Show Me the Money: The Economic Impact of Membership-Based Free Shipping Programs on E-Tailers

Abstract

This research examines the economic impact of membership-based free shipping programs (MFS) when introduced as an augmentation to widely accepted contingent free shipping policies (CFS). Under CFS, consumers waive the shipping surcharge if the order exceeds a certain threshold, whereas, under MFS, consumers pay an upfront fee and enjoy the free-shipping perk throughout the membership period. We develop a stylized model that considers consumer heterogeneity in two dimensions: 1) disutility from acquiring an auxiliary product—a product that consumers would not otherwise purchase—to qualify for CFS, and 2) shopping frequency over a given period. Our analysis suggests that the introduction of MFS allows the e-tailer to segment the market further, which could lead to a higher product price. When the disutility from acquiring an auxiliary product is moderate, the e-tailer should charge a high membership fee to target only frequent shoppers who forgo CFS. However, the e-tailer should lower the fee to lure also: 1) frequent shoppers who would otherwise take CFS, when the disutility is high; or 2) infrequent shoppers who would otherwise forgo CFS, when the disutility is low. In all cases, while the collected fee revenue can never compensate for the costs arising from offering the free-shipping perk, the loss can be recouped as a desirable outcome of a more segmented market. Our research generates insights into the optimal design of e-tailers’ shipping policies, shedding light on the practical challenges that confront e-tailers.