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Solving the Free Shipping Puzzle

Look at all the advertising and promotional materials produced by multichannel companies during the recent holiday season, and there’s one phrase they have in common: FREE SHIPPING. It’s the one thing on which everybody seems to agree—yet it’s also something about which virtually everybody disagrees.

In preparation for this article we tracked hundreds of promotions that arrived in our postal and e-mail mailboxes from August through December 2008. We also polled dozens of multichannel businesses on their free shipping strategies. What we found was an unbelievable array of opinions, conditions, restrictions and timetables. What we didn’t find was any kind of consensus on whether free shipping is a strategy that works.

It’s important to say at the outset that revenue from shipping & handling, or shipping & processing, is considered by most companies to cover not only the outbound shipping carrier cost but also some of the fulfillment labor costs in picking, packing and other shipping functions. Outbound shipping cost, with its accessorial charges, has become the highest individual fulfillment expenditure in most companies.

An Interview with Kevin Hillstrom I wanted to get a data base marketing perspective to free shipping and interviewed db marketing consultant, Kevin Hillstrom. Hillstrom is president of MineThatData, a consultancy that helps CEOs understand the complex relationship between customers, advertising, products, brands, and channels through a methodology he developed while VP of Database Marketing at Nordstrom, director of Circulation at Eddie Bauer, and manager of Analytical Services at Lands' End.  Curt Barry: I’ve spoken to dozens of executives from different companies, and they say results of free shipping are all over the place. What’s your experience? Kevin Hillstrom: Results are all over the place, and are completely dependent upon the customer that the business caters to. Businesses that are trusted get less benefit from free shipping than businesses that are trusted less. Free shipping means more to an online startup that nobody has heard of than it means to L.L. Bean. CB: What kind of lift do you need for it to be worthwhile?  KH: Free shipping seems to give a 5% to 35% bump in productivity. Depending upon each element of the profit/loss statement, you’ll probably need a 10% to 20% increase in sales in order to make free shipping profitable; and a key point: low gross margin businesses need a much bigger bump in performance to make free shipping work. If you’re running margins in the 15% to 40% range, you need a big bump in performance; if margins are in the 50s or 60s, you don’t need as big a bump.  Coming up with pro-forma estimates and measuring actuals is key. CB: Is there sufficient testing being done to know whether it’s working?  What kind of testing? KH: Not many folks are doing testing. The folks that are doing testing tell me that their business becomes “spikey” when they do on/off free shipping promotions.  In other words, in test/control groups, you see that free shipping gives you a +20% when the promo is on, then gives you a -10% when it is not being offered, then goes +20% and -10% again as it is put on/off over and over and over.  We train the customer to only buy when free shipping is offered—and therefore, we increase the number of free shipping promotions, further causing these positive/negative spikes. If the test/control group is done over a six or twelve month period of time, we don’t see much of a total increase; in other words, the negative spikes offset the positive ones, yielding little long-term benefit. Some companies are building shipping/handling into product costs and then offering free shipping. One retailer went from the standard $14.95 shipping to $5 shipping in 2005 and saw a 2-3 month bump, but then, business basically flattened out; that $5 shipping gave a bump in performance that didn’t really hold up over time. One of their competitors increases the price of comparable items $3, then offers free shipping—so when you buy two items, shipping at either company is essentially the same.  CB: Are we conditioning customers to wait for free shipping? KH: I believe we have conditioned customers to expect promotions. Long-term, I believe the model that offers the most benefit is either free shipping with increased prices, or cheap shipping coupled with free shipping over a certain level. I believe we’ve taken the focus off of merchandise, and that is a really bad thing long-term for catalog/online brands.

