Management & Finance

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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