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Mitch Arnowitz: If everyone is an affiliate of everyone else, how on earth do retailers distinguish themselves from one another?

Mr. Hecht: This is a problem that's permeating the industry. You have noticed that Amazon, which began as a book store, is now also a music store and a video store and who knows what else they are going to be. The majority of retail sales in America, however, don't occur at department stores. The growth is in specialty store, and there is still a way to pick affiliate programs that are complementary and contextually relevant to you. If everybody becomes a department store of everything else, and if there is no specialization, there is going to be an enormous shakeout and a lot of unemployed marketing directors. If you are an affiliate who's only joining programs and you don't have a core product, pick the ones that best fit you and develop a specialty. Wrap content around it, transactional content that people have a sticky reason to come back for. If you have a core product, complement it; if you don't, specialize.

Mr. Gerace: I think that's a very good point. If you compare the different link types—banners, buttons, search boxes, text links and text links placed in content—we have found the highest conversion is actually on the text links which are embedded into articles or which follow articles. The content wrapped around transactional links that Brian talks about forms more of an information opportunity.

Q: My name is Raj Khera. I'm the CEO of GovCon (http://www.govcon.com), one of the largest communities for government contractors on the Web. How much does it cost to set up an affiliate program? Also, I read an article in the March 1999 issue of Red Herring magazine (http://www.redherring.com) about zero margins. It described how margins are going so low that sometimes they are below cost. How does that affect an affiliate program?

Mr. Gerace: If your program is performing for you, the bulk of the cost of setting up an affiliate program will end up being what you pay your partners. To give you an idea of the scope of these programs, scaled affiliate networks should drive 20-30% of gross sales. That's true for all of our partners who have a network of more than 5,000 sites—20% of gross sales online for a given online merchant. Be Free has a variety of fees, either a percentage of sale or traffic-based pricing, and it varies, depending on whether somebody wants exclusivity in a space, etc. We are typically a fraction of what's paid to the affiliates. So, if you decide to pay your affiliates 10% of gross sales, your affiliate program's going to cost you roughly 13-18% of gross sales, depending on your ability to convert and whether or not you picked traffic or percentage.

Mr. Hecht: I don't want you to hike up the price on Electronic Newsstand, Tom, but this sort of overhead management of running an affiliate network, although not negligible, certainly pales in comparison with the upside. It's probably one of the best value propositions. I'd certainly recommend it over paying millions of dollars to one of the big guys before you have to.

To answer the question about margins, you have probably all seen that buy.com (http://www.buy.com) is selling computers below cost. The premise is that valuations of Internet companies go off of the top line—how much you sold rather than how much you lost in order to sell it. Buy.com depresses the price of a computer, sells it for say a $1000 rather than $1500, and books the $1000 in revenue every time with nobody caring what happens lower down on the balance sheet.

Just as an aside, I think that's a perfectly fine strategy for capturing market share. I would prefer that they booked it as a marketing cost rather than as revenue, but, that aside, the consensus I'm hearing is that, in general, those below margin loss leaders are unsustainable except in a very limited way. I don't think we are going to have to deal with them on a long-term basis. It's almost more of a single shot to get someone on the board.

With respect to affiliate programs, the sky's the limit. If a place is willing to sell a product below cost, and if you are an affiliate, I would say that's a signal that they are willing to pay a lot of money or lose a lot of money to generate a sale. Go to the negotiating table and hike up your affiliate percentage because, if they are taking a loss on the sale, they are taking a loss on you.

Mr. Gerace: I think there is also a lesson to be learned from traditional retail. There are a lot of companies today in the traditional space that operate at very low or almost no margins. Those companies, let's say CompUSA or your local grocery store, make the vast majority of revenue by charging slotting fees to their suppliers. CompUSA charges Compaq to appear on the CompUSA shelf. We think there is going to be virtual shelf space created, both on the retailer site—who is featured on your home page, for example, versus one level deep or two levels deep—as well as on the affiliate network where the merchant is going to have increasing control over what links are placed on affiliate sites. They will be able to sell that space to their suppliers and share that revenue with their affiliates.

Mr. Hecht: In the longer term, I think you'll see a steady state emerging, such as what you have in traditional businesses. In real estate, for example, a 6% margin is somewhat standard. I confess that doesn't bode all that well for the margin pressure on affiliates, since affiliate margins will have to come out of that, but I couldn't guess what the average margin will be a year from now.

Q: I'm George Molaski from Writers Club (http://writersclub.com). What are the terms and conditions that are most generic or industry standard now? Could you also address the number of clicks away from the front page that you want to be, as well as issues of exclusivity?

