Why Free Shipping Isn't Free

If you're like most brands, you have an e-commerce strategy that somewhere supports a "free shipping" strategy.  The biggest issue with this strategy is that it's not free...not for you or the freight companies.  So who is getting the better deal here?  Here at Verde Fulfillment USA, we encounter this exact issue all the time with our client base. 

Here are some interesting stats for you:

  • Over 80% of consumers will check three places online before making a purchase
  • Over 10% of all purchases are returned, resulting in 3.8% of profits lost
  • Almost 40% of online sales are through a mobile device
  • Offering free returns and exchanges can increase conversions by almost 65%

Back in 2002, Amazon came out with their "Free Super Saver Shipping" for orders over $99, so they could test the market and up-sell customers to buy more and get free shipping.  It worked.  For fifteen years, brands have been chasing and getting increasing frustrated with free shipping, and how to tame it and make it work to their advantage.  When speaking with potential clients here at Verde, we encounter businesses not understanding this important part of their business.  When offering free shipping, it all comes down to math.

For every product you sell, you have a cost-of-goods associated with it.  You buy it or have it manufactured for a cost.  These are your direct costs.  Next, add in your transport fees from your manufacturer to your fulfillment center, marketing dollars per piece, customer acquisition and ad cost per piece, as well as your cost of fulfillment per piece.  These are your indirect costs.  Together, these costs make up your cost of goods sold (COGS).   

Here's an example of the math with a small accessory item:

  1. Manufactured Cost = $5.00
  2. Ocean/Inland Transport Cost per Piece = $0.50 (10% of cost)
  3. Marketing Cost per Piece = $1.00 (20% of cost)
    • Includes online Ad cost & customer acquisition cost
  4. Fulfillment Cost = $2.50 (should be less than 10% of your sales price)

Total Cost of Goods = $9.00 (COGS)

A typical business formula says to double this cost of $9.00 to $18.00 for your wholesale cost, then double that again for your retail cost (MSRP) to $36.00.  If the majority of your sales strategy is B2C or direct-to-consumer, then you have a margin of 75% or $27.00.  If you want to factor in your free shipping strategy, you have to take away margin by reducing your profits to account for the cost of shipping the item(s) for free, which YOU are paying for.  

  • If your item is less than 16oz with all shipping materials, then it can ship by USPS First Class for the lowest possible price.  Typical cost would be around $3.25 that you will pay for.  
  • If your item is over 16oz or 1 pound, then you will need to ship by FedEx SmartPost, FedEx Ground or USPS Priority.  At Verde, we have better SmartPost rates than USPS Priority, so we'll use that as an example.  1 pound shipment with materials would be around $7.00 that you will pay for.
  • You can either eat the shipping amount and suffer margin-loss, or add it into your COGS. 

I hope this is starting to make good sense to you about the margin-loss by offering free shipping.  So how can you combat this?  Very simple, you either raise your prices to account for the cost of shipping in your COGS to maintain a healthy profit margin, offer free shipping after they purchase a certain amount, or you eat it.  

The best way to offer a free shipping strategy without breaking the bank:

  • do it periodically around a specific sale when you want to get a burst of sales moving quickly (promotional)
  • clearing out old inventory to make room for the new
  • during an introduction to a new product or product line
  • use of a discount code for signing up for your newsletter or FB page  

The most important thing is to only offer free shipping for only short periods of time.  At Verde we have clients offering free shipping only periodically, based on this strategy, and they are healthier companies by maintaining a solid profit margin rather than just offering free shipping 24/7.

We also have clients who offer $5.00 shipping during sales only over a specified period of time.  The shipping may cost above or below the $5.00 mark, but at the end of the day, they are not losing money on shipping and maintaining healthy margins.  A must if you are going to survive the world of e-commerce.  Remember, when offering free shipping, it isn't free.  But having a solid strategy of how to absorb the costs will keep you in business and competitive for many years to come.

Feel free to drop us an email with your own feedback and comments.  They are always welcome, as we are all in this together to help make you and your company as profitable as possible.