Survey of Catalog and E-Mail Free Shipping Offers
In the chart, “Free Shipping Offers,” we display the various offers presented by 35 businesses that used free shipping. Here are some of my observations:

• The majority of the offers were tied to minimum orders.  These minimum orders are shown in the “Free Shipping Minimum” column with the dollar value required.
• The “Conditions” column gives the terms and expiration dates. In the case of catalogs the expiration date was often a couple of weeks, though some extended through December or early January.  Free shipping expiration dates for e-mails were much shorter than for catalogs—usually less than 7 days—with one or more re-e-mailed reminders that free shipping was running out. Often a few days later the businesses started a new free shipping promotion with a short time frame.  Examples include Lands’ End and Coldwater Creek continually saturating my e-mail box.
• Our survey showed several businesses changing approaches throughout the season, probably testing shipping & handling rates (Cabela’s, Collections Etc., Abbey Press).
• The column “Standard Delivery Lost S&H” shows the retail dollar amount lost by giving away standard delivery shipping & handling (per the amount under “Free Shipping Minimum”). Hello Direct was second day delivery.  The percent of the minimum order that “Standard Delivery Lost S&H” constitutes is shown in the column “Minimum Order-% Total”. 
• The column “Minimum Order-% Total” shows how high shipping and processing has been driven upwards by record freight increases and accessorial charges. As these charges get to 15% and higher we believe that they become a negative factor and suppress sales. We think the customer takes into account the total cost (free shipping + merchandise).  We also see direct businesses with retail stores offering store pick up.  We are in a “caught between a rock and a hard place” dilemma.

As the season wound down we saw even more use of free shipping in some form, in concert with promotional product pricing to push out the product and avoid huge after-Christmas inventory positions, which may be harder to liquidate. Background.com picked up the pace offering not only free shipping, free tax and a price match on all orders.  In the end, we believe that 80% or more of all major businesses will have offered free shipping in some form during the Fall and Holiday seasons. Most merchants added and subtracted free shipping from their sites many times though the period.

Free Shipping Strategies
Because marketers consider free shipping to be highly strategic, few of the dozens of multichannel businesses we questioned about their free shipping strategies wanted to be quoted directly. Here are some of the observations they offered. 

• Men’s apparel cataloger: We use free shipping once or twice per season for our house file rather than prospecting. It is still effective, but not as much as it once was.  

• Non-profit cataloger: We did free shipping in September. Results were good considering the financial climate.

• Women’s apparel cataloger: Our early results in November with free shipping look OK, but not stunning.

• Major multiple title catalog company: We definitely use free shipping. It is a very powerful tool; however we have seen a dramatic falloff in Sept. and Oct. to our traditional lift in response with free shipping. This is a new phenomenon!!! We have not had a full accounting of the results yet.

• Major gift catalog: We have traditionally seen a 12%-15% lift vs. a control on free S&H. The Sept. and Oct. drops have had no lift. Average order has held. We traditionally ask for a higher AOV to qualify for free S&H. Obviously, this kills profitability. No explanation yet for the results; waiting on accounting to research.

• Major multi-title company: We test it regularly and here’s what we usually see:

On titles with a very low outbound shipping cost and high variable contribution margin, we can sometimes make it work. I don’t think most mailers understand how to analyze the results using the appropriate break-even costs. It works best to your high Sales Per Thousand (SPM) segments since the needed percent lift is much lower. We see many people using free shipping to prospect or reactivate, but this is very tough because the needed lift could be in excess of 30%.

The problem comes when you isolate these customers and look at their downstream ordering when they are NOT given free shipping. It’s definitely weaker, so they are worth less to us. In addition, we typically see a fall off in the lift with each subsequent time we make the offer. We ALWAYS back-test. We also test with varying dollar hurdles (the higher minimum order requires a lower percent lift to break even). Bottom line is that it’s tough to make work and we are currently not running any free offers in a roll-out mode. We would probably all be better off in the industry if no one offered it.

• Non-profit cataloger: We offered a free shipping banner on the front over for all of our catalog drops this year...valid through 12/24...redeemable only via our web site...we also offer free shipping via e-mail blasts...and it is our web orders that are really below plan...So while I'm sure the free shipping offers have secured some of our sales, I question how much it has motivated a new sale ... it's become a commonplace promotion. What I'm afraid of is if you condition the customer to free shipping can you ever stop it without hurting sales?  We could not get a reasonable response to our e-mail promotions without a free shipping offer.

• Major book publisher and gift company: Our company, because of our exclusive merchandise, is looking to raise merchandise prices to be able to afford free shipping. 

• Home décor company: We are doing some free shipping on selected items only.  All our tests show a discount of 20% off the merchandise gets us the lift better than free shipping. 

