Making money from free shipping

Hamish Mexted Increasing Profit

Offering a free shipping option is a sure fire way to increase your customer conversion rate. At the same time, it’s also a sure fire way to lose money if it’s not done right.

So, is there a way to make free shipping profitable? Of course there is…keep reading.

 

Four simple steps

There are four simple steps everyone can work through to increase their profit on free shipping offers. If you get your calculations right, you can even increase your bottom line by 15-30% possible.

The steps are:

1. Set a Baseline
Work out what your conversion rate is with and without free shipping.

2. Create Threshold
Set or increase the minimum order value required for being eligible for free shipping and check if there was an improvement in your overall gross profit.

3. Set Restrictions
Check what happens to your gross profit if you only offer free shiping on particular products – for example those that have a higher profit margin.

4. Increase Prices
Make all your product prices more expensive to compensate for the loss you take on free shipping and then see what it does to your profit.

 

Here’s a few examples on how our customers have used these steps.

 

 

Baseline

First up, you need to check how much the free shipping offer will increase your customer conversion rate. If you’re not increasing turnover through the free shipping you may as well stop now. Put another way, if the free shipping doesn’t make your product more attractive, you’re not going to increase your bottom line.

Test the conversion rate with and without the free shipping option. Just change the header and include free shipping.

We recommend setting up two different versions of your website, or only offering it to every second new customer you bring in.

From there, you’ll have actual results to compare your conversion rate before and after you offered the free shipping. Here’s some results:

  • Conversion rate improvements + 30%
  • Average size order value +  4%
  • Net margin – 40%

The impact on your bottom line is therefore a reduction in profit of 19% (for the accountants reading this the calculation is 130% x 104% x 60%).

This is your basement improvement in customer conversion. It shows that you have a huge potential in rising your conversion rate, although it’s coming at the cost of reduced margin.

The next question becomes what we do to increase the margin on these increased sales.

 

 

Shipping Thresholds

We want to save your margin so what if we force the customer to spend more money to get the free shipping.

In our first example we offered free shipping for orders over $100. Let’s look at what happens when we offer the free shipping for orders over $125, and then for orders over $150.

For orders over $125:

  • Conversion improvements + 25%
  • Average order value +  8%
  • Net margin – 20%

So, instead of the margin being down 40% initially, now it’s only down 20%.

For orders over $150:

  • Conversion improvements + 15%
  • Average order value +  6%
  • Net margin – 25%

Here, the margin is down 25%.

The result shows that we’re better only offering the free shipping for orders over $125. The $100 threshold is too low, and the $150 is too high, scaring customers off.

 

Restricted Shipping

Another version of offering free shipping is when you only offer it on products which have a low shipping cost.

This type of offer is ‘safe’ because you know you can more or less offer it indefinitely (i.e. the cost is never going to rise significantly).

These restrictions usually work best when you have one product main product and the shipping cost of that product is low.

If you’ve got multiple products then only offering free shipping on that one product is unlikely to significantly increase your margin.

 

Increase Prices

The final option is to combine free shipping with a higher product price. Normally increasing prices will lover the conversion but by combining it with free shipping and threshold limits will generally increase the overall profit.

Here’s what you might see with increased prices and a $125 free shipping threshhold:

  • Conversion improvements + 16%
  • Average order value +  12%
  • Net margin – 5%

Here, the reduction in margin from the increased cost of shipping is offset by the higher prices and the higher conversion rate. The overall impact on your bottom line is an increase in profit of 23%.

Note that the success of this option may be dependent on how competitive your market is.

For businesses which are unique/non-competitive niches you can probably (*) successfully combine free shipping with a product price increase.

On the other hand, for commodity type industry where you’re selling common products, this strategy may not work so well. That said, it’s always worth testing because you don’t know what you don’t know.

 

Conclusion

Don’t just jump in and offer free shipping alone. You need to calculate what free shipping does to your conversion rate, what the thresholds might do, how restrictions impact on your sales and finally increasing your prices. Finding the ideal combination is a tricky process, but will in time increase your bottom line.

* Now obviously this is all of a very general nature. Before you rush out and try any of this, please contact iif Chartered Accountants to run through the implications for you and your business.