Deborah Ng over at WiseGeek explains affiliate marketing best:

Affiliate Marketing is a revenue sharing venture between a website owner and an online merchant. The website owner will place advertisements on his websites to either help sell the merchant’s products or to send potential customers to the merchant’s website, all in exchange for a share of the profits.

There are three ways to earn money through affiliate marketing:

Pay Per Click — Every time a potential customer leaves the affiliate website by “clicking” on the link leading to the merchant’s website, a certain amount of money is deposited in the affiliate’s account. This amount can be pennies or dollars depending on the product and amount of the commission.  Note from Todd:  This is the most common type of affiliate marketing, and usually the easiest.  It shows the quickest income as you’re getting paid no matter if the surfer purchases from the merchant or not.

Pay Per Sale — Every time a sale is made as a result of advertising on the affiliate’s website, a percentage, or commission, is deposited into the affiliate’s account.  Note from Todd:  This is how I make the majority of my money online, but this method takes a lot of traffic.  Depending on the niche you are in, your conversion rate between unique visitor to purchasing visitor could be as high as 500:1!  Ask me a LOT of questions about this type of affiliate marketing before you decide if it’s for you or not!

Pay Per Lead — Every time a potential client registers at the merchant’s website as a result of the advertisement on the affiliate’s account, a previously determined amount is deposited into the affiliate’s account.

For many website owners, this is a great way to earn some extra money without actually having to “do” anything. All it involves is placing an ad on the affiliate’s website. There’s no selling or promotion of any kind. The affiliate can just sit back and wait for the profits to roll in.

It’s also beneficial to the merchant. By placing affiliate marketing advertising on websites all over the Internet, he has free advertising and doesn’t need to do much selling on his own. The more websites a merchant is affiliated with, the more exposure his products get, and all he has to do is allow ads for his products to appear on someone else’s website.

While affiliate marketing has its benefits, there are also a few cons. For instance, the merchant has to share the profits with an outside party. If an affiliate uses unsavory means to bring customers to his website and sell the merchant’s products, the merchant will also have to contend with doing a little damage control on his reputation.

The affiliate has to do thorough research on the merchant before agreeing to affiliation. To not do so can mean ending up with a merchant who refuses to pay commission fees or packs up his business and moves on without informing any of his affiliates. This is rare, however, and most merchants and affiliates have a pleasant and profitable business arrangement. Note from Todd: You may want to start out by using some of the more well-known, bigger affiliate networks such as Commission Junction, ShareASale, and ClickBank. Ask me how to get started with these – it’s a little confusing at first but I’ll help you through the setup every step of the way!

It’s important to choose wisely. In some cases, an ad can be placed on an affiliate’s website for months before a potential customer “clicks” or purchases something. If the commission is only pennies, this can lead to a frustrating relationship. Both the affiliate and the merchant are well advised to ensure the relationship will be mutually beneficial.

Affiliate marketing is considered one of the best ways to earn money online. If this is an avenue you wish to pursue, you’d be well advised to research each merchant thoroughly. After that, there’s not much else to do except wait for the profits to roll in!  Note from Todd:  This makes it sound a little easier than it really is – though affiliate marketing is one of the easiest ways to make money online.  You certainly do have to put in some time and effort getting your site out there and get traffic because without traffic, there won’t be anyone clicking on your ads to get that profit rolling in.  I can help you with many different traffic generation tactics, just ask me how!