You may want to jump to the conclusion that Joe should put his full advertising budget into the Affiliate Commission program. In a perfect and simple world that may be the case, however, this is not a perfect and simple world. The Law of Diminishing Returns states that “as successive units of a variable resource (like the affiliate sales costing 25% commission) are added to a fixed resource (Joe’s Website), beyond some point the extra, or marginal, product attributable to each unit of resource will decline.” In short, what this is saying is that the $2.49 profit per paid click from the affiliate ad program is not a linear relationship. Said another way, Joe cannot count on getting $2.49 per click for as many visitors possible.

Eventually Joe is going to run out of quality affiliates, or the online market for Joe’s customers will become saturated by his ads. This is the case with the other programs as well. Over time as his programs become more and more popular through the web, more and more clicks will be from people that have seen his site before and unknowingly were brought to the site via a “cheap junk jewelry” ad link or will simply ignore the fixed-fee ad. The result of this is based on the Law of Diminishing returns and is basically saying that Joe can’t count on his current per click income all the way up the total increase in traffic scale. What Joe wants to do is put money into a program until the profit per click is maximized. At the point of maximum profit, money spent on marketing should be shifting to another program that has not yet maximized. In order to see this Joe must monitor his traffic and do the above analysis on a regular basis and shift marketing dollars depending upon the result of the analysis. Over time Joe will see trends, when the trends are compared side by side, it becomes clear where to put the advertising funds. It is important to base the analysis on traffic growth from each program. Saturation and the Law of Diminishing Returns are based on volume. Here is a look at the profit results of Joe’s campaigns at different volume points:

We can see now that the first funding should go to the Affiliate Commission program until volume reached just past 8,000 per this time period. At that point, additional ad dollars should go to the Ad Affiliate program. This is a basic model but should suffice to get the point across.

In this example we looked at three different expense streams (affiliate commission, affiliate PPC, and standard PPC) vs. two revenue streams (contextual ads and product sales). What Joe’s goal would be is to have as many options on each side of the market as possible and do this analysis for all of them, switching ad funds between programs as the volume of traffic, and profit per paid click, change over time. This process will result in maximum profit generation for the business as a whole.

Essentially, the initial supply and demand models discussed will play a role here. As more and more ad space is devoted to a particular item or topic (supply), the less valuable that ad space will become (more supply, all else constant, lower price).

What we did here was first commoditize the market by breaking the various expense and revenue programs down into comparable per click basis. Then we are simply buying and selling those clicks. You may say that Joe is selling Jewelry, which is true, but when you break it down into a dollar per click basis and do the above analysis, it is simply receiving funds for a given click which you paid funds for. You pay for traffic in, and that traffic in turn pays you (whether it is contextual ads, affiliates, products, etc.) With the proper analysis and comparison of multiple revenue and expense programs, you can achieve maximum profit.

We’ve talked a lot about a few revenue and expense options so below I’ve created a larger list of available PPC, Affiliate & Contextual Ad programs.

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