How on earth do people make money with affiliate marketing?

The great thing about Amazon and other physical product networks is that it allows you to get involved in really specialised niches, and in some of these you'll find some really high ticket products that there is a demand for but not a massive amount of tough competition. I have a site, for instance, which promotes an item which costs over a grand each - and this is a consumable item that businesses involved in a certain industry need to buy regularly.

So I wouldn't discount physical products, they just require a bit of out of the box thinking when it comes to niches.

As well, Amazon is such a well recognized brand with such a large number of customers that a large proportion of them WILL buy something else from them if they don't buy the specific product you're promoting within 24 hours, whereas that's not very likely to happen with Clickbank. For example, I was selling WordPress website building guides and somehow managed to sell a car part that costed $3000 and made a quick $200 commission that way.
Remember that their cookies stay on for 24 hours, and almost every internet user who shops online uses and trusts Amazon.

The problem with creating your own product is "Demand"

Promoting affiliate products allows you to focus on products for which there is already a demand, and this is where the easiest money is - if you don't have a list, then it is tough to promote a product that people are not already searching for info on.

Creating your own product brings with it a different set of problems & costs - and the biggest problem, if you don't already have a responsive list - is creating a demand for your product. There are thousand of products out there that have had little or no sales, simply because the person who created it wasn't able to give it the kick it needed to get it to the point where there was a demand for it.

The OP discussed how crazy it seems to put money into promoting someone elses product with no guarantee of return - what's the difference in promoting your own product with no guarantee of return, other than this way you've also had to put time, effort & money into creating the product, building the website etc. ?

Personally I think affiliate marketing is great, because you can pick a product which has a demand already, and make some money from promoting it - and if you build a niche specific list as you're going along, then you'll do better & better as the list grows.

Yup, and burning hard drive space in the case of digital products

I definitely agree with this! If you create a product but don't put it out, you might as well not have even created it! The key with product creation, or affiliate marketing altogether, is trying to create (or promote) a product that will be helpful to your targeted visitors, whether geared to skin remedies, how to repair your marriage, etc. Of course, you can look on sites like Yahoo Answers to get an idea on how many people may be inquiring on wanted resolutions to their problems, and then check Clickbank to see how many of those products may be out there as an idea... if it's low, then you may have yourself a jackpot if the demand is high.

Create your site, hit up a few forums in your niche, post on some blogs related to your niche, and continue to promote where you can, whether on Twitter, Facebook groups, etc. Better to create your own product and make sales of it, and get people to be YOUR affiliates if you can go that route with it! And then promote other affiliates within your site or product and try to make some money that way as well.

It's a good plan but why is "give value" at the very end at #8? Most people don't even get to step #8 and it's usually the main reason why they fail.

See, I think this is what makes affiliate marketing harder than it should be. Creating value should come first, second in worst case preceded by finding a niche. Then you sell, then you promote. Not the other way round. That way not only you get better results but feel more rewarded by creating something of value as well.

If we're in a business of marketing then we're doing it wrong. Where did you see a serious marketing agency spitting out crap sites and articles or spamming people with their affiliate links? That's not marketing that's spam.

If we're in a business of creating websites then we're doing it wrong too. A site that consists of 99% ads is not a good website. It's also spam.

The importance of that step #8 is crucial, it turns out. It's the only thing that separates a spammer from an online businessman/entrepreneur/marketer or what you want to call it.

So now getting back to OP, this is how people make money with affiliate marketing. By doing step #8 first and giving value. It's a fundamental law of economics, really, and it's a tough life going against fundamental laws of economics.