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01Dec, 2015

Is Free Shipping Right for Your Business?

Author Chris Wilson Category

In our earlier blogs on Free Shipping, we had looked at Benefits of Providing Free Shipping on your eCommerce Store and 12 Ways to Offer Free Shipping to your eCommerce Customers. But, is free shipping really the panacea for all your eCommerce problems? Or does it mean different to different businesses (or industries)?

Often businesses get swayed by the promise of benefits offered by free shipping and jump to implement them on their eCommerce store. While some see their profits going north, others see them declining; even when free shipping seems to be working its magic (increase sales, improved conversion, increased order size, etc.).

To help businesses, like yours, evaluate this we will look at a few things that businesses must consider before providing free shipping on their eCommerce store. To better understand, let us first consider this example.

Consider a business selling electronic products on an eCommerce store.

Data before offering Free Shipping
  Example 1
Orders p.a. 10,000
Avg. Revenue/ Order $100
Gross Profit Margin (%) 20%
Avg. Shipping Charge/ Order $5
Avg. Shipping Cost/ Order $4
Total Sales $1,000,000
Gross Profits $200,000
Profit from Shipping $10,000
Net Profit $210,000

After you decide to implement free shipping on your eCommerce store.

Data after offering Free Shipping
  Example 1
Increase in Orders (Est.) 20%
Total Sales $1,200,000
Gross Profits $240,000
Shipping Costs $48,000
Net Profit $192,000

You can see that despite 20% increase in order volume the net profit of the business has declined by $18,000. In fact, the business will make more money only when the increase in order volume because of free shipping is more than 30%.

The important thing to note here is that you should not implement free shipping just because it will bring more customers or because your customers want it. It is an important decision and must be taken after due deliberation. There can be other alternatives which can help you achieve your goal without impacting your bottom line.

Free Shipping – Things to Consider

 

1) Know your Margins

For most businesses the first and foremost criteria for evaluating free shipping is the margin (the dollar value and not as a percentage of cost) they make on the product. Margins are important because you do not want to offer free shipping, see an increase in sales only to find yourself losing money on every order or at an aggregate level. Because, the incremental revenue you earn might not compensate for the costs of free shipping that you now have to bear.

Let us relook the example we discussed above but with increased margin (the dollar value increases from $20 per order to $50 per order)

Data before offering Free Shipping
  Example 2
Orders p.a. 10,000
Avg. Revenue/ Order $100
Gross Profit Margin (%) 50%
Avg. Shipping Charge/ Order $5
Avg. Shipping Cost/ Order $4
Total Sales $1,000,000
Gross Profits $500,000
Profit from Shipping $10,000
Net Profit $510,000

 

Data after offering Free Shipping
  Example 2
Increase in Orders (Est.) 20%
Total Sales $1,200,000
Gross Profits $600,000
Shipping Costs $48,000
Net Profit $552,000

You can see that compared to example 1, where the margins were much lower, the business ends up making more money because of free shipping in example 3.

2) Know your Products

The products you sell also play an important role in deciding if free shipping is right for your business. The nature of the product – dimensions, weight, etc. determine the cost of shipping. If you deal in products which are heavy then free shipping might now work in your favor; because heavy items cost more to ship. This information, of course, has to be looked in conjunction with information on your margins – if you deal in products with high profit margin then free shipping may be doable (even if expensive) if you can maintain an acceptable gross profit percentage.

Consider this

Data before offering Free Shipping
  Example 3
Orders p.a. 10,000
Avg. Revenue/ Order $100
Gross Profit Margin (%) 20%
Avg. Shipping Charge/ Order $10
Avg. Shipping Cost/ Order $9
Total Sales $1,000,000
Gross Profits $200,000
Profit from Shipping $10,000
Net Profit $210,000

 

Data after offering Free Shipping
  Example 3
Increase in Orders (Est.) 20%
Total Sales $1,200,000
Gross Profits $240,000
Shipping Costs $108,000
Net Profit $132,000

You can see that compare to example 1, where the shipping costs are much lower, the business ends up losing more money in example 3.

3) Know your Product Demand and Competition

Before evaluating free shipping, it is important to understand the objective that you want to achieve from free shipping. A number of businesses offer free shipping because of slipping product demand or because their competition is offering it. Evaluate your businesses and determine the demand for your product, what is the competition doing. While your margins and shipping costs allow you offer free shipping to your customers, it might not make any business sense if say you hold the monopoly for the product you sell (it is exclusively available on your stores) or if no competitor is offering it. You are better of extending the same benefit to your customers through other channels like discounts, extended warranty, etc.

Note – If none of your competitors are offering free shipping then free shipping can also be leveraged as a marketing tool to gain more customers. But the downside of it could be that it might trigger an unnecessary competition in the industry.

4) Know your Suppliers and Vendors

Businesses do not necessarily have to absorb the cost of shipping; they can get innovative and explore options like drop shipping by their suppliers and vendors. Understand and work with your suppliers and vendors to make this happen and ensure that they have proper quality management systems in place. If you have retail stores you can also give your customers an option to pick-up from the nearby store.

5) Know your Customers and Orders

Today everything starts and ends with customers and free shipping is no different. Understanding your customers and orders in little more detail will help you make more informed decisions. Understand where are your customers located? Where do you ship your products? You can offer discount shipping or even free shipping to locations closer to your fulfillment centers; thereby limiting the costs that you have to absorb.

Do you offer free shipping? Or evaluating if you should? Let us know your thoughts by commenting below.

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Is Free Shipping Right for Your Business?