of a hundred and twenty dollars — more than the sale price itself. So the forty is a stipulated figure for the worked example and not one derived from the third rule. Derive your own from your own gross profit.
Flag: a third of gross profit, or a quarter. A second reading applies the same three to one as a split of gross profit: three parts stay with the business and one part goes to the affiliate, so the most you pay is a quarter of gross profit, not a third. In an invented case with $240 of gross profit, a quarter is $60, against $80 for a third. This page does not settle which reading is right.
A second reading, for a services partner. A second view sets the share another way when what you sell is a service. A partner from online or digital work often assumes every margin is 100 percent; a service carries hard costs. So the offer is framed as an even split of the profit, then paid as a flat share of each sale, off the top, so that nobody has to audit your accounts every month. In the example, margins are taken as 30 percent; half of that is 15, so the partner gets 15 percent of the sale and you run everything else. The reason given is that otherwise you could give away too much margin. There, the share is half of an assumed margin, paid on the sale; on this page it is a share of the most you can pay to win a customer, and never a share of the sale. This page does not settle which reading is right.
3. The three tiers
The structure is three tiers, and the reason given for three is that everybody understands three. Its origin: a specialist consultant brought in to review an affiliate program, one of whose points was that the number of tiers should be three rather than two or five.
| Tier | Share of the ceiling | Payout on these figures | Who is on it |
|---|---|---|---|
| 1 | 25 percent | $10 | Everybody who signs up |
| 2 | 50 percent | $20 | Anybody who has activated |
| 3 | 100 percent | $40 | Anybody sustaining a level of performance |
The arithmetic holds at every tier: a quarter of forty is ten, half of forty is twenty, and all of forty is forty.
What each tier is for. Tier one is small and universal — it costs you a quarter of the ceiling to have somebody signed up. Tier two is the one that moves behavior, because it is earned by doing things the affiliate controls completely. Tier three is where you are paying out everything you can afford, and you are paying it only while the performance lasts. What triggers tiers two and three is SOP 48.
The average payout sits below the ceiling. Not every affiliate reaches tier three, so what you pay across all of them averages out under the most you could afford. Keep the full payout for the top producers and the difference is yours: it can pay for contests or for ads that bring in new affiliates, or be kept. In an invented mix, with half of sales through the top tier and a quarter through each of the other two, the average payout on the figures above is $27.50 against a $40 ceiling, and the ratio the channel returns rises above the three to one the ceiling was set for.
The top of tier three is yours to set. The level of sales that counts as a high producer may depend on the business: for some people it might be five hundred dollars a month while for another it might be fifty thousand. It depends on the business. There is no general figure. This page gives no figure for the sales level that should define your top tier.
4. Paying in product instead of money
If possible, pay in product. Product has a higher perceived value to them and a lower cost to you, and the gap between those two is the whole point.
| What it costs you | What they value it at | |
|---|---|---|
| Two hundred dollars of product | Might be forty or sixty dollars | Two hundred dollars |
| A hundred-dollar service delivered in-house | Around thirty dollars of hard cost | A hundred dollars |
They value it at retail because retail is the only other way they could get it. The condition that makes this work: it works best if they are consuming what you sell. People value free product often above what it would cost them to buy it.
Where it stops working. Set sales tiers and reward the lower ones with product or credit against retail — the lowest tier may qualify only for free goods, and a session is often worth more to them than a thirty-dollar check. As they send more customers they will usually want money instead, because at real volume the product reward stops being redeemable. A hundred sessions a month is not a reward anybody can take.
One figure in the service comparison is not established — a hard cost of thirty, a figure of seventy, and a retail price of a hundred are given together without saying how they relate. Thirty against a hundred is the pair the surrounding argument uses, and it is the pair carried here. The meaning of the middle figure: not established on this page. This page does not settle which reading is right.
5. Calculating the return on the channel
Compare what it costs you to get an affiliate against the gross profit of every customer they send you over the whole time they stay an affiliate.
| Line | Figure |
|---|---|
| Cost to get one affiliate | $4,000 |
| What an affiliate sells per month | $10,000 |
| How long an affiliate stays | 12 months |
| Total sales | $120,000 |
| Gross margin | 75 percent — goods cost 25 percent of retail |
| Cost of goods | $30,000 |
| Gross profit | $90,000 |
| Paid to the affiliate, at 40 percent of gross profit | $36,000 |
| Left to you | $54,000 |
| Ratio of that to the cost of getting the affiliate | Stated as 12.5 to 1 |
The ratio stated does not match the figures above it. Fifty-four thousand divided by four thousand is thirteen and a half. Twelve and a half to one would require either fifty thousand left over or a cost of four thousand three hundred and twenty. Every other line in the table checks out — a hundred and twenty thousand at twenty-five percent is thirty thousand; a hundred and twenty minus thirty is ninety; forty percent of ninety is thirty-six; ninety minus thirty-six is fifty-four. This page carries thirteen and a half to one, because it is what the lines above it produce. This page does not settle which reading is right. Taking 12.5 understates the channel by one point of ratio; taking 13.5 means the stated ratio is simply wrong.
