Practical Ecommerce

Free Shipping: The How-to Economic Model

Free shipping is a growing trend in the ecommerce industry.

As the owner of an ecommerce fulfillment company, I work with hundreds of successful webstore merchants and am in a unique position to see both the threats and opportunities posed by free shipping strategies.

Different Types of Delivery Offers

Most online retailers already offer limited delivery discounting that takes the form of absorbing unreimbursed shipping expenses such as dimensional weight minimums or rural area delivery surcharges.

Another common discount strategy is a set shipping-and-handling fee that is good for any size order, such as a $6.95 fixed rate, no matter the actual shipping cost. This, of course, encourages larger orders.

The fastest growing discount offer is free shipping in exchange for a minimum order in dollars. This is often in the range of $75.00, but the minimum varies widely.

In many cases, merchants offer free shipping for a limited time only, such as four weeks prior to the Christmas shipping deadline.

Online consumers, predictably, prefer 100 percent free delivery with no minimum, or a free upgrade to express delivery.

Free Delivery Can Produce Benefits, Downsides

There can be big profit potential in free shipping offers, such as:

  1. Increase in the total number of orders.
  2. Average revenue per order may increase.
  3. Item prices could be raised resulting higher gross profit.
  4. With larger volume, per-order costs may decrease.

The downside risks inherent in free shipping offers are equally large. They include:

  1. The revenue per pound may be too low for shipping discounts.
  2. Additional gross profit may be insufficient to replace lost shipping revenue.
  3. Some customers may comparison-shop free shipping deals.

The problem is working out the bottom line impact of free shipping offers when costs and benefits are so difficult to calculate. A good starting point, however, is to gather the facts and figures for your unique situation in a spreadsheet format like this one, which you can download here.

Screen capture of "Free Shipping Model" spreadsheet.

Screen capture of “Free Shipping Model” spreadsheet.

The benefit of an economic model like this is the various free shipping options can be compared side-by-side in terms of net contribution to overhead and profit.

A decision model makes getting started easier, but the fact remains that the key decision factors can only be known by real world testing.

Consider a “What-if” Decision Model

The example spreadsheet assumes an average of 12,000 orders a year with revenue of $100 per order, gross profit at 40 percent of sales, an existing $15 per order shipping and handling fee and $13 per order actual shipping cost. You can, of course, enter your own assumptions about your ecommerce project.

This sample analysis considers four alternatives.

  1. Don’t change anything.
  2. Switch to a $6.95 fixed delivery fee.
  3. Offer free delivery on at least a $200 order.
  4. Offer free delivery period.

For each of the discount offers, an initial estimate of the outcome for each new shipping strategy has been entered subject to later testing of offers that look promising.

In this example, the merchant’s contribution to overhead and profit presently averages $504,000 per year on product sales of $1,200,000 and shipping and handling revenue of $180,000 per year.

Option 2: Fixed Shipping Fee of $6.95

The example merchant is interested in a $6.95 fixed shipping fee offer. The initial assumption is the average order would increase by $20.00 and there would be a $1.30 net increase in the average shipping cost. These assumptions would need to be tested, but if the real world outcome were the same as the economic model, there would be a $16,200 loss of operating margin. In this example, the added revenue was not enough to cover the reduction of shipping and handling income and pay the added shipping expense.

Option 3: Free Delivery With Minimum Order

In the case of free delivery subject to a $200 per order minimum, the initial assumption is there would be a 1,200 order per-year reduction in sales volume. But because of the higher revenue per order, there would be an overall increase in dollar sales. Because of the heaver package ship weights, there would be an associated increase of $8.50 in shipping cost. If these assumptions were proven true by subsequent testing, the net result would be a $127,800 per year increase in operating margin.

Option 4: Free Delivery With No Minimum Order

If the offer were free delivery with no minimum, the initial assumption is a 3,600 increase in order volume per year and no meaningful change in per-order ship cost. If this were the real-world outcome, the merchant would see an $82,800 per year decrease in operating margin.

These are just arbitrary examples of how various free shipping offers could be analyzed. The main thing to keep in mind is there is a simple way to model free shipping economics, but real world testing must be conducted to project actual outcomes.

Per-pound Costs Decrease as Weight Increases

There is a vital fact that supports an offer of any kind that results in larger orders: Shipping cost per pound decreases as ship weight increases.

You will note from the carrier comparison chart in one of my earlier Practical eCommerce articles, “Shipping Rates: Comparison Shopping Save Money”, that the delivery cost of a 6 ounce package sent first class mail is $7.65 per pound, but the average cost of a 6 pound package delivered UPS ground is only $2.02 per pound.

In effect, as order size and weight increases, revenue goes up, but delivery cost as a percentage of revenue goes down. This opens the door to discount offers of all kinds.

