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)?
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!
Sr. Director & GM