Shipping Fees or Shipping Free? A Tale of Two Price Partitioning Strategies in Online Retailing

Abstract

In this article, we study the price partitioning decisions of online retailers regarding shipping and handling (S&H) fees. Specifically, we analyze two partitioning formats used by retailers in this context. In the first scenario, retailers present customers with a price that is partitioned into a product price and a separate S&H surcharge (the PS strategy); in the second, customers are offered free shipping through a non‐partitioned format where the product price already includes the shipping cost (the ZS strategy). We first develop a stylized game‐theoretic model that captures the competitive dynamics between (and within) these two formats. Analysis of the model provides insights into how both firm and product level characteristics drive a retailer's strategic choice regarding which partitioning format to adopt and, hence, determines the equilibrium market structure in terms of proportion of ZS and PS retailers. Subsequently, we conduct empirical analyses, based on product and S&H prices data for two different product categories (digital cameras and printers) collected from online retailers, to validate all the results of our theoretical model. We establish that PS retailers charge lower product prices than ZS ones, but the total price (product + S&H) charged is higher for the first group. The S&H charge for PS retailers can be significant—it is, on average, 5.4% (printers) and 3.0% (digital cameras) for our two product categories. Furthermore, retailers which are popular and/or face risky cost environment are more likely to opt for the ZS strategy, while retailers whose portfolio mostly includes large or heavy products with high cost (S&H)‐to‐price ratios usually choose the PS strategy. Lastly, our empirical study also illustrates that the price adjustment behavior of retailers is affected by their shipping‐fee policies—for example, ZS retailers change their product prices almost 1.5 times more frequently than PS ones.