Free Shipping Is Not Free: A Data-Driven Model to Design Free-Shipping Threshold Policies.

31 Pages Posted: 9 Oct 2018

See all articles by Gerard P Cachon

Gerard P Cachon

The Wharton School - Operations, Information and Decisions Department

Santiago Gallino

University of Pennsylvania - Operations, Information and Decisions Department

Joseph Xu

Tepper School of Business, Carnegie Mellon University

Date Written: September 17, 2018

Abstract

Online retailers often offer free shipping threshold policies: customers who purchase more than a threshold amount are not charged an additional fee for shipping. This paper provides a data-driven analytical model to (i) assess the profitability of a retailer’s current shipping threshold policy and (ii) identify the best freeshipping threshold policy for a retailer. The model is estimated from actual transaction and product return data. The model explicitly accounts for changes in customer shopping behavior due to a free shipping threshold, including strategically adding items to a shopping basket to receive free shipping, which we call orderpadding, and the subsequent adjustment in product return decisions. Roughly speaking, according to our model, a retailer that offers a free shipping threshold policy should set the threshold slightly abovethe average shopping basket amount. We calibrate our model to data from an online apparel retailer and determine that its decision to offer a lower free shipping threshold reduced its profitability considerably.This result is robust to a number of assumptions regarding the impact on long-run sales and possible price adjustments. We conclude that free shipping threshold policies are profitable only under a limited set of restrictive conditions.

Keywords: shipping fees, free shipping threshold, fulfillment policies, online retailing, empirical OM

Suggested Citation

Cachon, Gerard P and Gallino, Santiago and Xu, Joseph, Free Shipping Is Not Free: A Data-Driven Model to Design Free-Shipping Threshold Policies. (September 17, 2018). Available at SSRN: https://ssrn.com/abstract=3250971 or http://dx.doi.org/10.2139/ssrn.3250971

Gerard P Cachon

The Wharton School - Operations, Information and Decisions Department ( email )

Philadelphia, PA 19104
United States

Santiago Gallino (Contact Author)

University of Pennsylvania - Operations, Information and Decisions Department ( email )

3730 Walnut Street
558 & 559 Jon M. Huntsman Hall
Philadelphia, PA 19104-5340
United States

Joseph Xu

Tepper School of Business, Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

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