E-Commerce Affiliate Programs: Building Brand, Losing Money

SAN FRANCISCO -- As the saying goes, it's who you know that counts.

But often it's who you don't know that counts even more. That is at least true for a handful of e-commerce companies that have programs designed to gain access to new customers. Amazon.com (AMZN), barnesandnoble.com, Egghead.com (EGGS) and CBS SportsLine -- to name a few -- allow businesses, organizations and Web enthusiasts to recommend products from their sites with a direct link to a place to buy them. These programs have the same purpose: to drive traffic and business to the companies' sites in exchange for a commission.

Because many of the products that these Internet commerce companies sell have low margins, these programs don't always make money for them. Add the commission fee and the sale can even become a loss.

"We may not make money on all sales," says Shawn Haynes, Amazon.com's director of business development. Often, Amazon doesn't make money, Haynes says, "but we can attract new users. And if it helps establish [those referrals] as Amazon customers, then it's a very cost-effective vehicle."

These sales that come in as losses are likely regarded as just another marketing cost. Amazon.com pays 15% for sales of books or music featured on associates' Web sites and 5% for all other sales generated through an associates link; barnesandnoble.com pays 5% to 7% on referrals. (TheStreet.com participates in Amazon's associates program.) In addition to those fees, these companies also have account managers who work with the partners, especially the bigger ones, to help them pick books, etc. The more account reps, the bigger the expenses.

Ben Boyd, vice president of communications at barnesandnoble.com, wouldn't say the affiliate program is in the red, but he wouldn't say it's profitable either. The company "wouldn't set up a program that long term didn't focus on profitability," says Boyd. "Right now, everyone is focused on branding."

Neither Amazon.com nor barnesandnoble.com disclosed how much of their business comes from these programs for competitive reasons, but Amy Ryan, an analyst at Prudential Securities, estimates that it is a "very small percent."

Ryan, who has a hold rating on Amazon and whose firm has no underwriting relationship with the company, was surprised to hear that some of the sales generated from the program were running losses. "You got someone at Amazon to admit that?" she asked.

"But that is the strategy: Spend a lot of money to get new customers," Ryan says. And Amazon does plan to spend significantly in 1999.

Even if the programs generate only a small portion of e-commerce revenue now, they are growing rapidly. Amazon reported more than 200,000 associates at the end of the fourth quarter. That's up more than 600% from 28,000 at the end of 1997. Barnesandnoble.com had 55,000 in January 1999, up from just 1,000 a year earlier. That program was launched in September 1997.

As the programs continue growing, more account reps will have to be hired and there will likely be more sales that produce losses. Such losses are especially sensitive for book and music retailers, whose margins are low to begin with. At the end of the fourth quarter, Amazon had gross margins of 21%. But since Amazon pays up to 15% of its take in commissions to partners, the affiliate program can easily run into red ink.

"My impression was that it was just a lower-margin [business], not in the negative," says Michael Tucker, an analyst for Federated Investment Management's four growth funds, which recently sold their position in Amazon. Tucker believes that the program is a strong marketing tool for bringing new customers onto the site.

And that's basically the way the companies see it. "You win, we win," says Boyd.

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