The example is deliberately large, and scales down. The affiliate in it is an expensive one. Move the decimal point — forty dollars to get one, a hundred dollars a month of sales — and the structure is unchanged.
Note what the forty percent is a share of. It is forty percent of gross profit, not of sales. On these figures that is thirty-six thousand dollars against a hundred and twenty thousand of sales, which is thirty percent of the top line.
6. When the ratio is too low
The floor is three to one. Below it, three moves are given, in this order:
| # | The move | What it changes |
|---|---|---|
| 1 | Lower the cost of getting an affiliate | Better advertising, better offers, a better sales process |
| 2 | Get more of them to activate | Raises the lifetime profit and lowers cost at the same time |
| 3 | Improve the integration | Raises the lifetime profit on its own |
The second is the one singled out, because it is the only one that moves both sides of the ratio at once, and it is usually where the attention goes on an affiliate business. In practice that is usually done by adding a launch process and an activation process, and by adding the tiers in §3 so that becoming active is worth something.
The third works by making each affiliate worth more for longer, and it is done by picking one of the three integration models — they give your lead magnet away, they sell your lead magnet, or they sell your offer directly. Those are SOP 50.
7. What this page does not decide for you
These are gaps in the procedure, not omissions from this page.
- What ratio of lifetime profit to cost your business should run. Three to one is used here as both the derivation input and the floor; no method for setting your own is given.
- Why the tier shares are 25, 50 and 100 percent. The shares are stated; nothing says why those and not others.
- What sales level should define the top tier. See §3.
- What percentage of gross profit to pay out. Forty percent is the figure in the worked return; it is not connected to the tier shares, and no rule reconciles the two. The second reading in §2 pays half of an assumed margin, which no rule reconciles with either, and the flag beside the worked ceiling caps the payout at a quarter of gross profit.
- How long an affiliate should be expected to stay. Twelve months is the worked figure, and it is an average inside one example.
- How to price the product you pay in — at cost, at retail, or somewhere between.
8. The checklist
| Question | The answer |
|---|---|
| Who runs this | You, or whoever owns the affiliate program |
| What a commission is a share of | The most you can afford to pay for a customer |
| A second reading, for services | An even split of an assumed margin, paid as a flat share of the sale; flagged in §2 |
| How you find that ceiling | A third of gross profit, at a three-to-one ratio; a second reading takes a quarter (flagged in §2) |
| The worked ceiling | $40 on a $100 sale, stipulated for easy arithmetic |
| Number of tiers | Three |
| Tier one | 25 percent of the ceiling — $10 |
| Tier two | 50 percent of the ceiling — $20 |
| Tier three | 100 percent of the ceiling — $40 |
| The average payout | Under the ceiling, since tier three holds only some of the affiliates |
| When to pay in product | Wherever you can, if they use what you sell |
| Why product | Higher perceived value to them, lower cost to you |
| When product stops working | At volume, when they cannot redeem it |
| What you compare to calculate return | Cost to get an affiliate against the gross profit of everyone they send, over their lifetime |
| Worked cost to get an affiliate | $4,000 |
| Worked gross profit from one affiliate | $90,000 |
| Worked payout at 40 percent | $36,000 |
| Worked ratio | Stated 12.5:1; the figures give 13.5:1 — this page carries 13.5:1 |
| The floor ratio | Three to one |
| The three ways to improve it | Lower the cost; raise activation; improve the integration |
| Which of the three moves both sides | Raising activation |
| The right payout percentage | Not established on this page |
| The sales level defining a top tier | This page gives no figure for it |
9. What this page does not cover
What an affiliate has to do to reach tier two and tier three is SOP 48, along with who to recruit and what to offer them. The launch that gets a new affiliate selling is SOP 49. The three long-run integration models, which are how you raise the third term in §6, are SOP 50, and the lead magnet you hand them under the first of those models is SOP 51. Costing a lead against payroll, which uses the same shape of calculation on a different channel, is SOP 42.
Tax treatment, payment terms and affiliate tracking software are not covered on this page.
Terms defined on this page
- Affiliate
- A separate business that promotes your product to its own audience. It resembles a referral, but it is really a deal between two owners, set up so both come out ahead.
- Ceiling (affiliate commission)
- The most you will pay to win one customer. At a three-to-one ratio of lifetime profit to cost, it is a third of gross profit, and each commission tier is a share of it, never of the sale.
- Lifetime profit to cost ratio
- Lifetime gross profit to cost ratio; see that entry.
- Paying in product
- Rewarding affiliates with product or credit instead of money, since it costs you less than they value it. It only works if they use what you sell; at high volume they usually want money.
- Three tiers (affiliate commission)
- Commission levels paying 25, 50 and 100 percent of the ceiling: tier one for everyone who signs up, tier two for anyone who has activated, tier three for anyone holding a set level of sales.