Can Retailers Take the Free Out of Shipping?

Tucked away inside the wave of enthusiasm over the strong 2005 holiday shopping season — which saw sales exceed forecasts while shoppers expanded their buying to new categories — is a slight complication that could trip up some retailers hoping to turn those great sales into great profits.

One of the big drivers of online shopping was free shipping, which was being offered across the Web — but those giveaways tend to grind down profit margins, especially when they aren’t keyed to a significant minimum purchase size, as was the case in the run-up to Christmas 2005.

In fact, earnings reports in the next several weeks could bear evidence that product discounts and free-shipping promotions steered some companies out of the black.

Already, Overstock.com has warned that full-year profitability, which it had hoped to achieve on the back of a strong holiday season, won’t occur until next quarter at the earliest. Others could follow suit. “Continued heightened competition could hurt profitability,” said Goldman Sachs analyst Anthony Noto.

The free-shipping bonanza for shoppers came even as costs of shipping were going up — as major shippers, including the U.S. Postal Service, FedEx and UPS, sought to boost rates to keep up with rising fuel costs.

“The issue of shipping has been a difficult one for a lot of retailers,” Nielsen//NetRatings senior analyst Heather Dougherty told the E-Commerce Times. “It could be one of the issues from this year that we see companies struggling with how to change in 2006.”

Free for All

In years past, free shipping typically came in exchange for a minimum order size of US$100 or $75, Dougherty noted.

“A lot of merchants were so eager to drive online sales this year that they eliminated thresholds,” she said. “It’s a dangerous game, and consumers are likely to get hooked on that again. Next year, they’ll ask, ‘Why should I spend $75 now when you gave it to me for free last year?'”

In fact, more than 75 percent of retailers were offering some sort of seasonal free-shipping promotion online, up from about 64 percent last year, according to a report from Forrester Research released during the holiday rush.

More than half of the abandoned shopping carts in one study conducted by Forrester were tied directly to shoppers’ unwillingness to pay the shipping costs that came up when they were completing a purchase.

Few retailers have as much experience struggling with the free-shipping conundrum as Amazon.com. Amazon offered free basic shipping on orders of $25 or more but pushed upgrades during the holiday season, including a shipping program that provides unlimited free shipping on all orders for a one-time payment of $79 per year.

Amazon has gone from seeing a profit from shipping and handling charges to seeing growing losses tied to delivering goods. Last fall, Amazon CEO Jeff Bezos said efforts to boost sales through shipping discounts would be “expensive,” in part because higher transportation costs were being passed on to the e-tailer.

Catalog retailers have long struggled with the right recipe for shipping costs and the question has been brought into focus online by the aggressive posture of Amazon.com, Lee Helman, senior vice president at Gruppo Levey, a boutique investment firm that works with multi-channel retailers, told the E-Commerce Times.

The Amazon Formula

“I think everybody is looking at [how] Amazon has done it and wonders how they can keep doing it,” Helman said. “People are constantly looking at how to shift their shipping and handling charges. If you look at catalogs, you’ll see 10 different approaches to it.”

Amazon is not only pressuring competitors, but also conditioning consumers to expect free shipping as part of the online experience, Helman said. Four out of five shoppers now consider free shipping an important factor in deciding whether to buy something online, found a recent survey by BizRate.com.

“Everybody wants to get the best deal they can, and all the different shopping search engines and comparison sites have made it very easy to compare the terms of a deal,” Helman explained. “It’s like a corporate transaction now. It used to be all about price, but now the consumer looks at all the terms of a deal. If they can get something shipped for free, that’s going to be pretty compelling.”

The free-shipping problem is most acute for companies that are selling mass merchandise, rather than specialty retailers. “If my site is the only place where you can get something, you’re going to be willing to pay the shipping costs,” Helman pointed out.

Some retailers — notably Wal-Mart.com — defied the trend, sticking with paid shipping on all orders. Backers of that approach say the costs of free shipping are typically hidden in product costs.

Still, there are psychological advantages to free shipping. Some consumers are more willing to buy if they feel they are getting a deal on shipping. It also speaks directly to the No. 1 reason that shoppers turn to the Web: convenience.

Channel Surfing

Multi-channel retailers have an added option for dealing with the problem. Companies such as REI offer free shipping of items on their Web sites to their stores. The promotion has the added benefit of bringing customers on site to pick up the often bulky items — tents, bikes and kayaks for instance — where they are likely to spend additional money.

Free shipping may be just one more item in the arsenal of tools to convert shoppers to buyers, but retailers are increasingly aware of the need to use it judiciously, much as they would any other discount or promotion — as part of a larger strategy to drive qualified traffic.

“When we did free shipping, sometimes we would pass the shipping cost onto the consumer in the way of higher prices, or we would absorb it ourselves depending on the season,” Tom Bianco, CEO of Atlantic Consulting and Sales, told the E-Commerce Times. Atlantic runs several niche e-tail sites, including weddingfavorstogo.com and a wedding ring site.

“What you are really talking about is conversions and traffic. We specialize in getting the most traffic possible at the lowest cost to our sites and then converting that traffic to sales using best conversion practices,” he said.

“On our ring site, we always offer free shipping. It only costs $10 to ship a ring, and that product can absorb the cost due to the higher price point and margin,” Bianco explained. “None of these [shipping promotions] work as well as high-qualified traffic and a site that can convert without giving away the farm.”