The growth and evolution of the e-commerce sector has highlighted the importance of shipping and handling (S&H) fees for business models that involve a spatial separation between customers and retailers.  The salient point is that when a physical separation exists, the firm must either subsidize the shipping services or charge fees to consumers.  The importance of understanding consumer reaction to shipping fees is apparent from the level of experimentation occurring in the marketplace.  Perhaps the best example of this activity is Amazon.com’s frequent tinkering with shipping fee schedules that provide free shipping for order sizes that exceed some threshold.  Most recently Amazon has implemented a scheme (Amazon Prime) whereby consumers can pay an annual fee that provides access to subsidized shipping rates.  Other retailers ranging from Buy.com to Domino’s Pizza have also experimented with different shipping fee structures.   

The paper provides an analysis of how shipping fee schedule design can influence customer acquisition, customer retention, order sizes and contribution provided by the shipping function.  This analysis is based on data provided by an online grocer that has also experimented with a variety of shipping fee structures.  The retailer has used fee schedules that charge higher fees as order size increases, schedules that reduce costs as order size grows and has offered promotions that waive shipping fees for all orders.  In addition to the shipping fee schedules the data also includes details on merchandise pricing, banner advertising and other e-mail based promotions. 

Analyzing response to shipping fee schedules is frequently difficult because shipping fee schedules often involve nonlinear pricing.  To perform the analysis we select a model specification that captures the nonlinear structure of the shipping fee schedules.  Rather than directly use the shipping fees assigned to order size categories, we use the differences between subsequent order size categories.  This enables our analysis to speak to both the effects of shipping fee levels and shipping fee structures that provide order size incentives and penalties. 

In terms of empirical results, we estimate the effects of shipping fee structures on customer acquisition, customer retention, expenditures by both new and existing customers and the contribution provided by shipping fees.  In general, the results are fairly intuitive as we find that higher shipping fees deter ordering rates and order size penalties have a significant influence on consumer expenditures.  More interestingly, the results suggest that customer acquisition and retention are primarily impacting by different elements of shipping fee schedules.  Customer retention is more responsive to shipping fee levels while customer acquisition rates are more influenced by the order size incentives and penalties.  In terms of average expenditures, new customer order sizes are significantly more elastic to shipping fees (levels and penalties) than repeat buyers.  There is also directional evidence that shipping fees have a greater influence on buyer behavior than equivalent changes in merchandise prices.

Furthermore, the estimated system of equations is useful for assessing the overall impact of different shipping fee structures on profitability.  A notable finding from this analysis is that “Free Shipping” promotions are unlikely to have a positive impact of profits.  The increased ordering rate from new and existing customers is unlikely to makeup for the lost revenue from shipping fees combined with smaller orders sizes.

In summary the research provides several findings that should be of value to marketing managers:  First, by varying shipping fee levels and the structure of shipping schedules (the relationship between the fees assessed for shipping different order quantities) direct retailers can significantly influence order frequency, customer acquisition and average expenditures.  Second, because customer acquisition and retention are differentially impacted by shipping fee levels and structure, shipping schedules may be used to emphasize either customer base growth or retention.  Retailers that wish to improve retention are advised to reduce the general level of shipping charges while customer acquisition can be best managed through order size incentives and penalties (that impact customer self-selection).  Third, because of the heightened attention paid to shipping fees in the online environment consumers are more responsive to changes in shipping fees than to equivalent changes in merchandise prices.  The implication is that retailers in categories where baskets tend to contain many items can benefit by lowering shipping fees and raising product prices.  Fourth, in terms of overall impact on profits the evidence suggests that shipping fee schedules that provide free shipping benefits to consumers who purchase larger basket sizes tend to be the most profitable policies.