Free Shipping: Customer Centric or Lost Profit

15 Comments | This entry was posted in Guest Blog Posts
My heart sang when reading David Bolotsky’s recent blog post, “One Retailer’s View on Why Not to Offer Free Shipping.”  This debate has raged for years within the online retailing community and the majority consensus seems to be that a) consumers love Free Shipping (FS), b) it is the most popular promotion with retailers, c) and it is increasingly seen as a “cost of doing business” to stay competitive.  Well, David, you have a friend on this debate as I have also taken a contrarian view on this for years, swimming against the tide of popular sentiment.  Here’s why:
 
Most objectives for online retail business, including mine, include making money.  That means profit is required.  If you are a brand that does not place a priority on bottom-line profit then stop reading.  I am impressed by the scale of some rapid growth businesses like one that starts with a “Z” and ends in an “S” who have helped popularize FS, but unimpressed with their profit margins.  So for those of us who actually need to make money to keep shareholders, bosses, and board members happy, it boils down to this question:  “Does offering FS drive incremental profit on a marginal basis?”  You can only answer “yes” to that question when the customer would not have purchased if FS was not offered.  I know consumers prefer FS – we all do; but that isn’t the question.  The question is whether they will still purchase without FS.  This sets up a relatively easy “break-even” analysis: 
 
A) How much does it cost me to give free shipping to everyone (including those that would have purchased anyway without the FS offer)?
vs.
B) What percent of my orders have to be truly incremental to drive to break-even on a bottomline VARIABLE PROFIT basis (after COGS and volume-driven, variable OPEX for shipping expense, fulfillment, other marketing, technology, payment processing, customer service, etc. is removed).
 
For many branded manufacturers with higher gross margins, that break-even percent typically ranges between 25-33% depending on the type of promotion, time of year, products included, etc.  But if you are a multi-brand environment with lower gross margins, this break-even percent will range even higher.  I have a simple spreadsheet that illustrates this:    Click Here for Simple Break-Even Model
 
So do you believe that 1 in 3 or 1 in 4 customers will simply walk away from your site because of a lack of free shipping (and that’s just to BREAK-EVEN; you still haven’t moved the needle forward!)?  If so, then give it away.  But contemplate whether there is any seasonality to the answer to this question?  I think there is.  Considering that most online business happens in Q4, and that a consumer’s propensity to buy is extremely high in Q4 (evidence:  conversion rates do climb for most of us), I think they are less likely to walk away when they really need to buy that gift.
 
I would acknowledge that if your product is easy to find in multiple consumer outlet points, then the “switching costs” for a consumer to flip to another site are relatively low.  This will make it easier to believe in higher abandonment due to the lack of a free shipping offer. 
 
There are ways to mitigate this profit loss:  hurdles are often used to “cap” the downside.  Generally, a hurdle is set above the AOV and the thinking is that “hey, people will strive to spend more to earn the FS promotion.”  But this same breakeven analysis still applies:  there are some people who actually already spend more than your AOV (that’s why it’s called an average order value).  Some of these people are purchasing without a FS promotion.  Do the math.
 
Finally, keep in mind that a $1 of lost shipping income is 100% pure bottomline USDA Grade A profit.  There are no “offsets” to $1 of shipping income, unlike $1 of product sales when COGS and any volume-driven variable operating expense must be deducted.  You might be left with .20-.30 of every $1 of product sales to cover fixed costs and provide an acceptable profit.  But if you lose $1 of shipping income, you lose $1 of bottomline profit.  Don’t squander it.  For those of you brave enough to swim against the current, you may find that shipping income can be as much as 35-40% of your total profit.  No joke.  It’s a gold mine.  Enjoy your bonus checks!
I’ll be hosting a roundtable on this topic at the Annual Summit and welcome different points of view and more discussion on this topic.  See you in Vegas!
 
 
 
 
 
Troy Brown
Sr. Director & GM
Timberland.com
Bookmark and Share
Posted in: Guest Blog Posts

13 Comments

  1. Craig
    Posted September 3, 2008 at 3:58 pm | Permalink

    Thanks Troy so much for writing such a well thought out blog posting. I’m confused however about one thing. I went to your website and saw that you can get free shipping when you spend $150. What made you decide to offer it if you think you’ll lose money?

