October 1, 2010, 11:55 AM

Go Figure

Online shoppers dearly love free shipping, but e-retailers must coldly calculate its value.

As the 2010 holiday season approaches, e-retail executives are faced with deciding which promotions to offer in what’s likely to be a highly promotional season. There’s one they know can boost sales: free shipping.

“Anytime consumers are exposed to the word ‘free’, they are engaged and significantly more likely to purchase,” says Derek Gaskins, president of Aleva Health, an online retailer of foot care, arthritis relief and other health-related products. “Offering free shipping can have a huge impact on conversions.”

Indeed, 86% of online retailers are planning to offer at least some form of free shipping during this year’s holiday shopping season, according to a recent survey by The E-tailing Group Inc.

But free shipping can also cause headaches for merchants, cutting into profit margins and creating costly expectations among shoppers. “Once you condition customers to expect free shipping, they’re going to want it all the time,” says Fred Pritchard, co-owner of online kitchen products retailer Golda’s Kitchen Inc.

To be free—or not

In effect, free shipping is for many retailers a double-edged sword, says Corey Tisdale, chief operating officer of diversified web-only retailer ShoppersChoice.com. “We know that people will buy more if we offer free shipping, but we can’t afford to eat all of our shipping costs and never pass any of it on to the customer,” he says.

So what’s a customer-hungry, cost-conscious retailer to do? Test what works among different product categories and pricing strategies—offering free standard shipping only for light-weight but high-margin products, for example, or for orders above a certain amount—and keep testing as conditions change, Tisdale and others say. And keep in mind other options, such as trimming, but not eliminating, shipping fees.

“The sweet spot comes from being analytical, knowing your competition and your average order value and seeing if you can get customers to a higher order threshold,” says David Redlich, co-founder and director of sales at ReStockIt.com, an online-only retailer of office and restaurant supplies.

ReStockIt, which has realized conversion rate hikes of 20% to 30% through free-shipping offers, has found free shipping works best when offered as standard fare on more than 100,000 of its higher-margin products. But it’s also proven effective as part of special limited-time promotions for lower-margin products. Cases of large-size Gatorade energy drinks, for example, may run with long-term free shipping, while cases of smaller Gatorade bottles may come with free shipping only occasionally.

At Aleva Health, which operates six niche health products sites including AlevaLegs.com, FocusFeet.com and SportSocks.com, Gaskins says he has tried several minimum purchase thresholds for letting customers qualify for free shipping. “Our sweet spot is $75,” he says.

At that threshold, Gaskins says, many consumers buy two products instead of one from Aleva Health, whose average product price is $40.

Do the math

At BedBathstore.com, a web-only home furnishings retailer based in Lynbrook, N.Y., chief operating officer Mike Reichman uses a spreadsheet tool developed in-house to periodically crunch the numbers associated with shipping offers.

The spreadsheet tracks the performance of certain key metrics—including total revenue, operating margin, number of orders, number of customers who viewed a free-shipping offer, average shipping cost per order, average order value of shipped orders, and the average conversion rate for a free-shipping promotion—against variables associated with particular promotions, such as the threshold amount a customer must spend to get free shipping.

The retailer will also look at such data over a 90-day period to determine what’s working best overall, considering the impact on conversion rates, sales and profits. “Based on our current data, an $89 threshold for free shipping is best,” Reichman said in an interview last month. “We found that it was more profitable than a $79 threshold.”

Free by ground only

BedBathstore.com conducts tests of different shipping offers every two or three months. A prior test, for example, showed a $99 threshold for free shipping produced the best combination of sales and profits.

Reichman and other retailers have also found that free-shipping offers produce the best financial returns when limited to standard ground shipping. “Customers already expect to pay extra for expedited or white-glove delivery, so free shipping for these faster and higher-end shipping services may help only marginally with conversions—and the huge increase in shipping costs may not be worth it,” says Tisdale of ShoppersChoice.

But many consumers, he adds, view shipping fees as the necessary evil part of online shopping, one that often deters them from completing an order. “If you can get rid of that evil, you make it easier for them to purchase,” Tisdale says. “Free shipping is effective in reducing cart abandonment.”

Continuous testing is required because much can change in the free shipping profit and loss equation. Shipping carriers may adjust their fees, product costs go up and down, and consumers buying trends may shift.

BedBathstore.com, for instance, has observed that many shoppers appear to be reacting to the slow economy by purchasing only what they need and falling far short of the $89 minimum required to obtain free shipping. “In this economy, some customers would rather pay for shipping than buy more products to qualify for free shipping,” Reichman says.

To maintain sales among economically pinched customers without absorbing the cost of dramatically dropping its free shipping minimum, BedBathstore tested reducing the flat rates it charges for shipping. It found that by dropping that rate $1 across all of its shipping categories, starting with the basic fee of $5.99 reduced to $4.99, it realized a 7% increase in conversion rates across all paid-shipping orders, Reichman says.

Dealing with carriers

Making shipping offers attractive to customers as well as profitable overall for the retailer takes more than just the ability to crunch cost and revenue figures. Reichman says he’s able to negotiate advantageous rates from his primary carrier for orders of five pounds or more, UPS, because of his volume of business.

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