Practical Ecommerce

Ecommerce Know-How: The Free Shipping Equation

In 2009, every major carrier in the United States will be raising shipping rates. Profit conscience online shopkeepers, therefore, should take pause and reevaluate whether or not offering “free shipping” is really a good idea.

There is, of course, really no such thing as free shipping. The United States Postal Service (USPS), FedEx, and the United Parcel Service (UPS) all insist on getting paid for trucking or flying your wares across the country. So what “free shipping” really means is that merchants are hiding shipping costs, marking up a product’s price rather than being up front about the real cost of transporting goods. Yet, according to a recent Practical eCommerce survey, 52.2 percent of our readers offer free shipping on at least some orders. And there is anecdotal evidence that consumers prefer it too.

To Offer or Not to Offer Free Shipping

In this “eCommerce Know-How,” I will (1) introduce what I call the free shipping equation, (2) look at a two real products and run them through the equation, and (3) discuss the idea of making a profit from shipping.

Free Shipping Video

The Free Shipping Equation

The decision to offer free shipping or not ought to be a financial one. Like any marketing tactic, you need a way to measure return on investment. Here is the bit of math that I use every time I contemplate offering free or even discounted shipping.

First, consider the cost of the product or products you’ll be shipping. For example, take the best selling item in your store and figure out your actual cost—the price you pay the manufacturer for the item plus an individual item’s share of transportation costs from the manufacturer to your warehouse. If some widget costs $1.00, and is shipped in a master pack of 12, and if that master pack costs $6.00 to have transported from the manufacturer or distributor to you, then your total cost for that widget would be $1.50—its price plus its share (1/12th) of the freight costs.

Next, calculate your credit card processing and shopping cart fees. Every payment processor takes some cut of your sales, and many shopping carts, such as Yahoo!, take 1.5 percent or more of every transaction. In many cases, fees can total 5 percent or more of a sale.

Now consider your packaging expenses. Thankfully, the USPS, FedEx, and UPS all offer free boxes for their premium services, but you may still need to purchase boxes for some items. If you have a cost associated with packaging, be sure to consider it. Don’t forget packing “peanuts”, tape, labeling, and labor costs.
Radio Flyer's No. 18 Classic Wagon

Once you have these basic expenses, calculate your average shipping costs. Pick a medium sized city about 1,000 miles from your shipping location. And get prices from your favorite carrier.

Now you can total it up. What is your actual cost to purchase, package, and post your best selling product? Subtract what you find from the price you list on your website. Can you make a profit if the shipping is free?

A Little Red Wagon

For a specific example, let’s take a look at the Radio Flyer No. 18 Classic Red Wagon. In this example, I am going to make two assumptions. First I am going to assume that a merchant pays about $50.00 for each No. 18 wagon. I don’t know the actual cost, but this seems like a reasonable guess for an item in this category. Next, I am going to assume our warehouse is in San Diego, Calif.Table showing the cost of offering free shipping for the wagon

Our No. 18 wagon has to travel from Radio Flyer’s facility in Chicago to San Diego, and we then ship our package, say, to Odessa, Texas, which is 1,009 miles away. We won’t need to package the No. 18 wagon, it comes in a great box already, and the No. 18 weighs about 26 pounds. In the table, I have separated the product cost of the initial shipping cost.

It is not a good idea to offer free shipping if you sell the No. 18 Red Wagon. The profit margin is just too thin. You would have to sell 11 times as many wagons as a result of your free shipping offer to make up for the difference and break even. If offering free shipping won’t increase your total sales by 1,100 percent (if you normally made 55 sales, you would need 605 orders), don’t do it.

Woman’s Down Jacket

For a second example, consider the North Face Antoinette Down Jacket. We again assume that our warehouse is in San Diego and we’ll assume that the store’s cost before freight for this jacket is $70.00. Also, we’ll assume that it will ship from the North Face’s facilities in San Leandro, Calif. Our customer is again in Odessa.Table shows the figures mentioned in the article

With nearly $100.00 in profit after all costs, free shipping won’t really hurt your bottom line. If it brings in more customers, offer it all you like, but you are still giving away money.

Why Not Make Shipping a Profit Center?

When Internet retailing was young, many online proprietors thought they needed to offer free shipping in order to compete with brick and mortar stores where customers lug their own purchases home. But in reality online stores offer a value proposition that doesn’t really require giving away shipping, rather customers purchase online because of convenience and they purchase online because of availability.