One source willing to be quoted was Susan Pizzano, executive vice president of marketing consulting firm Marketsmith, Inc., who echoed what some of the multichannel businesses said: “We are seeing a heavier use of promotions in general among our clients. Even luxury brands are now using offers to entice customers. However, none of our clients is using free shipping as a promotion this season or in the spring. We feel it does not provide the lift it once did. We advise our clients to do promotions which are a call to action, offers with a reason to buy, such as a percent or dollar amount off tied to a greater spend. We work with our clients on the language they use to make sure it focuses on the client’s need for the product or the product relevancy to the season. The goal is to create a ‘have to have’ reaction by the customer.”

What Does It All Mean?
In the past few years a high percentage (70% to 80%) of mailers have used free shipping to try and get the customer to place an order. When you look at what’s being charged and given to the customer for a higher than average order, it looks like a significant inducement on the surface. But the success rate among our clients in the use of free shipping varies widely, and the shipping and processing offset that you have to give up is very expensive in a time when sales are soft anyway. Those we interviewed primarily said that they aren’t convinced that it’s working, when you take into account if it gets the response lift, if it’s worth losing the offset from shipping and processing, and if customers are just being opportunistic for that one item and the free shipping. However, it’s probably better than getting stuck with the merchandise and having to suffer the markdowns.

Without thorough testing it’s impossible to determine the lift in response and the down stream effects that free shipping has on customer purchases. But to do a credible test, you must have a control group where free shipping is not offered. Is this kind of testing being done adequately? Is there sufficient testing that is done by marketing to be conclusive, company by company? (See sidebar: An Interview with Kevin Hillstrom)

One consideration to be aware of is, setting a free shipping limit can be tricky. Most businesses are still pegging qualification for free shipping to a high order value. Are these dollar order levels something that the customer will realistically reach to spend?  If they are set too high compared to your average order, they are probably meaningless.

Conditioning the Customer
Overall, I found there is a lot of concern in the industry that free shipping is conditioning the customer to expect never to have to pay shipping and processing—yet we keep offering it because we’re afraid otherwise we will not get the order. We wonder, “Will the consumer take another offer because of the cost difference?” If industry leaders aren’t conditioning the customer, certainly the press is. On Yahoo’s Finance for Cyber Monday, December 1, writer Kimberly Palmer of US News & World Report advised readers, “Always look for free shipping. More retailers are putting this into the mix. Don’t miss out on the perk. It can be worth $20 on large orders. Type ‘free shipping’ into a web search before you complete your order. Much of the time the search results will direct you to a coupon code providing free shipping.”

In general, 50% to 70% of most businesses' customers are one-time buyers; they don't shop a second time. When you consider the initial acquisition cost for customers, and then add in free shipping if used in prospecting, this is bad news. Is there any end to this slippery slope into poor or no profitability? The only hope I can provide is the thought that if you merchandise unique products, you will have less pressure to offer free shipping. Customers will hopefully want the product assortment you have and will live with reasonable shipping fees.

The predominant sentiment I heard from the companies I spoke to was, “Wish we could all agree to not use it"—and I don’t hold out much hope of that ever happening. Businesses like Coldwater Creek, Lands’ End, Woolrich, and LL Bean have upped the game by offering free shipping with no minimum order value. Many businesses continually start and stop free shipping offers in their catalogs, e-mail blasts and on their web sites.

As we condition customers to expect free shipping, we are also making it so the customer has to be careful and read the fine print about when free shipping applies and when it expires. It may say “free shipping” on cover, have some conditions on an inside page (often page 2) and the remainder on the order blank.  But with some of these businesses you almost develop a sense that their promotions will always include free shipping. So the question is, in this business climate and considering the number of companies using free shipping, can you afford not to offer it?

Curt Barry is president of F. Curtis Barry & Company, a fulfillment consulting firm for catalog, e-commerce, and retail businesses. We offer clients expertise in business process and order management systems, inventory management systems, warehouse management systems; warehousing and distribution; call center services; inventory management and forecasting solutions; and strategic, financial, and operational planning for all business channels.

He can be reached at 1897 Billingsgate Circle, Suite 102, Richmond, VA 23238, phone: 804-740-8743; email: cbarry@fcbco.com; website: http://www.fcbco.com.