Affiliate marketing is built for profitability. It is performance based as the advertiser pays the affiliate a commission only once a sale has been made. So you are never paying for “potential sales” or impressions. One of the reasons CMO’s love the affiliate channel is because of this high return on investment (ROI.)
JEBCommerce wrote this guide so you can fully understand the costs and set proper expectations to ensure max profitability for your affiliate program.
What is the Difference between ROI and ROAS?
ROI (return on investment), is the calculation to determine how much you earned on a sale after the costs are subtracted.
You simply take your overall revenue and subtract any costs associated with the product to determine your overall ROI. This can be very helpful in determining if an affiliate partner is profitable as an advertiser and how much you make on a given sale or campaign.
ROAS (return on Ad spend) is another useful metric to track and, while it’s often used interchangeably with ROI, the two are completely different.
Whereas ROI gives us a final dollar amount left over after a given placement or period, ROAS returns that performance as a ratio.
ROAS can sometimes be more helpful than ROI when gauging the performance of an affiliate program because it gives us a consistent metric value to track across all types of campaigns. It can also be used to set benchmarks when tracking your affiliate program profitability.
For example: an $88 ROI may or may not be successful based on margins, forecasts, and when compared to similar partnerships. However, a ROAS of 8.3 gives us a metric we can compare to other partnerships and channels to accurately determine how successful the partnership was.
How to Calculate Affiliate Program ROI and ROAS
In affiliate marketing, an ROI calculation would look something like this: I sell my product for $100. I pay my affiliates a 10% commission, and there’s a 2% network fee on the sale as well. My formula is ($100 – $10 – $2)/$12 = $7.3 final ROI
To determine ROAS using the above situation, simply divide revenue by total costs. I.e. $100/$12 = 8.3 final ROAS.
Why Calculate Affiliate Program ROI
The unique opportunity an affiliate program provides is the chance for an advertiser to set their own ROI & ROAS. Since they set the price of their products as well as the commissions up front (what they’re willing to pay affiliates for each sale), they know what they’re going to make and what their costs are going to be on every sale. This allows them to manage their affiliate program profitably from the very first day. You just use your current revenue and ROI goals to back into a commission structure that will be profitable for you. This will become more important as the program grows and you start testing different commission structures.
Why Calculate Affiliate Program ROI
The unique opportunity an affiliate program provides is the chance for an advertiser to set their own ROI & ROAS.
Since the merchant sets the price of products as well as affiliate commissions up front (what they’re willing to pay affiliates for each sale), they know what they’re going to make and what their costs are going to be on every sale.
This allows CMOs to manage the affiliate program profitably from the very first day. You just use your current revenue and ROI goals to back into a commission structure that will be profitable for you. This will become more important as the program grows and you start testing different commission structures.
What is a Good Affiliate Program ROI?
The easy answer is a good ROI & ROAS for an affiliate program is one that is profitable for the advertiser.
That is going to look differently for each brand based on margins and profit goals. The important thing is to know all your pricing and costs upfront and factor those into setting up and negotiating commission rates.
As mentioned above, a target ROI is hard to determine because it’s going to be different for each sale and each advertiser – dollar amounts are subjective. But a good overall ROAS can range anywhere from 2-5, depending on what will be profitable for the advertiser.
Ensuring Affiliate Program Profitability
Now that you’re familiar with the terminology, it’s time to crunch some numbers and find out what commission rate you should set to ensure profitability for your affiliate program.
Now is a great time to reevaluate your affiliate commission structures and make sure they’re still profitable for your business. Here’s how:
- Calculate the affiliate program’s ROAS by dividing current revenue by current costs.
Example: I make $100,000/month in revenue and costs are $75,000. This gives you a current ROAS of 1.3.
- b) Set a target ROAS that is inline with your target revenue.
Example: I want to make $400,000 in revenue/month. That would make my ROAS 5.3 (assuming costs stay the same for this example).
- c) Use the target ROAS (example is 5.3) to backout commission rates that will contribute to that profit goal.
Example: I sell a $200 product. 200/5.3 = 37.74. $37.74/$200 = 18.9%. So I’m going to set my affiliate commission at 18.9% on all sales, because I know what’s left over will contribute to my ROAS goal of 5.3.
JEBCommerce Tip: Lowering commissions (costs) is going to increase your ROAS as long as it doesn’t lower revenue at the same time.
You may already be calculating ROI and ROAS for other marketing channels. It is ok to use those ROAS numbers as a guide when setting up affiliate commissions.
If paid search is seeing a 2 ROAS, use that as your target affiliate ROAS to get started and set your commission accordingly.
Maintaining ROAS and Negotiating Commissions
As an advertiser trying to maintain your affiliate program profitability, one of the most helpful things you can set is a commission ceiling. A commission ceiling is how high you can go before the sale is not profitable for you.
This is separate from your target commission which should be used as a baseline. Setting a ceiling is helpful because it allows some room to negotiate premium placements with affiliates who may request an increased commission.
For example: If commissions need to be at 5% overall in order to maintain target ROAS, a baseline commission of 3% makes sense and most affiliates should be set at that commission rate.
Proven affiliates that are generating sales month over month, may be bumped up to 5% in order to encourage their efforts and negotiate additional placements.
That would also allow room in the commission budget to approach larger affiliates that may require a 7% commission to optimize. Of course, you wouldn’t plan on giving all affiliates 7% because that wouldn’t be profitable, but considering the majority of affiliates are at 3%, you can test higher traffic placements at 7% and see how they perform. It may even lead to a reevaluation of our current baseline commission.
Affiliate marketing provides advertisers with a unique opportunity because they can run all these calculations before launching their program without spending any money.
Most other forms of advertising require a set budget upfront and what you get that from that investment remains to be seen. It’s only after most campaigns finish that you can determine success.
For an affiliate program, you determine what you’re willing to pay someone for making a sale for you – then you turn it on – it’s that simple.
Even a poor performing affiliate program, while it may not bring in much revenue, won’t use up your marketing budget because if affiliates aren’t making sales, you’re not paying.
Affiliate marketing is built for profitability.