Can Retailers Escape the Scourge of Free Shipping?

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If retailers are hurting today, among the wounds — both self-inflicted and imposed from outside — is free shipping. On the demand side, customers are increasingly expecting free delivery and even free returns. The problem for retailers, of course, is that free shipping cuts deeply into profits.

The innovation bubbled up as a way to get customers comfortable with the idea that online shopping could be no more expensive than physical visits — that it leveled the online total purchase tab with the physical-store receipt.

It worked. The customer has moved online, and now retailers find themselves on the horn of a dilemma. The cost of free shipping to retailers is high, but the cost of yielding loyalty and market share to a competitor is even higher. How did retailers get here?

“One of the first online retailers was Zappos,” says Wharton marketing professor Barbara E. Kahn, who is also director of Wharton’s Jay. H. Baker Retailing Center. “People had thought no one would buy shoes online, because you have to try them on, but Zappos started free shipping and free returns, so that let people buy a size bigger and a size smaller, and free shipping and free returns minimized the risk. That set up the expectation of free shipping. For most of the legacy retailers, because of the costs of the delivery and the returns, they frequently make less money online than in physical stores. The costs are very high.”

Now, among the retailers offering free shipping are Dell, Kate Spade, L.L.Bean, Neiman Marcus and Nordstrom. Last holiday season, Target and Best Buy introduced free shipping, and retailers are reporting that the point at which they often lose an online customer is at the very end of the transaction — when shipping costs get added.

So, what now? Given that online shopping is woven into habit for most U.S. shoppers, might retailers be able to cut out free shipping?

“It might be too hard to walk that back now,” says Wharton marketing professor Peter Fader. “But there are so many areas costing retailers even more — promotions they run — that they should be trying to wean themselves off of.”

Instead, retailers will probably have to find other ways of recouping the cost of free shipping. Ironically, the answer may lie in a phenomenon best illustrated by Amazon, which is of course the source of much of the scramble for market share. Amazon refers to its Prime service as a way to get “fast, free shipping and more,” and many customers themselves refer to the service as being free. But of course, they are paying $10.99 a month or $99 per year for their “free shipping.”

People are good at creating “different mental accounts,” explains Fader. “They keep one account for membership and they are paying for membership, and that is coded entirely separately from this transaction. They are part of the club and they forget about the fee. It’s very clever on Amazon’s part, surrounding the customer with benefits that give the impression that the company has your best interest at heart. People like this.”

“Free shipping is certainly one aspect of how Amazon has recalibrated our consumer brains, to be honest,” says retail futurist Doug Stephens, author of The Retail Revival. Stephens says that Amazon innovations like quick and efficient searches, intelligent recommendations based on prior browsing history, fast and free shipping and making consumers increasingly reliant on online reviews “fundamentally changed our wiring as consumers” to such an extent that “many experiences we have with other retailers seem somehow dissonant now.”

“Free shipping is certainly one aspect of how Amazon has recalibrated our consumer brains, to be honest.”–Doug Stephens

Fast, Cheap and Out of Control

Studies and surveys show that customers increasingly want their stuff, they want it now, and they don’t want to pay extra. The number of customers who said they would pay nothing extra for next-day delivery increased to 38% from 22% between 2015 and 2016, according to a September Deloitte online survey published in the Wall Street Journal. The number willing to pay more for same-day delivery showed a similar increase in resistance, with 32% in 2016 saying they would not pay extra, up from 24% in 2015.

One study found free shipping to be the top incentive to online buying, “with almost nine in 10 consumers reporting that free shipping would make them shop more online,” according to a survey by Walker Sands Communications of 1,400 U.S. consumers. “This number has steadily increased over the past two years and has become significantly more influential than other logistics considerations, even as same-day shipping becomes more prominent,” says the firm in its “Future of Retail 2016” white paper.