  2. tbrown
    Posted September 3, 2008 at 8:56 pm | Permalink

    Craig – great question. Two words: internal dissent. Just because I think this way doesn’t mean that everyone agrees. And the reality is that outside of Q4, the propensity to buy is lower, so it is a little easier to believe the break-even point is easier to attain. But at least the presence of a hurdle (in this case, over $150) drastically reduces the order pool over which this break-even phenomena must occur. Personally, I think the downside is still there, even with a hurdle; but it’s just a whole lot smaller, so I concede the point in the off-season to save the peace. Historically, we clamp down in Q4. But my last day at TBL is Friday, so who knows what will happen this year? Great question!

  3. Posted September 3, 2008 at 11:05 pm | Permalink

    Troy,
    Thanks for this post. I operate http://www.freeshipping.org which shows online shoppers what stores offer free shipping and save statistics on free shipping when I come across them. Here’s a couple that might help retailers in their decision making…

    43% of shoppers abandon their shopping carts because of unexpectedly high shipping charges.
    -PayPal, comScore (2008)

    60% of respondents in a Harris Interactive survey said free shipping is a reason they are more likely to shop online.
    - Harris Interactive (2008)

    Shoppers who call themselves bargain hunters account for 44% of shoppers who have made an online purchase in the past three months, up from 41% at this time in 2006. 90% of respondents said free shipping offers would entice them to spend more online.
    - The Conference Board (2008)

  4. Craig
    Posted September 4, 2008 at 5:26 am | Permalink

    Troy, thanks for answering and so quickly. I have a small online business and have been grappling with this question, which is why I asked. I think you’re right; it’s just hard to resist when so many shops offer free shipping.

    Thanks again and good luck in your new endeavor.

  5. Posted September 4, 2008 at 12:20 pm | Permalink

    This is a very timely post as we enter the holidays. I have a few comments that reflect what we’re seeing in the market.

    1) Our customers with larger price point products ($500+) are offering free shipping and simply rolling the avg shipping costs into the product cost. Customers get FS; but, its baked into their buy costMany of these “retailers” are in fact manufacturer/retailers.

    2) Discount shipping or 1-2 day delivery for the price of ground is another thing we’re seeing. Shipwire offers retailers the ability to plug into a warehouse network in the U.S., Canada and the UK and move inventory closer to buyers. By nature of the warehouse network we see merchants moving best sellers closer to end buyers. We can deliver to N.Am and Canada buyers in 1-2 days if merchants have inventory in 4 of our warehouse (East/West of Canada and US). Some of our merchants are then leveraging this strategic inventory placement and turning it into shipping discounts for buyers.

    3) I love Troy’s assessment of Shipping revenue being pure profit. This is one of the main drivers for merchants to strategically place inventory in multiple warehouses. Take best sellers, put them on the east/west coast. When a purchase is made, ship from the warehouse closest to the end buyer. Faster Delivery at less cost, especially for larger bulky items. Buyers don’t know where it shipped from so there is even more margin that you can choose to pocket or offer back to the buyer as discounted or free shipping.

    I’m interested to keep watching the Free Shipping debate rage on. I think a lot of merchants are seeing it as a chance to differentiate OR a profit center. I see it as both.

    Nate with Shipwire
    Store-Sell-Ship
    warehouses in U.S., Canada and Europe
    Free Trial at shipwire.com/trial

  6. Posted September 4, 2008 at 12:44 pm | Permalink

    Hi Troy,

    You are obviously a very astute person with a strong analytical background with financial clarity and I enjoyed your recent post. I think it’s also important to consider the competitive landscape and consumer expectation for specific product types. In addition, there is intra-competition between brands for similar product types. These partners are also willing to share or shoulder the burden for FS promotions. You’re absolutely right about the impact to the bottom line: it is dollar for dollar.

  7. tbrown
    Posted September 4, 2008 at 12:49 pm | Permalink

    Luke – thanks for the survey data. There are in fact a LOT of data points like this that exist.

    My problem with them is that what consumers “say” and what they “do” are often different. When asked, “Do you want free shipping?,” invariably, we all say yes. Naturally. And yes, I’d like a million dollars too while we’re at it.

    My favorite internal example of this comes from our own bizrate survey. The “Pro-FS” camp will often use a consumer comment who is complaining about shipping costs or saying they really really want free shipping as “evidence” that FS should be offered more often. After all, what could be better than the voice of the actual consumer for prooftext that FS is desired?