Mr. Hecht: There are contractual standards emerging, and there are best practices emerging. Tom's Be Free has an application form which standardizes a lot of the agreements, although the percentage commissions vary greatly. Generally, agreements deal with issues of ownership—the name is shared somehow and there is some sort of a co-branding element. There usually are not contractual restrictions about where on your site you put the affiliates, but there are best practices if you want it to be worth your time. I only know my own business, but if you put a picture of a magazine cover on your site, you will drive three to four times as much revenues than if you just name the magazine. If you put it on the home page or the second page, you will also see a multiple over putting it on the third or fourth page. You'll have better results if you integrate offers into your content, rather than simply putting it in a shopping area where you rely on people to go shop for magazines, something they probably didn't come to your site to do.

Mr. Gerace: We see from the affiliate side that certain things are expected of affiliates. First, there will be no adult content. Very few online merchants are willing to risk their brand by having it sit next to adult content. Usually there is no competitive content since most merchants want to make sure that their brand is protected as distinct from their competitors online. Those are two big conditions, usually, to working with a merchant. The only other item is that the click-to location is actually as important as the click-from location. Affiliate links should get the user as close to the register as possible. They should be one or two clicks from making a purchase, rather than having affiliate links that point to, say the Electronic Newsstand's home page, then make the user drill back down to the products they want.

Q: I'm Howard Friedman with e-cerv (http://e-cerv.com). We provide managed applications that are focused on customer relationship management. Most of your focus on the affiliate programs has been on the consumer side. How would you contrast that for business-to-business affiliate programs? How would you take a company like ours, one which has a suite of products targeted at very different company sizes and business segments, and market them effectively through an affiliate program?

Mr. Hecht: As a provider of business-to-business products, are you talking about enlisting businesses to sell on your behalf to other businesses they might work with?

Mr. Friedman: Business associations, etc.

Mr. Gerace: Barnes & Noble launched a business solutions program. They want to be the online bookseller to Fortune 1000 companies and they are using an affiliate network infrastructure to place links on the intranets of corporations like Motorola, Arthur Andersen, Microsoft and others where the company selects what titles appear. They can recommend titles to their employees or each division or any individual manager can recommend those titles and then Barnes & Noble uses the affiliate network to take those corporate purchasers to a secure, discounted location on their site. That's actually ended up being a great way to capture corporate buying and business-to-business transactions.

Mr. Friedman: Isn't that very similar to the consumer version since you are targeting individual consumers as opposed to the enterprise?

Mr. Gerace: You are also targeting corporate buyers where corporations want to automate their purchasing process, use corporate credit cards and receive detailed reporting. They want to know that if they told everybody in a division to buy a given title, how many actually did. Yes, you are purchasing consumer-related goods that are not parts or widgets, but what is interesting is that the corporation selects the goods. They could select discounted insurance policies or widgets. They could have three widget makers and show the lowest prices or make it easy to click through, but they are placing links on their intranets and embedding the content and the recommended items.

Mr. Hecht: I'm intrigued by the thought of it. I haven't given a lot of thought directly to that sort of permutation of situations. We would probably be talking about something like an office furniture vendor which has its own core suppliers on its Web site realizing that it has the attention of office managers who are of interest to Office Max or Staples . . . it should work. I would say, though, that the variations on what I described are going to be much more akin to a business development kind of relationship. Part of the nuance of running a consumer affiliate marketing network is that you are dealing with mass numbers of affiliates, and your success or the success of the network doesn't depend on any one of the affiliates. It seems like that would just be a layer in the supply chain for business-to-business affiliates. I think you probably enter the people to run it in the core skill set.

Mr. Arnowitz: Tom, is Barnes & Noble's pay-out to the intranet host companies the same percentage it pays to other affiliates?

Mr. Gerace: Good question. They actually have two completely separate affiliate networks. One is a consumer network which is their larger network, then there is this business solutions program. Instead of giving a commission on sales, they give a discount that's realized at the point of transaction for those business customers. Anybody coming through this network goes to a secure environment which is mostly separate from their consumer side, where they get a transaction that's realized at a lower dollar value. The corporate purchasing actually results in discounted purchasing.

However, we can't do what Barnes & Noble has asked us to do, which is to review books, put up the reviews, add content and create new pages. We have an application. We are one of those value-added providers that gives away something for nothing and connects our clients with their customers. That's what we want to leverage and we have a targeted audience. How do we take advantage of the affiliate program without having to add staff and create a Web page environment?