Exactly how much is free shipping eating into profits? Jerry Storch, CEO of Hudson’s Bay Company, which includes Lord & Taylor and Saks Fifth Avenue, has pointed to the high costs as well as the larger, fundamental problem of e-commerce: “The economics are clear,” he said at the Shoptalk conference in 2016. “Direct-to-home has a supply chain cost three times higher than a store-based model. So, when we say the internet retailer can charge less, how can that be? Maybe this is why so many of us have so much trouble emulating Amazon’s model and making any money. It’s because it’s really expensive and it is also why Amazon [has] had trouble making money on merchandising sales. It’s a very expensive model and it’s not less expensive than the store-based model.”

The expectation for free shipping, and the heightened awareness around price generally, is something retailers brought on themselves, says Fader. “The reason we are having this conversation is because it’s a race to the bottom. Anything that retailers do that calls attention to price is not in their best interest. That plays to Amazon’s strength, and most retailers can’t win that battle.”

Amazon and other mega-retailers can negotiate lower shipping rates than smaller retailers, and Amazon Prime U.S. membership has doubled in the past two years, to an estimated 80 million members. Prime carries an increasing number of benefits, and Prime members spend more than non-Prime customers: an estimated $1,300 versus $700 per year, according to Consumer Intelligence Research Partners.

“Free shipping is not going away since Amazon knows that it is painful to them but much more debilitating for their competitors,” says Wharton emeritus marketing professor Stephen J. Hoch. “Amazon Prime is a two-part tariffs pricing policy, where Amazon sells stuff for close to cost and makes all their profit on the fixed membership fee, just like Costco. And free shipping is just another cost that Amazon absorbs in order to get the flat fee and longer term loyalty.”

“Free shipping is not going away since Amazon knows that it is painful to them but much more debilitating for their competitors.”–Stephen J. Hoch

Very specialized sellers don’t compete with Amazon and so should have little trouble passing on shipping costs to their buyers, Hoch adds. “I might also point out that, due to huge investments in logistics and IT along with massive scale, Amazon’s shipping costs are likely significantly lower than most competitors – even Walmart.”

While Amazon invests in the delivery fleet of the future, Walmart has fired a low-tech salvo in the struggle between the two retailers. It recently started a pilot program in which store employees drop off online orders to customers on their way home from work. “There is really strong overlap between where our associates are already heading after work and where those packages need to go,” a Walmart spokesman told The Washington Post.

How Fun Can Be Better Than Free

One way in which retailers might be able to side-step the free-delivery trap is to give customers another system of options and incentives — “to try to get the customer once again to bear the cost of that last mile,” says Kahn, “so even if you are shopping online, if you pick it up in person in the store, that saves a lot of money.”

Another option, she suggests, is giving customers a better price on an item if they are willing to wait until a delivery truck is already scheduled to come to a particular neighborhood.

Ultimately, says Kahn, “the competition is going to be at the platform level. For example, if you tell Alexa you’re out of milk, then you’re going to be getting it from Amazon — when consumers shop for things that need to be replenished, it will be a big advantage when a voice recognition system is in the house, particularly if it gets to the point where everything is automatically delivered. Once people are locked into a system, it’s a loyalty loop; if Amazon — or Google or Facebook — can make shopping super-convenient, and deliver items easily when you need them at a competitive price, people will stop going to the physical stores for these kinds of items.”

But another big way retailers can alleviate the burden of free shipping, and take on Amazon, is by doing what the best of them have done well for so long: making shopping a joyful experience. Amazon is all about efficiency. Even its bricks-and-mortar stores telegraph this ethos. Like the website, the new Amazon bookstore model is cheaper for Prime customers — again, highlighting price — and stocks only 3,000 of the most popular titles. The store serves as both a big advertisement for Prime and a tidy way for Amazon to eliminate some of its own cost of free shipping. It has not been getting good reviews.

“Amazon’s first bookstore in New York City sucks the joy out of buying books,” was the headline on one recent review of the experience at the relatively small (4,000-square-foot) store on Columbus Circle. “For the most part, the layout creates clutter that mirrors Amazon’s own site, except without the ease of actually getting the book you want quickly and cheaply,” writes Thu-Huong Ha in Quartz.