    However, the “anti-FS” camp – of which I’m a founding member – quickly points out that Bizrate is a POST-PURCHASE survey. The only way the consumer was offered the survey was AFTER making a purchase. So yes, they complained about it, but yes, they did make a purchase. They would not have been incremental had FS been offered.

    And that’s the problem with stats like these – they really don’t tell the full story because they do not precisely define consumer behavior when time is at stake and a credit card is on the line.

  8. Posted September 4, 2008 at 9:17 pm | Permalink

    Troy,
    Great and thoughtful post. I will keep my comment to a single comment – that doesn’t happen very often! Accurate and precise measurement will allow a company to make the right decision – anything less and you might as well rely on your dartboard (or in the theme of Las Vegas – a roll of the dice). See you at Shop.org.

    -Larry Freed
    CEO ForeSee Results (www.ForeSeeResults.com)

  9. Gordon
    Posted September 5, 2008 at 9:27 am | Permalink

    Troy, great topic. I think your perspective is dead on for a mature business/brand focused on margin and profitability, but I think free shipping or any promotion can be viewed in a few other ways. the Z folks are in the process of building a brand/ aggressively growing marketshare and have chosen to use free shipping as a customer acquisition and loyalty tool in lieu of other marketing initiatives. The size of the database and the passionate advocacy of their customers are well publicized. How loyal those people will remain when they transition into profitability mode will be interesting – I suspect they will remain loyal based on the other key pillars that have been established around service and selection. The situation does create interesting tension between established and growing brands in a transparent marketplace such as ours. I look forward to the discussion in Vegas.

  10. tbrown
    Posted September 5, 2008 at 1:02 pm | Permalink

    Gordon –

    Agree there are multiple ways of looking at this. I probably come across as near neo-Nazi like in my disdain for the use of free-shipping :)

    I think your last point re: tension between established and growing brands in a transparent marketplace is key. The fear of established brands is that by not offering it, they are losing sales to the emerging brands. And maybe they are to some degree, but I think everyone needs to think about it in break-even terms….

    …notwithstanding the valid point that – temporally – this might need to be viewed over a period of time (like Z) vs at a point in time (like the thrust of my blog).

    Best –

    Troy

  11. Posted September 5, 2008 at 1:43 pm | Permalink

    The mainstream media is also having this conversation, in part to the Shop.org community! Here’s a USA Today article from today that talks about free shipping offers for the holidays.

    http://www.usatoday.com/money/industries/retail/2008-09-04-free-shipping-holiday_N.htm

    There are already some interested comments circulating with the story.

  12. Jon
    Posted September 9, 2008 at 1:57 pm | Permalink

    Troy, your approach on evaluating FS is right on (although you do have to consider actual AOV and shipping $ since AOV will tend to drop with FS promotions). My major point is that all mid to large ecommerce business units should be performing real time A/B testing for all promotions so that they do not have to guess on the most profitable one. We A/B test FS, discounted shipping, and a control group to determine the most profitable scenario and then switch to that promotion after we get a statistical sample (sometimes less than one day). We also do this with other discounts, creative, and product presentation – anything to increase conversion. Keep in mind the results (or lift) for any promotion will change with the season, competition, and as the customer gets used to the change so you can never stop testing as the lift results do change.

  13. Posted July 22, 2011 at 1:06 pm | Permalink

    “Does offering FS drive incremental profit on a marginal basis?” You can only answer “yes” to that question when the customer would not have purchased if FS was not offered. I know consumers prefer FS – we all do; but that isn’t the question. The question is whether they will still purchase without FS.”
    Interesting read. As a consumer, it does seem sometimes that shipping costs are too high when shopping online. But free-shipping sometimes makes me wonder if the prices are raised to off-set the cost of shipping. Doesn’t really feel like I’m saving anything. So I guess I will buy with or without FS, if it’s a quality product at a good price.

2 Trackbacks

  1. By Holiday Shipping, Still Time to Act : Monetate on September 16, 2008 at 5:18 pm

    [...] light of the recent discussion about free shipping over at shop.org I was interested to read that gourmet food company Harry & David has cut prices to ship most [...]

  2. [...] is a great business article on Free Shipping at shop.org. It’s something we’ve been grappling with over the last year. Everyone [...]

Post a Comment

Your email is never published nor shared.

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>