Mr. Hecht: I come from a content background so I grapple with this all of the time—how much content and how do you create it on a budget when you're not a primary content provider? I would go home tonight and, since you are probably an expert in what people think about when they are traveling, write down a list of ten products that you would like to sell. Write one article, one piece of content that you could author yourself, using all the buzz words—"10 Things You Must Think About On Your Trip." One piece of content. Give it a prominent link on your site. You don't need an expensive editorial staff to do transactional content. If you are not a great writer, have someone who is a great writer edit it and put it up on the site. I'll bet you that if it's marketed in the right way, that button will get a competitive number of clicks to your core service. Then you will have a way to test whether that's valuable for marketing.

Mr. Gerace: Another thing to think about is that affiliate links take a lot of different forms. They can also be links to promotions. If Brian happened to have about 40 travel magazines to sell, you might have a button that says, "Buy discounted travel magazines, the absolute lowest prices for Freetrip users from the Electronic Newsstand." You can use even the regular deals that are promoted as featured items on the site. Additionally, email links are becoming increasingly popular. That's where people are embedding affiliate links—in their email updates, newsletters or even in their signatures.

Mr. Hecht: I would say that is the wrong metric. The average is going to be depressed by the 80/20 rule—20% of our affiliates produce 80% of our revenue. We have traditionally done "good" rather than "plenty" with about 5,000 affiliates. That pales in comparison to the 50,000 or 100,000 we're beginning to think about. If you have a "plenty" situation, it's probably a 98/2 rule where 2% of your affiliates produce 98% of your revenue. It's unfair to ask about the average per affiliate because, of the 20% that actually do sell, some of them sell one, two or three magazines a month and they get a check for $10 or $20. We also routinely send out checks for hundreds or thousands of dollars a month.

Mr. Gerace: I believe that the standard deviation is as telling as either the average or the mean. The average and the mean are going to be very different numbers. The fluctuation in the standard deviation is actually far more interesting. We have run this number for each of our networks individually and for our networks in aggregate. In aggregate, the standard deviation in average payment is $32,000 a month, so no matter what average I made, there are sites making a ton of money out there and there are sites making nothing. The sites that are making a ton of money are those that have content which very closely matches their audience interests and that merchandise that content effectively. The sites making nothing are typically those that list a bunch of different products on a page or a bunch of different vendors on a page and link to their home pages.

Q: I'm Arnold Kling with homefair.com (http://www.homefair.com) which provides relocation information to consumers. We give the information away for free and we'd like our affiliates to help us give it away for free. We once received a check for $1.59 from Electronic Newsstand. Thinking about the cost of writing that check, putting it in an envelope and adding the stamp, I wonder whether people are trying to come up with more creative ways of paying, perhaps things that can be transferred electronically to make that process less expensive?

Mr. Hecht: Yes, but you are going to have an adoption problem. I'm not in the electronic banking business so I'm not going to wire you $1.59. The fact that you got a check for $1.59 is a testament to the courtesy we try to show our affiliates. A lot of affiliate programs won't send you a check for less than $50 or $100. They save it up, which is really their way of rounding down. If you have enough people who earned $1.59 and you don't pay them, you start making money off of them. I'm sure that I lost money sending you that check for $1.59, but I hope that you appreciated our effort and that you are going to work with us to sell more magazines.

Mr. Kling: Is anybody looking at quasi-currencies such as frequent flier miles or other things that can be transferred?

Mr. Gerace: At Be Free, one of the things we do is the payment infrastructure for most of the networks we enable. Many times when you get a branded check, we wrote that check for the merchant. We have begun exploring electronic funds transfer (EFT) in earnest. The one big barrier is that the costs of insuring against EFT are higher than check writing, particularly when you are sending out thousands of different wires to locations where you haven't confirmed the identity of the person on the other end. Insurance companies are funny that way. As far as points programs, we expect to roll out the opportunity to pay in miles or points and people are using consumer bucks.

Mr. Hecht: CD Now (http://www.cdnow.com) gives out CDs. We prefer the cash option, but I think that the up and coming model will be that for any value up to $100 or $200 you can accept that in cash, sky miles or something like it. In a way it becomes almost more fun, a carnival-like environment where you get to pick your prize. That might be a better option with smaller affiliates for whom the dollar check is never going to be meaningful, but they would get a kick out of 500 frequent flyer miles.

Mr. Arnowitz: There are also payment consolidators such as Commission Junction (http://www.commission-junction.com) that will aggregate or pool together a bunch of little amounts and send you one check at the end of the month. They are getting pretty popular.

Mr. Hecht: You can get an $8 check instead of a $1.59 check.