“They’ve taken the fun and joy and treasure-hunt aspect out of retailing, and made it into this cold, calculating science, and you just don’t want to play that game.”–Peter Fader

“They’ve taken the fun and joy and treasure-hunt aspect out of retailing, and made it into this cold, calculating science, and you just don’t want to play that game,” says Fader about Amazon generally, pointing to the AEIOUs of retailing as a means of focusing on what matters to shoppers. A is for advice, which great sales people are skilled at offering; E is for experiential value, such as providing snacks or samples as customers browse a pleasant, attractive store environment; I is for interaction, as in with humans, who might be specially trained to provide different service levels for the best customers; O is for opportunities that are often missed online that misinterpret past buying histories to make inappropriate recommendations or that miss cross-selling opportunities; and U is for understanding, which traditional retailers often don’t gather efficiently from their own salespeople about what customers are looking for and how the experience might be improved.

“There’s no P for price in there,” says Fader. “It’s a matter of creating a competing proposition that people just want to buzz about. Part of that is experiential, making it a joy to interact with that company, and part of it is going to be personalization — the kinds of things Amazon does not want to do that could raise costs.”

In other words, says Fader, it’s about retailers sending the message to the customer: “We anticipate your needs, it’s not just about efficiency and price.”

The extent to which retailers are being threatened by free shipping depends on which end of the spectrum a retailer positions a brand, says Stephens. “Right now, there are two kinds of shopping — fast shopping and slow shopping. Fast is commodity items, as in it’s 10 at night and I’m in my pajamas and I want to find what I need from Amazon. And I think there is a place for fast shopping. It’s about breadth of assortment, ease of finding it, and how cheaply you can get it.”

If you go up against Amazon, then fast and free shipping is an essential arrow in the quiver, Stephens says, and Walmart is being drawn into that fight. “But if you’re a brand about slow shopping, it’s about having a rich, immersive, tactile and maybe even emotionally connected experience, and then the emphasis is taken off [of free shipping],” Stephens notes. “Some customers might abandon their cart when it comes to paying for shipping, but many will say it’s worth the difference.”

Which companies have been good at differentiating themselves? Stephens believes Sephora succeeds. “You could argue that cosmetics are commodity items,” he says. “They don’t necessarily sell things that can’t be purchased elsewhere, but they’ve managed to create an experience online and in stores that is elevated compared to the Amazon experience.” He notes that Sephora has strong content, good technology in stores and “they hire true brand ambassadors – not just salespeople who are half there. They get customers to bypass Amazon and go to the store itself.”

“Amazon is not the end of competition, or the end of fun. People still have a need for that. And that’s what it should be.”Barbara Kahn

Kahn agrees that experience is critical. “Amazon is positioned to take over these kinds of basic-need items. They offer large assortment, convenience and fair prices,” she says. “But I think people will still find value and fun in shopping, or they will respond to a cool new brand. The value added could be experiential or aesthetic, something different that will attract people, and consumers will go to that.”

With Amazon, we really are in a paradigm shift in terms of change in shopping behavior, Kahn adds. “Long ago, Walmart broke the mold and radically changed the grocery business, and the big box stores broke the mold. But Amazon is not the end of competition, or the end of fun. People still have a need for that. And that’s what it should be. Shopping is not always about just pushing a button and then something arrives on your doorstep. People will still enjoy ‘retail therapy.’”

Kahn also doubts that free shipping is going away, but says the economics of it will be hard to sustain without some mitigating factor. “I do think there will be some kind of shake out,” she says, “and then it’s maybe you get free shipping, but you are paying a subscription price, or the price is built in somewhere else. It’s like the way you are lured into a store to get some incredible discount on something for sale, and then there is a higher premium on the other things you bought along with the sale item. You get free shipping, but the margins come from somewhere else.”

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