Table shows that you will earn more profit if you don't offer free shipping.So why not make a profit on your shipping? Run the equation above, but this time build in $1.00 profit on each sale, charging the shopper the cost of packaging and delivery plus your profit. On the No. 18 wagon your profit would be $17.08.

I know of a retailer that earns 5 percent of total profits from adding an additional shipping fee. Plus, we selected an example shipping fee sending a product further away could have cost even more.

And even our jacket would have brought in 12 percent more profit, if we have passed the shipping expenses onto our customers and added a $1.00 fee. Does the free shipping offer really increase of orders by 12 percent?

Summing Up

For high-margin items, offering free shipping is perhaps a reasonable marketing endeavor. But in price competitive categories, it makes no business sense to offer free or discounted shipping. In fact, in price competitive markets, you may want to consider adding a fee and making more profit.

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Armando Roggio

Armando Roggio

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Comments ( 13 )

  1. kanko January 14, 2009 Reply

    Excellent article – this site is hands down the best online for ecommerce advice.

    I have just signed up as a result of this article, having been a lurker for a few weeks.

    Well done guys – keep up the great content!

  2. gpolk January 15, 2009 Reply

    Very good points!

    The comment regarding when to give away "free shipping" as it relates to the weight of the item is a very good point and easy rule to follow.

    Thanks!

  3. chrislo2401 January 15, 2009 Reply

    Good article, and I agree entirely.

    However, we find ourselves in a position where our 2 biggest competitors charge free shipping across their catalogue, whilst keeping their prices either the same or slightly lower than ours. We feel that we’ve been forced into a position where we must also offer free shipping on all but our lowest margin products.

    If you have the time, I’d be interested to hear yours or anyone elses thoughts on this. Are we doing the right thing? Are there other ways to avoid offering free shipping whilst somehow remaining competitive?

    Thanks,
    Chris

  4. Armando Roggio January 16, 2009 Reply

    @chrislo2401

    I certainly don’t know the particulars of your situation. But it is really a matter of profit. If you can offer the free shipping and still make an acceptable profit, you won’t hurt your business.

    But you need to define what is an acceptable profit.

    I grew up in an entrepreneurial, but blue collar family. We always had our own businesses and my dad consulted a bit, but our efforts were usually labor-related—sheet metal, sign making, horse racing, retail furniture business, etc. So I tend to think about profit in terms of an hourly wage.
    With this in mind, consider breaking your transactions down into hourly earnings. For example, imagine it takes you 15 minutes to process an order. (That time includes each order’s share of your general store overhead—for example if you spend one hour a day reading and replying to customer service emails and you sell 60 orders a day, then every order requires one minute for customer service overhead. The same is true for site maintenance, product photography, etc. You also have to accept the order, print packing slips and labels, pull product from inventory, pack and tape the box, process the credit card. etc. So again let’s say that it takes 15 minutes.)

    So how much did you earn?

    If your average order is $25 and your gross profit before shipping is $10, your store will be grossing $40 per hour. If paying for the shipping drops your profit to $4 an order, your store’s hourly profit falls to $16. Subtract your labor costs per hour, share of advertising costs, etc., and ask if it is really worth being in business at all.

    Next, I would say that you don’t need to worry about the competition too much. Price certainly matters, but it is not the only thing that matters. In one of my stores, I sell a name brand product at a price that is about 30 percent higher than the lowest priced store I know of online. I also charge for shipping, and add a handling fee. Yet, I still sell a couple thousand a year.

    There is more than one way to deal with your competition, so why not try something other than price or free shipping?

  5. Uwe Ahlgrimm January 16, 2009 Reply

    As every manager in business knows! Or should know!
    Minimum performance equals
    100% Sale
    50% Cost of Sale
    30% overhead
    20% Pretax
    5% Tax
    My small Biz father told me , every single product has to have a Gross Margin "GM", If you sell one single product at a loss than 100x the same price is still a loss, only a bigger one.
    What we see in this down economy, is proof of this basic strategy. merchandisers have sold below their viable Gross Margins, have no cushion and are going out of business. Having merchadised in ASIA for 12 years , I met with hundreds of business people and found that they applied the , what I call Sunami approach, they based their bussiness on volumn only, as the volumn builds , the Surge begins, growth costs investment, when the un planned volumn stops , as it has now, Asia wide hundreds of thousands of companies are out of business, as the Tsunamie has hit the beach. Zhencen lost 27K Manufacturers in a few month.
    Another lesson, every price has a Taker, now than, sell quality and you do not have to worry about shipping cost, free shipping indicates that you are desperate!
    When the times are tough find a niche and service it at a profit .

