The free shipping dilemma: what’s the right order amount?

Free shipping is popular among both shoppers and merchants

It is common knowledge in the ecommerce world that online shoppers have become accustomed to obtaining free shipping on their orders, at some level or another. An article recently published by Internet Retailer (Striving for free: As free shipping becomes a must-have service, retailers crunch their numbers to make it work) pointed out many interesting elements to this crucial part of the “marketing mix” adopted by an ecommerce store.

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  • 89% of ecommerce merchants surveyed by The E-Tailing Group used conditional free shipping as one of their top 3 sales boosting strategies
  • 52% of online retailers offered some form of free shipping in Q4
  • 75% of online shoppers surveyed by AlixPartners said that they were willing to wait at least 5 days for the order to arrive, in shipping were free.
  • Offering free shipping on all orders (no order amount threshold) can cause a decrease in the average order amount (more orders, smaller). This can lead to serious issues if the decision to offer free shipping had been made based on calculations that used a higher average order amount.
The article talks about both unconditional (e.g. UPS Ground always free) and conditional free shipping (e.g. UPS Ground free for orders above $69). In the remaining part of this blog post, we will refer to free shipping always as “conditional” free shipping.

Will it work for your store?

The issue is clear: free shipping can kill already low margins. Stores that offer heavy, low-margin products find it impossible to offer it. On the other side, merchants that have a catalog full of light, high-margin items, have no problem providing some sort of free shipping option. Most stores are right in the middle of those two extremes, and making a decision is not easy.

The only way to make it work is to find a good formula where an increase in the average order amount leads to gross margins that at least partially offset the absorbed cost of shipping those orders free of charge.

In order words, offering free shipping allows you to make more money – on a per-order basis – and that pays (at least partially) for the cost of shipping those orders. “Partially” might be OK if you see free shipping as a marketing cost, and therefore it makes sense to absorbe part of its cost as part of your marketing budget.

Whether you want to cover all or part of the shipping cost, the key is an increase in the average order amount, triggered by offering free shipping. The idea is that customers will add more products to the cart to get to the amount above which you offer free shipping, and that amount is higher than the average order amount for your orders in absence of free shipping.

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Determining the right threshold (order amount that triggers free shipping)

Assuming that you are not currently offering free shipping, and you are evaluating this idea, how you can you attempt to calculate the right amount to set as the free shipping threshold. It’s not easy, and it certainly changes from store to store, but here is a basic idea (there are certainly more sophisticated ways to do it). Note, this method assumes that there is some order history in the store.

  1. Export all orders for the last 6 months or so
  2. Open the exported data in MS Excel
  3. Using filters, locate the orders that were shipped using the shipping method that you expect to provide free of charge (e.g. UPS Ground)
  4. Again using filters, order the remaining orders by order amount
  5. Now remove the bottom 5% and the top 5% orders, based on order value
  6. Calculate the average order amount for the remaining orders

Now that you have calculated a pretty accurate average order amount, the next step is to decide how much higher you want that order amount to be in exchange for offering free shipping. The calculation here gets trickier. Here is a suggestion:

  • Using the same spreadsheet, filter orders that have an order amount around the average (e.g. if the average is $42, you could filter orders with an order amount between $39 and $45).
  • For those orders, calculate the average shipping amount (if the shipping amount is in a column that contains an array of data, you can convert it into separate features using the Data > Text To Columns feature).
  • At this point, you could calculate how much additional margin you need to cover that amount, using this equation:

Free shipping threshold = Average Order Amount + (Average Shipping Amount / Gross Margin %)

For example: let’s assume that store XYZ has the following metrics:

  • Average order amount before free shipping: $42
  • Average shipping amount (calculated as described above): $6.75
  • Average gross margin: 23%
  • The calculation for this hypothetical store becomes:

Free shipping threshold = $42 + ($6.75/23%) = $71

So store XYZ may decide to offer free UPS Ground shipping for all orders over $71 (or maybe a more marketing friendly $69).

What do you think? Let’s discuss in the ProductCart forums.

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