Free Shipping and Handling Aren't Free

Christmas is coming early this year, at least if you’re an e-tailer planning to be in synch with your customers. According to BizRate’s “2006 eHoliday Mood Survey,” 35 percent of consumers plan to start shopping by Halloween. Online merchants are ready for them.

What’s on top of online shoppers’ wish lists? You guessed it — free shipping and handling. Historically, consumers have perceived any shipping charge as high because anything is more than they would have paid in a retail store. This year, customers needn’t worry. Online retailers are determined to level the playing field. They’re lining up to act like Santa. Eighty-three percent of them plan to give away some form of free shipping in hopes of driving more holiday sales.

As a marketer, I believe in fulfilling customers’ desires when it’s practical. Problem is, free shipping and handling charges aren’t free at all, at least not for e-tailers. Shipping costs have risen considerably over the past year due to higher fuel costs. The reality is that shipping charges have a clear effect on the bottom line since they cover the real operational expense of getting product from your warehouse to the customer. In some cases, merchants treat shipping charges as a profit center, since building a profit margin into shipping charges is often less visible than raising prices.

From a marketing perspective, attracting new customers with free shipping and handling is similar to using a low-price strategy. These customers tend to be more price sensitive and less brand loyal than full-price customers. As a result, it can be difficult to keep bargain hunters purchasing without further price inducements after the holidays.

Ensure Profitability

There are several ways to enhance merchandising to maximize the results from a free-shipping offer. Bear in mind that over time, most promotions lose their effectiveness. Try the following:

• Set a minimum order size that ensures profitability. Only offer free shipping for larger-than-average orders (dollar order value or unit order size). Exclude products with low profit margins and high shipping costs. Be clear about restricting premium delivery time and holiday deadlines for shipments, as these drive up costs. Amazon.com does this with free basic shipping and handling for most orders over $25.
• Include offers for related products in the shipment. Since many of these products will be gifts, package a related promotion with the product so the recipient is exposed to an attractive offer.
• Add an offer to your bill. Reward customers with a special promotion for their gift-giving largess. To help post-holiday sales, make the offer effective in January.
• Give recipients a reason to register on your Web site. Create product-related content or an associated offer that drives people to your site. The aim is to get recipients, who are your target market, to register so you can market to them directly after the holidays.
• Back-test free shipping offers. This works if free shipping is only offered in e-mailings in which the promotion can be targeted. Since many marketers are under pressure to deliver strong results during the holiday period, it may be too risky to broadly test a less generous promotional approach. By not offering free shipping to a small sample of your customer base, you’ll be able to determine whether free or paid shipping produces the best bottom-line results.

Metrics to Assess Free Shipping and Handling

Since free shipping has a quantifiable cost in forgone revenue, it’s important to determine its impact to protect profit margins. When considering free shipping promotions, analyze the following to determine how many extra orders free shipping must yield to at least cover the cost:

• Calculate the breakeven number of orders required to compensate for forgone shipping and handling on orders you would have gotten without offering free shipping:

  Forgone revenue = initial revenue projection – revenue without shipping = projected shipping revenue

  Gross margin per order without shipping = revenue per order without shipping – [cost of goods sold per order + fulfillment costs per order]

  Incremental number of orders needed to breakeven without shipping = forgone revenue/gross margin per order without shippingThe breakeven number of incremental orders will fall if a free shipping offer either increases average order size or increases the proportion of orders that include certain highly profitable add-on purchases.

• Assess the impact of free shipping and handling on pretax profitability. Perform a sensitivity analysis at a 0 percent, 10 percent, 20 percent, and 30 percent increase in the number of orders due to offering free shipping.
• Calculate the lifetime value of customers acquired using a free shipping offer to determine how they rank relative to other segments of your customer base. This should be an indicator of how much you should spend to acquire new customers like them.

Free shipping and handling aren’t free. Free shipping may help move lots of product, but it doesn’t guarantee you’ll make more money. It does guarantee more customers. But these new price-driven customers tend to have a lower lifetime value than your traditional customer base. This makes it even more important to figure out ways to engage these customers and develop brand loyalty.

Meet Heidi at E-Mail Marketing, the first in the new ClickZ Specifics conference series, October 24-25 in New York City.