Q: I'm Bob de Lorenzi with PatriotNet (http://www.patriotnet.com), a local Internet service provider. We don't have much of a sales force. Actually, you are pretty much looking at our sales force. We are focusing specifically on DSL, a very complex product to sell, and we are trying to come up with methods and compensation structures to support some sort of affiliate program or channel reseller—some way in which we can have people out there making the transaction for us. We are asking customers to spend hundreds of dollars a month and we have come up with the ability to pay good revenues, a residual income for three years on people who sell these circuits for us. How do we apply this with the affiliate perspective you are talking about?

Mr. Hecht: I think you probably need to do a hybrid affiliate/sales representative model. If it's a complicated product, you are not going to simply tell somebody about it online and have them tell their neighbors. College-represented programs have their affiliates come in for a one-night training session. They brief them on the product, give them a stack of blank contracts and explain the payment system. There is some training there, but in the end it's up to them how much they make of it. You can use the Internet as a connection and as their sales resource center where they get updates on how to sell and so forth. It's a virtual sales force, but I think there has to be an initial human contact since it's so complex.

Mr. Gerace: If one of the challenges is that a lot of people don't know what DSL is, and if you are doing an up-sell from lower bandwidth connectivity, one option may be to have a pay-per-lead system where you pay a low dollar amount for all of the leads you get inbound, then you can hand them off to vendors who are positioned to complete the sale for you.

Mr. Hecht: The market, now, is $1-$2 per lead.

Mr. de Lorenzi: I've seen our competitors pay as much as $300 for somebody who brings them a circuit. What we think is really going to attract people is paying 15% per month for the first year, 10% per month for the second year and 5% per month for the third year. You make a sale one time and you have this generation of revenue over the course of three years.

Mr. Gerace: That definitely incentives the person who closes the sale, but I think you could pay to get a list of names of potential buyers online through an affiliate network by saying we'll give you a $1 or $2 a name. Then you hand those names off to a partner who can close for you. They're going to have to do the educational sell. Paying a buck or two per name is not going to close sales, but it will let you know what your market looks like and it's going to bring the market to you.

Mr. Hecht: It's probably more like a car sale where there's a complicated purchase. People aren't buying a lot of cars online. They are researching the cars on the Net, then going out and closing the sale with a human being.

Mr. Gerace: We do that with the Lending Tree (http://lendingtree.com), for example, where they pay for a mortgage application. Obviously, no one is going to actually close their mortgage today through an online application, but they pay for the name and address of the person who is looking to buy or refinance.

Mr. Arnowitz: How do people know what kind of deal to strike? We have heard pay-per-lead, pay-per-click, percentage of the sale, flat fee, store credit, tiered programs. How do they know?

Mr. Gerace: If you're first in the space, you get to decide. If not, you will see a number of different models. One of the things you can do is come up with a model that your partners like better as a way to compete and capture affiliates from a competitive network.

Mr. Hecht: It's ruthlessly Darwinian right now. There are no rules and there are no rate cards. Every person who goes out and raises venture capital or who has a business idea, also has a business plan that says they have to sell banner advertising or placements or slotting for a fixed fee. Right now, there is just no demand in the market. If every impression on the Internet was sold at a supply and demand equilibrium, there would be a 20¢ CPM instead of the $60 or $80 CPM on Yahoo's rate card. You have to figure out how to worm your way into those crevices. If you are joining affiliate programs, go ahead and ask for an up-front payment, but you are not going to get it unless you are really big and important. Get the best commission you can. Work your way down—go for a quick deal, go for a per lead deal, then join an affiliate program. If you are on the sell side and you are trying to get your distribution built, offer your affiliates the lowest reasonable thing you can, which is a percentage. Many will take it. If there is someone who is in a better position, they're bigger in the jungle and can demand a higher percentage, let them ask.

Mr. Gerace: The way to think about it is, first, consider what your customer acquisition is through other programs, then consider what each repeat transaction is worth to you. Acquire customers for the repeat transaction number if you can, otherwise consider a hybrid that rewards first-time buyers more handsomely.

Q: Good morning. I'm Joe Zuccaro with Covad Communications (http://www.covad.com), a DSL services provider . Have you ever had to decide whether or not to give an affiliate the boot? Have you found some that just drop off on their own accord?

Mr. Gerace: We know of circumstances where affiliates have been shut down. Typically those affiliates begin to violate some of the core principles I mentioned earlier. They start having content that is either considered adult or offensive in other ways, or they begin working with a competitor. The cost of having an affiliate in your program is relatively low, if you have technology that automates your work flow and if you have processes inhouse that make supporting those affiliates efficient. Typically, even if somebody is driving only one sale or zero sales for you in a year, it's not worth booting them out because you're still getting reach and branding that even the smallest partners bring. Booting them also creates a negative impression in their mind and they tell three friends and so on and so forth. But for people who violate your agreements, it's absolutely important to enforce those agreements and we have seen that happen.

