Design of Contingent Free Shipping Policy: The Role of Return Environment

Abstract

A contingent free shipping (CFS) policy offers free shipment of an order only if it satisfies a pre-specified threshold amount. Such a policy may induce customers to pad below-threshold orders to meet the threshold. On the one hand, such padded orders economize the retailer's logistics cost; on the other hand, it exposes the retailer to enhanced return costs as customers may engage in bubble purchases—orders with spuriously padded items that are later returned. A retailer designing the policy's terms—threshold and shipping fee—should attempt to balance these competing trade-offs. We study how the selection of these CFS terms is moderated by the retailer's returns policy and associated customers' ease-of-return experience.

We collaborate with a retailer who switched across multiple CFS policies over time. Our empirical strategy builds on the quasi-natural experiments induced by these switches, and location-based variation in the retailer's returns policy. We find, that in markets with a convenient ease-of-return process, customers pad 15.7% to 23.0% of below-threshold demand, and that 2.9% to 18.5% of these padded orders are bubble purchases. Interestingly, we find that, in markets with modest inconveniences in the returns process, the beneficial order padding is prevalent (13.2% to 20.3%); however, bubble purchases are altogether eliminated. Our counterfactual analysis illustrates that ignoring this moderating role of ease-of-return experience when selecting a CFS policy can result in selection of suboptimal terms, with a loss of 13.2% in profits.

Our study documents a novel determinant of optimal CFS terms: ease-of-return experience. To reflect its impact on the CFS policy’s embedded trade-offs, a manager shall apply the following counterintuitive adjustment; set lenient (resp. stringent) CFS terms when the customer return process is convenient (resp. inconvenient).

Keywords: Online Retail Operations, Contingent Free Shipping, Product Returns Policy, Shipping Threshold, Shipping Fee, Empirical OM, Causal Inference, Natural Experiment