Summary

Free shipping or some form of shipping discount strategy is perhaps a desirable alternative for your ecommerce business. A good way to begin the assessment process is to gather the basic per order revenue and expense data and model the possible outcomes of various shipping discount offers. From there you can conduct a set of real world sales tests to accurately gauge the cost versus the benefits.

John Lindberg

John Lindberg

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Comments ( 8 )

  1. Robert Farago December 29, 2009 Reply

    Excellent, common sense analysis. But the author fails to calculate the hidden costs of a shipping policy. More specifically, ordering ease and branding.

    Remember: there is no shipping costs to real world retail. Well, not that the consumer can see. THAT is e-commerce’s real competition (online shopping accounts for less than 4% of total U.S. retail).

    The customer is always right, and the customer doesn’t want to pay for shipping.

    When a customer sees a price for an item on a website, they may know that the price doesn’t include shipping, but they don’t like it when they actually see the final price. It makes them unhappy.

    Contemplating shipping charges also adds another step in the decision process. Whoa! Do I really want to buy this? I’d love to see a comparison of abandoned shopping carts pre and post-shipping charge reveal.

    So . . .

    Don’t charge them. Whatever the damage to your bottom line, suck it up. Find a way to eat the cost. And TELL THEM. "No shipping charges. Ever."

    Whatever your brand’s Unique Selling Point, shipping charges are a distraction. Necessary or unnecessary? Your call.

  2. The Collectors Hub December 30, 2009 Reply

    Our results for flat rate shipping doesn’t support the assumption of an increase in individual order size. It seems to promote single item purchases at least with small light weight items.

  3. John Lindberg December 30, 2009 Reply

    I have noticed the same thing from my perspective doing just the order fulfillment for our clients…that the single flat rate offer doesn’t have much effect on average order size in many situations. I have seen the same problem with 100% free delivery offers. The offer that seems to provide the best economic outcome from the merchant’s point of view is tying free shipping to a reasonable minimum order.

    John Lindberg – President
    EFULFILLMENT SERVICE

  4. Jagath Narayan December 30, 2009 Reply

    @Robert. You raise a great point. "Free shipping" does have a psychological impact on the shopper and may result in increased sales. I came across a recent Comscore report that supports this argument. According to Comscore, 42% of all e-commerce transactions in Q3 2009 included free shipping. In a survey they conducted, 73% of respondents said that shipping charge is a very important factor in their purchasing decision.

    I have come across some interesting ideas to deal with this phenomenon. One of them is to simply add the shipping cost into the product price and then offer "free shipping". Another approach is to calculate your average order price and then set a free shipping threshold above that $ figure to entice customers to round up their purchases.

    I have linked to the sources of these ideas in a recent blog article http://bit.ly/5Bns9H

  5. kdthornton July 21, 2010 Reply

    I have a few questions regarding your spreadsheet.

    Regarding the Free delivery with a minimum order, if we are currently not doing any kind of free shipping or flat rate shipping, for our case, wouldn’t you say that we would not be losing any orders?

    For the calculation of the free delivery with minimum order, will you explain why the formula has all of the orders multiplied at the minimum order? Wouldn’t you really want to go with a portion of the orders being at the minimum and the other portion at your average revenue per order?

    I appreciate any help you can give. I am researching if it is feasible for our company to do free shipping w/ minimum order or a flat rate shipping.

  6. John Lindberg July 22, 2010 Reply

    Excellent questions…

    1. Yes, if you add free or flat rate delivery you will not lose orders. The problem is you will lose some profit margin because of the added shipping cost. The question is if the extra profit from additional sales revenue will cover that added cost or not.

    2. The spreadsheet calculation for free delivery subject to a minimum order requirement assumes a reduction of orders shipped (B2+b13) because of the imposed minimum per order, but also assumes an increase in revenue per order (B12 instead of B3). In effect, this would be a net change taking into account all of the variables.

    Overall, the free delivery issue comes down to if the extra profit from extra sales covers the extra expense of shipping. This is a complicated business problem to solve, to say the least.

    My suggestion is to first capture your present profit margin and shipping figures and then run a series of real-world tests by adding different kinds of free shipping offers to your webstore and then carefully measure the outcomes.

    By the way, something often overlooked in free shipping discussions is absence of ecommerce sales taxes as a counterweight to shipping and handling fees. In my state, the sales tax is 6% and that represents a kind of "free shipping" alternative all by itself.

    John Lindberg – President
    EFULFILLMENT SERVICE

  7. Derik September 24, 2013 Reply

    Link to the spreadsheet is broken. Wondering if you could re-upload it?

    • Kerry Murdock September 24, 2013 Reply

      Hi Derik.

      We’ve fixed the broken link. Sorry for the hassle.