Mr. Hecht: We don't boot affiliates for low activity or inactivity. If there is a chance that they even have a button of ours somewhere on their site, someone might see that and make a sale and there is no incremental cost to us maintaining them. We have booted folks for violating "community standards" and we have affiliates on our radar screen which we check back with from time to time to make sure they haven't crossed that line.

Q: I'm Ira Kaufman from E-teen (http://e-teen.net). We're building a portal for young people from around the world. Have there been any examples of sites aggregating noncompetitive vendors as an affiliate program for a special target market, like a mall? How does that work and what are the dynamics around it in terms of sharing commissions and so forth?

Mr. Hecht: Tom and I are both in discussions with a major mall site now. I think the mall concept is coming back again, even though it was shed a few years ago when the specialty product retailers like Amazon came along. You are seeing folks like Value America (http://www.valueamerica.com) that are becoming more like malls, and I think there is going to be a second wave. Amazon has become like a mall, but it's best when you do it for a target audience. There is a viable mall concept for special interests and I would say that demographic niches, whether it's iVillage or Bolt or Tripod, are extremely hot right now. If you can capitalize on that, by all means do so. If you are going to be a portal, however, transactive content and stickiness are going to be more important to you than merchants. You have to put the horse before the cart.

Mr. Gerace: We just announced a relationship with GeoCities (http://www.geocities.com) where they are going to create an aggregated network for multiple merchants to plug into the 3.4 million GeoCities homesteaders. We are going to do exactly what you suggested—have a number of different merchants that can place buttons or banners or links on these homesteader pages. GeoCities will write one check from their program. That is a model we see emerging. We also see what I keep calling "virtual distributed portals." That's where a group of content sites which have a niche focus—women's sites or dog lovers or whatever—form a content network that can be pointed to a variety of different merchants. They actually increase their value by aggregating the content and then pointing the network to a merchant or set of merchants.

Q:  I'm Jim Jacobson with Wave Communications. After about 12 months we finally launched our E-commerce site called ConsciousMedia (http://consciousmedia.com). It's like an Amazon that sells books, music and video for body, mind and spirit. We're looking to form affiliations with traditional retailers of the products in that area—bookstores, etc. Do you have any thoughts on how to solicit them? We are competitive with them, but also can bring them advantages.

Mr. Gerace: Think not only about the people in the real world who might have appropriate content, but also go to the search engines and search on the key words that are related to your space. The second thing to do is to narrow the search by looking for those pages you found which link to one affiliate program or another. If you've got that subset of sites that have appropriate content and which already get the affiliate model, there's a good group of low-hanging fruit to start off your network. We don't typically recommend that people go off to find the tougher affiliates right off the bat—the ones who might consider you to be in conflict with their traditional channels. Prove the model with somebody easier, then go back to the people who aren't selling online.

Mr. Jacobson: We have our own inventory of 40,000 products. We need their customers. They have a certain rapport and it's the rapport and the relationship that has built up in the retail arena that we want to leverage.

Mr. Hecht: I might try something like a content sponsorship where you make a deal with someone like Deepak Chopra to create some sort of a guide and the tradeoff is that you carry those products so it's really advertising for him. Most sectors have come around to some sort of co-operitition model. I work with magazines that are also selling magazines on their own sites. They authorize me because they want more business. If your sector is more mature, try to take baby steps with them and try to do a content deal. Say, "Look, I want to start off with good faith sale. I want to give you banners throughout my book area in addition to the products we sell." That's my best guess.

Mr. Gerace: You've got a tough sell trying to get other merchants to hand off customers to you. Right now, people consider this to be a land grab for customer attention. Somebody who is actually transacting business online wouldn't do it. Somebody who is transacting in the real world considers online to be a horrible threat. You're going to have a tough time saying, "I'd really like to be the group to cannibalize your existing sales." There are a lot of affiliates that have content and don't sell at all online. You would be a perfect place for them to earn extra revenue by sending their audience through.

Mr. Jacobson: We are finding people who are Amazon affiliates actually moving to us, which is great.

Mr. Arnowitz: Thank you all very much. This has been most interesting. Marketing is critical to any business, so I hope that you have picked up a few tips this morning that will help you promote your business on the Net just a little bit better. Personally, I was particularly taken with what Brian had to say about "contextual selling," a concept that's also getting quite a bit of buzz on the Net these days. Please join us in the Netpreneur Program Ad-Marketing list (http://netpreneur.org/connect/am) to continue this conversation or to start a related one.

Once again, thanks to everyone, particularly Tom and Brian, and have a good morning.

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