What is the top reason 50% of customers abandon items in online shopping carts? Why do e-commerce brands incur an annual revenue loss of about $18 billion?
The answer: shipping fees.
Because of this, online retailers have shown a growing interest in membership-based free shipping (MFS) to help them recover high shipping costs and satisfy consumers’ expectations of free shipping. In this model, consumers pay an up-front membership fee in exchange for unlimited free shipping.
Nearly 40% of the world’s top retailers have adopted MFS or advertised it as a premium service in their paid membership programs. While some retailers such as Walmart and Sephora have introduced MFS with few added perks other than free shipping, other retailers have integrated MFS into their subscription programs. For example, Best Buy provides members with complimentary tech support, and Bed Bath & Beyond offers member price discounts along with MFS.
In a new Journal of Marketing study, we investigate the effectiveness of MFS. Collaborating with a top online retailer, we utilized real-world data to study how MFS impacts consumers’ purchase behaviors, including:
- how much they buy (total spending, purchase frequency, average order size),
- what they buy (purchase variety and impulse purchases), and
- net customer revenue.
The dataset spans 22 months before and 14 months after the launch of MFS.
We find that average MFS members may not initially increase their purchases, but they do so over time. Initially, consumers are more likely to exploit unlimited free shipping benefits at the beginning of enrollment when they break down large orders into smaller ones without increasing their total spending. As a result, retailers may not immediately gain incremental revenue due to the reduced profit margin caused by increased shipping costs.
However, over time, the free shipping benefit builds a switching barrier that motivates consumers to increase spending and make more frequent purchases with larger order sizes. Also, MFS changes consumers’ purchase variety and the component of shopping baskets—in other words, members purchase from broader product categories and make more impulse purchases.
Moreover, we observe a monthly increase in net customer revenue by 12.75% (an increase of $19.93 per month). This suggests that the membership fee could compensate for the increased shipping costs and be a major net revenue source.
The profitability of MFS may vary across customer segments. We find that light buyers, who were the most willing to pay shipping fees or purchase from the broadest product categories before enrollment, contribute 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 and do not exploit the free shipping benefit with a reduced order size.
In contrast, heavy buyers, normally regarded as the best-value segment, have no significant increase in revenue contribution after enrollment because 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 were unwilling to pay the shipping fee or purchase from limited product categories before enrollment.
We also show that MFS is an effective marketing instrument to increase customer retention. It is particularly helpful at increasing the retention of consumers who like to purchase from diverse product categories.
Lessons for Retailers
We offer the following suggestions for retailers:
- We suggest online retailers adopt MFS as their shipping policy. MFS can enhance retailers’ revenue because the membership fees can recoup the shipping costs. Moreover, MFS leads to increased spending and revenue over time.
- When promoting the MFS program, managers should target light buyers, who were the most willing to pay shipping fees or purchase from the broadest product categories before enrollment. Those consumers are the most likely to generate the highest percentage change of revenue contribution after enrollment.
- Managers should avoid promoting MFS to heavy buyers, normally regarded as the best-value segment, because 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.
- MFS helps retailers retain customers and consolidate customer spending.
Read the Full Study for Complete Details
From: Fangfei Guo and Yan Liu, “The Effectiveness of Membership-Based Free Shipping: An Empirical Investigation of Consumers’ Purchase Behaviors and Revenue Contribution,” Journal of Marketing.
Go to the Journal of Marketing