  6. Lorraine Pierce January 16, 2009 Reply

    I offer free shipping for sample orders, and orders of $75 or more.
    Reasons:
    ~Average sample order only weighs 1 or 2 oz.
    ~Average sample order sale is $15.00
    ~ I make a lot of profit on the samples and full sized product and they can’t resist the free shipping.
    ~Encourages a lot of international orders (which normally only cost .05 cents more to ship).

    Other companies in my industry (cosmetics) do the opposite: Free sample kits(usually 3-5 items and then charge for shipping, normally about $5.00. But they don’t have ANY way of selling them more for that shipping fee!

    I’d much rather ship free and sell them more!

    I disagree that free shipping makes you appear desperate. I think it depends on the industry. In this economy everyones looking for a bargain, sale, or coupon code.

  7. pattyspamperings January 22, 2009 Reply

    I disagree with free shipping for 2 reasons. !st. You do have to raise the price of your product or lower your profit or both. Then along comes the auction sites pushing the free shipping concept and of course they charge you a higher insertion fee and final value fee because you’re paying fees on the shipping. They make their profit at our expense. I’ve open my own web store where I have the control of my pricing,shipping, and discounts. 2nd this one is a very expense lesson that I paid for. It comes from returns & refunds, YOU do have to refund the total amount of the sale, Because you stated free shipping. And You have to refund the the full amount.

  8. John Lindberg March 1, 2009 Reply

    Another way to think about your shipping and handling strategy is to consider the fact that as your package weight increases, your cost per pound goes down. You can use your declining cost per pound for heavier orders to fund shipping incentives once you know the facts about your unique product and shipping mix.

    To see how this works, divide each of your products gross profit by it’s shipping weight to calculate the GP per pound per SKU. Then, determine the average ship cost per pound for your orders at various ship weights — one pound, 5 pounds, 10 pounds and so forth.

    Most online merchants use first class mail for packages under 13 ounces, priority mail for packages 14 ounces to 3 pounds and UPS ground for packages over 3 pounds with zone 5 as the weighted average ship distance.

    You can quickly see the relationship between the product mix for various combinations of SKUs and quantities including the declining cost per pound as the total ship weight increases as a result of minimum order incentives.

    For example, if you are selling both coal and diamonds, you can use this approach to create profitable shipping incentives for both kinds of product even though there is a huge difference in the GP per pound and the average ship weight per order.

    John Lindberg – President
    EFULFILLMENT SERVICE INC

    • Thom Westergren March 27, 2014 Reply

      Thanks for the more nuanced view and great suggestions, John. We need to remember to look from every angle, when making these decisions. And once those internal, vendor-centric considerations are made, then it’s time to consider external factors.

      Many customers, who make regular and bulk purchases (such as in B2B) expect quantity discounts. I found that free shipping is an easy way to satisfy that desire. The perception is that they are being rewarded for making a larger single purchase—which they are. And since the numbers work, I’m happy to oblige.

      Assuming that free shipping will be perceived by the customer as desperation is an oversimplification and probably not true in most instances. There are many, many factors involved for every different product and market, both mathematical and emotional. That’s the challenge.

  9. Tao Wong June 15, 2009 Reply

    Interesting article. We have to give free shipping; again because of competitive purposes – but do so for a minimum order amount. We see a few advantages for this – it attracts large purchase customers to the site who are generally very good return customers (reducing our overall cost per acquisition for customers); increases our average order size and total quantity ordered. The more products ordered, the better margins we can get from our suppliers.

  10. IbnSaeed July 2, 2009 Reply

    Hello Lorraine Pierce,

    Can you post your website, I would like to take a look at it, if it’s alright.

  11. Jared Brickman September 11, 2009 Reply

    Well done – very practical advice. In the rush of all the business dealings we sometimes we forget about all the costs that come into play.

    If you’re talking dollars and cents, don’t forget labor.

  12. Armando Roggio September 11, 2009 Reply

    @Jared Brickman, Good point regarding labor.