Examining the Impact of Membership-based Free Shipping
By Caroline Barnhill
There’s just something about that “free shipping” offer that entices online shoppers. In fact,
shipping fees are the top reason that drives around half of customers to abandon online shopping carts, leading to an $18 billion revenue loss annually. So should all companies switch to a free shipping model? Not necessarily.
Online retailers have to grapple with consumer demands for free shipping while balancing high shipping costs. Recently, many online retailers have shown a growing interest in a novel membership-based free shipping (MFS) policy, in which consumers pay an upfront membership fee for unlimited free shipping. Nearly 40% of the world’s top retailers, such as Walmart, ASOS and Sephora, have adopted MFS policies. But is it working?
Fangfei Guo, Poole College assistant professor of marketing analytics, recently published a study, “The Effectiveness of Membership-based Free Shipping: An Empirical Investigation on Consumers’ Purchase Behaviors and Revenue Contribution,” in the American Marketing Association’s Journal of Marketing. We sat down with her to learn more about what she found.
Q&A with Fangfei Guo
What did your research look at?
To answer this important managerial question, our research looked into the effectiveness of MFS. We collaborated with one of the world’s top online retailers that adopted MFS. By analyzing its customer transaction data, we find that MFS enrollment does not lift average consumers’ spending at the beginning of the enrollment, as large orders are broken down into smaller ones. Retailers do not gain incremental net revenue due to the increased shipping costs during this period.
However, MFS can help retailers generate increased spending and net revenue over time since consumers purchase more often with larger order sizes, purchase variety and impulsive purchases. In addition, we find a greater increase in net revenue for light buyers, variety seekers and those willing to pay shipping fees before enrollment. Surprisingly, the conventional best-value customers, heavy buyers, might hurt retailers’ revenue after enrollment, as they are more likely to take advantage of free shipping benefits with reduced order size.
How many companies did you study?
We collaborated with one of the world’s top online retailers that experimented with various shipping policies, including the membership-based free shipping policy. Given the popularity of MFS, our research findings can be generalized to other retailers who adopt or tend to adopt this shipping policy.
Did you find membership-based free shipping to be profitable for companies?
Our research suggests that MFS is profitable for retailers to adopt for the following two main reasons. The unlimited, free shipping benefits that MFS offers would build a switching barrier that encourages larger order sizes, higher shopping frequency, increased purchase variety and impulse purchases over time. Meanwhile, the upfront membership fee would recover the heavy shipping costs, eventually increasing net revenue contribution.
MFS can also help retailers strengthen customer relationships in the long run, as it effectively reduces customer churn. It is particularly helpful in increasing the retention of consumers who seek to purchase from diverse product categories.
Did anything surprise you about your findings?
The first surprising finding is that MFS does not lift consumers’ overall spending during their membership period, and consumers’ purchase behaviors change over time under MFS. We find that an average MFS member may not initially increase her purchases, but over time she does.
Consumers are more likely to exploit their unlimited free shipping benefits at the beginning of enrollment. In this period, consumers break down large orders into smaller ones without increasing the total spending. Retailers may not gain incremental revenue due to the reduced profit margin and increased shipping costs. However, the free shipping benefit builds a switching barrier that motivates consumers to purchase more frequently with larger order sizes over time. It eventually leads to increased spending. Meanwhile, the upfront membership fee is an important revenue source and can compensate for the shipping costs, leading to increased net revenue in the long run.
The second surprising finding is that the profitability of MFS varies across customer segments. We find that heavy buyers, normally regarded as the best-value segment to target, have no significant increase in their revenue contribution after enrollment, as they are most likely to exploit free shipping by splitting large orders into smaller ones or purchasing from categories with a lower price level. The MFS program even loses money from heavy buyers who are unwilling to pay the shipping fee or purchase from limited product categories before enrollment.
In contrast, light buyers, who are the most willing to pay shipping fees or purchase from the broadest product categories before enrollment, are the most responsive customer segment that has the highest percentage change of revenue contribution after enrollment. This is because these consumers tend to consolidate their spending after enrollment, with a much higher purchase frequency but not exploiting the free shipping benefit with a reduced order size.
What do you think businesses that are considering moving to an MFS model need to know?
We offer the following suggestions for retailers who adopted or tend to adopt MFS:
First, we suggest online retailers adopt MFS as their shipping policy. MFS can enhance retailers’ revenue as the membership fees could recoup the shipping costs. Moreover, MFS leads to increased spending and revenue contribution over time.
When promoting the MFS program, managers should target light buyers who are the most willing to pay shipping fees or purchase from the broadest product categories before enrollment. Those consumers are the most responsive customer segment to generate the highest percentage change of revenue contribution after enrollment.
In contrast, managers should avoid promoting MFS to heavy buyers, normally regarded as the best-value segment, as they are most likely to exploit free shipping by splitting large orders into smaller ones or purchasing from categories with a lower price level. The MFS program can even lose money from heavy buyers who are unwilling to pay the shipping fee or purchase from limited product categories before enrollment.
To conclude, we recommend that retailers look into MFS as an effective shipping policy. It meets customers’ needs and can help retailers boost revenue if they target the right customer segments. It will also help retain customers and further consolidate customer spending.
Are there any big questions this study revealed that would be worthwhile to study next?
Some retailers add additional benefits to the MFS program subsequently, such as streaming service on its own or partner platforms and premium customer service. The perceived value of membership-based free shipping benefits may differ for those subscription programs with additional major perks. It would be interesting to learn which membership program is more effective. Second, we focus on the effect of MFS on customer retention, but factors that impact their membership renewal and cancellation decision also have significant managerial implications. We leave these analyses as a fruitful topic for future research.